What nervous investors should do now

18.10.2007

by Merryn Somerset Webb

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Here’s a question doing the rounds of the market. What’s worse? Is it a situation in which a pile of over valued tech stocks collapse, a group of smug twenty somethings lose their jobs and a few quite interesting if well forecast scandals follow? Or is it a situation in which the price largest asset owned by most individuals is bid up to an insanely unaffordable level by a massive credit bubble which then collapses leaving a trail of debt and imploding consumer confidence in its wake?

I think most of us would probably choose the latter. Which begs the question as to why so many market participants think that the half a percentage cut in US rates is enough to make the fall out from the credit crunch ok: most markets have soared since with the MSCI Emerging Markets Index and the MSCI All Country Asia ex Japan Index both back at all time highs. This makes no sense. In the aftermath of the tech crash of 2000 the Fed cut interest rates on 13 separate occasions from 6% right down to 1%. They cut almost every month in 2001, once in 2002 and once in 2003. Rates didn’t start rising again until 2004.

The Fed can’t exactly act more dramatically this time, despite the fact that – as I think we can all agree – the sub price crisis is far worse than the dot com crisis ever was. In fact, however much they will want to, they might not even be able to act as dramatically. Why? Because in 2000 there was no obvious inflation risk. Commodity prices were still low and the rise and rise of the Chinese manufacturing sector was having a convenient deflationary effect on developed world prices.

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Today neither of those things are true. Commodity prices – oil prices and food prices in particular – are rising fast and there are signs that rising wages and standards in China have called a halt to the falling price of manufactured goods. So aggressive cutting by the Fed not only won’t solve the basic problem of the credit crunch (that it risks being the straw that breaks the back of US consumer spending – the spending that makes up 70% of GDP) but is also likely to create more problems. Think fast rising inflation and an ongoing dollar collapse for starters.

So what are nervous investors to do? What the real bears (me included) have been doing for a good few years. Buy gold. It has just hit a 27 year high but given its historical position as the greatest of hedges against inflation and the fact that its fundamentals look very good (there’s not much supply but demand is rising fast) my money is on it continuing to rise for some time. I’ve been holding gold in my pension since 2002. I bought it around the same time as a hedge fund manager friend of mine told me that it was an idiotic thing to think of as an investment. So much for the endless cleverness of hedge fund managers. Right now he’s looking for a job and I’m looking forward to a very luxurious retirement.

First published in The Evening Standard