Is bird flu the next financial hurricane?

The possible bird flu pandemic is a phenomenon that investors should start to seriously contemplate. There are two levels of concern to study.

First, there is the likelihood that the actual outbreak of bird flu is limited, like SARS, but it results in significant disruption to business. For example, in Hong Kong SARS decimated local tourism and crippled the domestic economy for a number of months.

Imagine if this impact were replicated in several key global cities simultaneously due to bird flu. There would be something of a panic by the public, nobody would want to fly anywhere, and non-essential business sectors would face a collapse in demand.

As in the case of Hong Kong with SARS equities and real estate would come under pressure from an investment perspective and money would flow to cash, bonds and precious metals.

Economic Armageddon

The second, Armageddon prognosis is for a really deadly outbreak of the flu as a major pandemic. Flu pandemics have taken place several times in the past couple of centuries, killing millions of people.

This is clearly a stage beyond the SARS scare, the reality of a pandemic rather than the fear of one. In the event of a major bird flu pandemic, the effects of scenario one would be magnified with a serious break-down in certain supply chains and inflation of prices, a depression in tourism and transport sectors and a risk of major economic instability with systemic risk to financial markets.

In such a grim scenario, money would flow into precious metals and other perceived havens of safety such as treasury bonds, particularly inflation-protected bonds.

But equity markets and real estate would likely collapse in the face of sharply falling company profits and reduced demand. Commodities whose supply chain was interrupted would surge in price but overall deflation of commodities would prevail due to a collapse in demand.

Prudent hedging

Investors should not panic and assume the worst. But it would seem prudent to take a cautious view of the future and to plan for economic survival under all circumstances.

Thus a diversification into the safest investment options would appear a sensible option, so that if the worst happened then at least part of an investment portfolio would surge in value therefore compensating for falling equity and real estate investments.

The gold price is to some extent an index of fear, and the recent 18-year high of $482 an ounce suggests that some investors are getting nervous and wanting to spread their risk. Interestingly much of the gold buying is coming from Asia and the Middle East while Western investors appear less convinced about the need to diversify.

Another reason for such diversification is the growing divergence between the strength of the global financial community and the weakness of the outlook for global growth in the face of higher oil prices and inflation. This looks like a far more predictable accident waiting to happen than the bird flu.

However, any prudent portfolio ought to include some doomsday assets, just in case the worst happens and like the residents of New Orleans you suddenly find yourself under water.