DABERIAM XXXII

July 2007

Mid-July and the beginning of the silly season, when we expect an increase of volatility in the markets, i.e. small amounts of news producing disproportionate effects. Volatility also seems to be being exacerbated by the enormous increase in computer programme trading and the huge amounts of money flowing across the main exchanges but also probably more importantly into the burgeoning derivative exchanges, that are driven by enormously complex algorithms that take advantage of minute movements. Many of the trades made by these complex beasts last for fractions of a second and try and trap movements that are measured by the number of noughts after the decimal point. It should be a fun, if that is the right word, few months.

Underneath the froth, the inexorable upward trend in interest rates around the world, with the possible exception of America, will continue to stress the economic system. While world liquidity generated by the shift of resources to the Middle East and Asia is funding some market excesses, the re-rating of debt instruments by Moody’s and others, is likely to destroy enormous amounts of value held by institutions that have bought sub-prime debts and other instruments constructed on its back. Moves by the rating agencies that I anticipated in January have now become a subject of journalistic debate. The danger here is that large financial institutions will start to unload some of the paper they are holding as their finance departments start to consider their year-end reporting requirements. This will create problems in market liquidity as we approach the year-end. 

Markets will also be unsettled as the retail and house-building sectors feel the effects of a reduction in consumer expenditure as higher costs of fuel, food and interest take a larger share of the consumer’s budget. The increase in prices of Chinese sourced retail products will also affect consumer consumption, or retail profits if the prices aren’t passed on.

Asian growth is inexorably driving up prices of all commodities where the shortage of supply in virtually all areas will take five to ten years to correct. The volatility in individual prices created by financial institutions trading the commodities and their derivatives, will continue to produce very confusing signals.

In the oil and gas market volatility is being exacerbated by the activities of Mr Putin in Russia who has effectively taken control of European gas supplies, and governments from Nigeria to Venezuela, who are disrupting supply for various reasons. While these are relatively recent phenomena, the response by the governments of the US and Europe to the long predicted decline in the easily accessible oil and gas prices has been effectively zero.

Political smoke screens and by vested interests that are confusing the ‘green’ movements mean that government policy is not addressing the potentially very serious economic consequences of major disruptions to our fuel supplies in the relatively near future – within the next five years. One can only conclude after careful examination of the various options that strategic security (the business of government?) can only be met by nuclear energy fission in the short term, and possibly fusion in the longer term. Both options are being delayed by lack of government policy. It is interesting to note that, with the exception of the senior members of the Chinese Government, there is almost a total lack in Europe and America of qualified scientists or engineers in the upper echelons of government. 

These observations are likely to produce markets, which are polarised between increase in profitability in sectors relating to commodity production, engineering and infrastructure building, or in many areas re-building, while markets are likely to sag in the financial sectors and the retail areas. Economic imbalances are self-correcting and the optimistic view that one can hold in this globally connected, technology driven world, is that the correction will not be violent as knowledge and information is so widely available. While changes in trend will tend to be smoother, because of globalisation, short-term volatility could easily be exacerbated by the same technology.

Damon de Laszlo 
July 2007