Sovereign wealth funds play it cool

Last year GCC foreign acquisitions grew threefold to $89bn, according to banking analysis and systems firm Dealogic.

Compare this with first quarter results which showed foreign buys down by 30% to $20bn. Given the high oil price and record revenue flows these figures reflect an aversion to risk and a shift into cash, despite the twin evils of US dollar devaluation and inflation running at multi-year highs.

This will not help in rebalancing the world economy. The financial health of consumer nations depends on the recycling of petrodollars from oil producing countries. If this does not happen, trade deficits get bigger.

However, most cash placed on deposit in GCC central banks ends up purchasing US treasuries so that does redress the balance somewhat. But recent interest rate cuts have made US treasuries less attractive and diversification into other currency holdings is probably happening at a greater pace than generally acknowledged, helping to further account for the weakening dollar.

This is also seen in a shift by Gulf countries towards buying Asian assets, although at $2.4bn in the first quarter this remains a far less important destination for GCC investment than the US and Europe.

Oil revenues

Oil remains a remarkable tax on consumer countries in favour of producers, and this tax will grow this year. The US Energy Information Administration forecasts OPEC oil revenues will grow from $676bn to $980bn in 2008.

Wall Street optimists hope that all this available liquidity is going to burn a hole in the bottom of the pockets of sovereign wealth funds and that they will not be able to resist diving back into cheaper stock markets this autumn.

US election

Indeed, there is logic in expecting some sort of a rally in a US presidential election. The problem now, however, is that US house prices are not expected to bottom out until the middle of 2009 at the earliest, and that will propel the financial sector into a further deterioration. Therefore, playing it cool and waiting for renewed stock market weakness in 2009 could be a wise decision.

Certainly with a new administration taking over in Washington amid a continuing housing slump there is scope for just the sort of uncertainty that really spooks stock markets.

More cynically, in the US election cycle the first year is a good time to get bad news out of the way, ensuring that things can only get better thereafter.

Defensive positioning by sovereign wealth funds is therefore understandable, and that will likely mean another assault on $1,000 an ounce for gold, but sideways trading may otherwise be the watchword for 2008.

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