Why GCC investors should fear a US crash and buy gold!

You only have to look at the $1 billion pay checks for hedge fund managers to know that this manipulation of global financial markets using massive leverage just has to end in tears. These unregulated funds may shortly produce the equivalent of a massive secondary banking crisis with their high-risk borrowing activities.

Only last week the International Monetary Fund warned that the private equity sector was also facing a crunch. What happens when stock markets drop leaving private equity funds with overvalued and overleveraged positions in major corporations?

For the trigger to start a major crisis we need only look across the Atlantic to the housing downturn sweeping across the US mainland. Here we see individual borrowers handing back the keys on homes that they should never have been allowed to own in the first place.

HSBC already hit

This cost the giant bank HSBC a $10 billion charge against 2006 profits, wiping out most of the expected increase in profits that year. But commentators should be asking who is next, not pretending that we can continue with business as usual. For if HSBC can get the US markets wrong, what hope for the rest of us?

Sixty per cent of the US public expects a recession in the near future, according to opinion polls. Surely this bearish mood alone ought to be enough to pop complacent stock markets that have just recovered from their bout of nerves at the end of February.

The truth is that the US stock market has formed a 'double top' in the terms of chartists and will now push into a far more dramatic bear market downturn. What is to support it? What is the outlook for profits in a recession? Do you need more than one brain cell to make the connection between falling profits and stock prices?

In this environment the leverage that has fuelled the market recovery, with carry trade borrowing and the sundry other leverage techniques of the hedge funds and private equity whiz kids, will now act in reverse and deepen the downturn.

US rates to fall

Of course, the Federal Reserve would have to respond to such a crisis with lower interest rates, and rates are at a level from which a substantial cut can be made. But like the dot-com crash of the early 2000s, which was also followed by ultra low rates, this will not be enough to save many of the actors on this particular stage.

The US dollar would first rally on a big downturn as markets sold off and then resume its long-term decline as the reality of a likely long period of very low interest rates dawned.

In this scenario the only major asset class which would show strength, apart from long-dated bonds, would be precious metals as flooding the capital markets with liquidity would produce inflation and that money would flow into a very tight market for gold and silver; low interest rates would also make the nil return on gold look more acceptable.

In the GCC stock markets will shortly face the reality of a real estate correction and this coming US recession will impact the oil price to the detriment of government revenues and might end with local banking crises. Thus these bourses have yet to hit a bottom in this cycle.

Again local investors will probably turn to the safe haven of gold and silver, particularly if the US dollar looks like taking a further dive downwards. Next week Dubai hosts the fifth City of Gold conference and with gold trading picking up strongly at the Dubai Gold and Commodities Exchange this emirate is again positioning itself to capture a major global trend.