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The Henley Group

For more information, please contact:Martin W. Hennecke, Chief EconomistT: +852 2824 1083 E: mwh@thehenleygroup.com.hk

Down butnot out?

“In investing, what is comfortable is rarely profitable.”

Robert D. Arnott, American entrepreneur, investor, editor and writer

Down but not out - is gold staging a comeback? Precious metals have seen a notable rebound over the past two months supported especially by China which imported a record amount of gold through Hong Kong during 2013 (1,139 tonnes to be precise), although obviously we are still a long way off the highs reached in 2011.

Recent developments in Europe could soon be lending further support for a continued price recovery of the sector as well, given the rising concerns about the safety of bank deposits following the publication of an EU report last month suggesting that “the savings of the European Union’s 500 million citizens could be used to … help plug the gap left by banks since the financial crisis”, according to Reuters.

Continued…

The Henley Group | Global Overview March 2014

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At the same time, when we look at current market valuations, it so happens that exactly those three countries that fare best in the emerging markets vulnerability comparison also happen to be the most attractively valued markets among both emerging and developed countries globally. Accordingly, investors may be best advised to actually take advantage of the recent sell-off by carefully evaluating the risks and opportunities prevalent in the different markets, and accumulating positions in those areas supported by strong fundamentals on the one hand and outstandingly attractive prices/valuations on the other.

Of course though, positions in emerging markets also come with various risks and relatively high volatility, hence such investments would only be recommended for a medium-to-longer-term time period, as part of a diversified portfolio and without the use of leverage.

Martin W. Hennecke Group Chief Economist

Meanwhile, France’s fiscal position is worsening amid a 77% drop in foreign direct investment during 2013, while unemployment reached a new all-time high, all of which should not be surprising in a country with a 75% high-end tax bracket. (In the middle ages farmers used to revolt if they had to give “only” half of their harvest to the state). Hence a return to crisis including possible political instabilities may well be on the cards for Europe, presumably going hand in hand with the necessity of a vast increase of inflationary bailout policies.

And talking about political instabilities, another major event during the past month has been the turmoil in Ukraine, following in the footsteps of a general emerging markets scare during January.

What should be kept in mind in this regard though, first of all, is that not all emerging markets are equal, and during the past 17 years (following the Asian financial crisis of 1997) some of them have developed into major economic powerhouses, with huge manufacturing and/or asset bases to fall back onto, coupled with enormous pools of foreign exchange reserve holdings. No longer could these be knocked off balance easily by a shortage of “hard currency” cash reserves. Moreover, some of these markets also clearly are not overvalued now, which often is the prerequisite for a major market drop, and instead appear significantly underpriced.

Among the key factors determining external vulnerability of emerging market countries to a financial crisis/financial shock are the measures of current account balance and foreign exchange reserves versus short-term external debt. When we review these factors we find that Turkey was/is indeed a vulnerable candidate owing to a current account deficit of -7.3% and a low foreign exchange reserves to external short-term debt ratio, while South Africa, India and Indonesia look a bit better but still relatively weak as well. On the other hand South Korea, Russia and China stand out as having both a positive current account and a healthier foreign exchange reserves to short-term external debt position.

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