US federal funds rate at 4%, what does this mean for investors?

This column's bearish outlook at the beginning of 2005 now looks more than vindicated, although the jury is still out on whether GCC stocks will end on a high note or suffer another correction like the 30% fall in July. But this is all now in the past, or soon will be, and the tricky thing is to look forward.

Earlier this year we could only get optimistic about gold and oil - a position that has been proven correct by events. Both are additionally priced in US dollars which also gained ground, contrary to our expectations - although to the benefit of gold and oil anyway.

Looking into the future the US economic outlook seems to lag the UK by about 12 months. US house prices are starting to show signs of weakness, and with mortgage rates now picking up, a further slowdown looks inevitable. This will impact on the over-borrowed US consumer who is already reeling under the weight of higher energy costs.

GM, Ford sales collapse

The 23% collapse in sales at Ford and General Motors in October do not look a harbinger of economic health either. A US recession later next year is quite probable, and presumably that will be preceded by some kind of a financial market crunch too. So US equities do not look the place to stash your cash, and equally bond prices are now coming under pressure from higher US interest rates.

Perhaps the rally in the US dollar will now continue for a while but the twin deficits of the US economy still point to longer term dollar weakness. The slowdown in US economic activity will also gradually impact on world trade, and the fall off in demand for energy seen recently as a consequence could pull back oil prices.

On the other hand, the oil price story was very similar a year ago. Everyone thought the bull-run might be coming to an end, and prices have shot up since then by 40%. Indeed, crude oil has been the best performing investment class by far for 2005. Will oil surprise us again in 2006? Well, we should not be so surprised if it does!

The supply and demand situation for the world's most important commodity looks decidedly problematic. Oil fields are old, not a single major find has been made in 20 years and refinery capacity is ageing and insufficient to meet booming demand from places like India and China whose large populations want to consume energy like other countries.

Gold still hot

Gold is often perceived as both a proxy for oil and a hedge against inflation. In this environment then gold ought to perform well as an asset of choice, if only because so many of the 'normal' investment options - equities, bonds and property - do not look very inspiring in a period of stagflation, that is low growth with higher inflation.

The US dollar and cash deposits are a bit of a wild card. A recession might result in a US dollar rally because a recession would reduce the trade deficit and correct this imbalance. On the other hand, investors might flee the US in a panic and let the dollar collapse.

In either of these scenarios gold is a neat two-way play. It is priced in dollars and would rise in value with the US dollar, and also surge in value as an alternative investment if the US dollar were to get into trouble. And some people wonder why gold is rising in value!