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And what have we seen recently? First, the doubling of Japanese interest rates that has caused the winding down of the yen carry trade that was supporting global liquidity. Then a stock market crash in Shanghai spreading to other global bourses. Even the gold price has weakened as Dr. Faber suggested, though the US dollar has yet to strengthen in a sell-off but we should wait and see what happens this week.
More worrying perhaps is the deterioration of economic fundamentals, which Dr. Faber has mentioned on many occasions, but has now reached a critical point.
Global downtrend
Whether we look at the 17 per cent fall in new US home sales in January, or the 10 per cent collapse in German retail sales that month, conditions in the real global economy are getting worse. Even former Federal Reserve chairman Alan Greenspan warned that a US recession was possible last week.
Against this background a bearish trend in global asset markets looks inevitable. How quickly this action is played out is always hard to predict, and even Dr. Faber avoids trying to be too precise on market timing.
But asset market corrections tend to be much swifter on the downside than on the upside, so given last week's events it would be reasonable to assume that most of the bad news may be in the market by this summer, or autumn at the latest.
A lot will depend on how the authorities in the industrialised countries respond. The European Central Bank looks likely to raise interest rates this week, about the most foolish thing possible after those German retail figures. But Dr. Faber thinks the US will choose the option of lower interest rates to support its economy rather than flush out inflation with higher rates.
Precious metal uplift
That will mean that any short-term rally in the US dollar from asset sell-offs will be replaced by longer term dollar weakness. This will boost precious metal prices as a hedge against inflation and negative real interest rates. But equities do not generally perform well in an inflationary environment, and real estate would probably fall in real as opposed to nominal value.
In such an economic slowdown or outright recession the oil price is likely to drop considerably which will impact on liquidity in the Middle East. We have already seen stock market crashes, so further weakness in regional equities may not be that big, but a real estate correction is definitely on the cards.
Therefore cash and precious metals probably remain the only safe investments, with a switch from cash to precious metals after the present asset sell-off is complete the most likely clever market play for 2007. Local stocks could also bottom out then.
Peter J. Cooper
