From a state of mass hysteria to euphemism, financial markets across the world have seen it all in just one calendar year. Doomsday forecasts flooded investors inboxes with some predictions getting close to economic ice age to some a little less dramatic. Now, only a year later, things look somewhat different. The financial system has started to heal, growth has started to normalise, and asset prices have followed suit, discounting a less dismal outcome for the global economy and markets overall.
The question remains whether it will feel like the ?same old normal? going forward or whether we are at the dawn of a new age in financial history. It?ll be foolhardy to predict but?educated guestimates blended with tell-tale signs demystifies the cloud over the horizon. This ?year of deliberation?, as I?d like to call it, follows the ?year of hope? of 2009.
Economics
Developed economies have started showing signs of economic revival. Recent GDP numbers showed more solid growth momentum, with the major emerging markets, in particular Asia, remaining in the lead.
India?s growth trend is significantly influenced by capital inflows. Unlike in some other Asian countries, India?s macro economy is more dependent on capital market funding. 2009 saw close to $20 billion being pumped in, a lot of it being attributed to the, ?dollar carry trade?. Capital inflows rising sharply going ahead would produce significant challenges for policymakers.
First, it would make it difficult for the RBI to lift the cost of capital and restrain domestic demand, thereby increasing the chances of overheating and producing inflation risks. Second, it would likely raise asset bubble risks, something which RBI is clearly wary of. The balancing act between inflation and growth would lay the foundation on which 2010 would hinge.
Gold
As the price of gold has pulled back from its recent run up to $1,200, many investors are left to ponder what exactly drives the movement of such an important and financially sensitive commodity. Most people are aware that gold prices respond to inflation expectations and that of central banks, as the largest holders of gold, are big players in the market. The penchant for buying gold and thereby de-risking the falling value of US treasury paper saw the gold hit a 20-year high. The inverse relationship between gold and dollar is a well documented fact. In a scenario of low interest rates, atleast in the first half of 2010, there is enough steam left in the up move for gold. As long as the global economy is transmitting mixed signals, gold stands to benefit as an uncertainty hedge and a store of value. How long the price is in the $1,100 range or higher remains to be seen, but this unusual convergence of factors creates favorable conditions for gold investors
Dollar
Within the next 12 months, the US Treasury will have to refinance $2 trillion in short-term debt?the effect of quantitative easing post-Lehman. And that?s not counting any additional deficit spending, which is estimated to be around $1.5 trillion. The US holds gold, oil, and foreign currency in reserve. It has 8,133.5 tonne of gold (source: US Treasury). At current dollar values, it?s worth around $300 billion. The US strategic petroleum reserve shows a current total position of 725 million barrels.
At current dollar prices, that?s roughly $58 billion worth of oil. And according to the IMF, the US has $136 billion in foreign currency reserves. So altogether that?s around $500 billion of reserves. According to the US Treasury, $2 trillion worth of debt will mature in the next 12 months. Given that 44% of this debt is held by nations across the world the revenues aren?t enough to cover the debt. It is unlikely that emerging markets led by China (which hold nearly 36% of US treasury papers) would be queuing up to buy any further issuances by the treasury. Moreover, given the fondness of central banks to de-risk itself by buying gold puts a huge question mark on the likely source of funding for the US. This leaves the Fed with no choice but to print more bills thereby weakening the dollar.
?The writer is a derivatives analyst