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Words from the (Investment) Wise for the Week That Was (August 11 - 17, 2008): Part II

GaveKal: Chinese equities looking increasingly attractive
"After selling off -9.4% in the last two days of trading, and -60% since its peak last October 16th, the Shanghai Composite is now back to December 2006 levels (i.e. below 2500).

"How do we explain this? After all, we have been arguing that the main reason the Chinese equity bubble burst so long before the Olympics (the previously anticipated catalyst) was that commodity prices soared, which in turn squeezed margins, hampered domestic demand, raised political uncertainty and risk premiums, etc...

"So today, with oil and other commodity prices in determined decline, shouldn't Chinese equities be catching a break? We have come up with four potential explanations for the continued selloff: 1) foreign outflows; 2) continued inflation concerns; 3) excess inventories; and 4) disappointing government support.

"Needless to say, the continued selloff in Shanghai shares is concerning. However, since Chinese shares are now massively oversold and valuations are looking increasingly attractive, we are getting cautiously optimistic. And if commodities can continue to moderate, perhaps the most significant weight on Chinese equities will be lifted ..."

Source: GaveKal - Checking the Boxes, August 12, 2008.

GaveKal: Asia - tremendous buying opportunity
"... with a) Asian equities being very oversold, b) Asian central banks shifting their tune to easier policies, and c) valuations getting more attractive, this might be a good time to start nibbling on Asian assets. Indeed, this could end up being a tremendous buying opportunity."

Source: GaveKal - Checking the Boxes, August 13, 2008.

Vladimir Savov (Credit Suisse): Russian equities
"Russian equities have been excessively punished over the last couple of weeks, and even allowing for a higher risk premium and more normal oil prices, valuations look compelling, says Vladimir Savov, strategist at Credit Suisse.

"He notes the market has fallen to levels last seen in November 2006, but says there are material differences in the economy and valuations since then.

"'Russian GDP in 2006 was $986 billion, compared to our expectation for 2008 of $1,644 billion,' he says. 'The average oil price in 2006 was $66 a barrel, compared with $116 so far in 2008. In 2006, earnings growth was 39%, against our forecast of 51% for this year. A price/earnings ratio of 12.1 times in November 2006 compares to our estimate of 9.2x times for 2008.'

"Mr Savov says investors have taken too conservative a view on Russian market risk. He adds that while recent government actions to address pricing issues at Mechel have impacted on the mining sector in general, these measures should be positive for inflation and growth in the longer term. On the South Ossetia conflict, he says that fundamentally Russia's economy and infrastructure will not be affected.

"Mr Savov sees three catalysts for Russia to bounce. 'First, a lasting ceasefire, and ultimately, some long-term resolution of the South Ossetia issue; Second, a rebound in oil prices. Third, an outcome of the Mechel situation in which the company remains a going concern.'"

Source: Vladimir Savov, Credit Suisse (via Financial Times), August 11, 2008.

Bloomberg: Goldman reverses course, says dollar has "bottomed"
"Goldman Sachs Group reversed course on its dollar forecast, saying the greenback has 'bottomed' as global growth weakens, oil prices decline and the US trade balance improves.

"The US currency, after reaching a 5 1/2 month high of $1.48 per euro, will climb to $1.45 per euro in three months, analysts led by Thomas Stolper wrote in a research note. Goldman had forecast a decline to $1.56 for the same period. From today's 109.8 yen, the dollar will strengthen to 110 yen in three months, up from a previous forecast of 106.

"The dollar has gained 7.6 percent versus the euro since touching a record low in July as traders reduced bets that the European Central Bank will raise interest rates and crude oil tumbled.

"'The fundamental picture for the dollar has improved substantially in recent weeks,' Stolper wrote in the note."

Source: Ye Xie, Bloomberg, August 14, 2008.

Bill King (The King Report): US dollar an unattractive haven
"After over-levered dollar shorts/euro longs cover those positions much of the world will realize that the exploding US budget deficit and further financial system problems make the dollar an unattractive haven. So with the euro and pound no longer safe havens from the dollar, the yen and gold should rally.

"With international tensions reaching a new level of intensity and the global financial system still under historic duress, we'd guess that the dollar rally could continue but it is a temporary technical reaction.

"Soon the fundamentals, especially an already record US budget deficit that should greatly escalate, will re-emerge and instigate a very, very painful re-connection with economic and financial realities."

Source: Bill King, The King Report, August 11, 2008.

John Authers (Financial Times): Sterling breaking down

Click here for the full article.

Source: John Authers, Financial Times, August 13, 2008.

Eoin Treacy (Fullermoney): Harrowing time for precious metals
"For investors in precious metals this has been a harrowing time where portfolios have taken a beating. There are a range of arguments against this sector advancing, including a strong dollar, deleveraging in the commodity complex, demand destruction due to high prices and a negative platinum lead. However, we must not forget that acceleration is an ending signal and they cannot keep falling at this rate so there is cause for some optimism.

"Platinum's upside acceleration was a warning that we were on the cusp of a medium-term correction. However, the faster downward acceleration this week also indicates that we are swiftly approaching the lows for this reaction. At Fullermoney, we continue to believe that precious metals are in a long-term secular uptrend, but given the technical deterioration, investors will have to be patient before these metals can justify significantly higher levels. However, for investors unwilling to wait out the correction, this is probably a bad time to sell considering how overextended the market is right now. Patient, more risk tolerant investors may consider nibbling around current levels or more prudently wait for a clear upward dynamic which will signal that at least a short-term floor has been reached."

Source: Eoin Treacy, Fullermoney, August 15, 2008.

Ambrose Evans-Pritchard (Telegraph): Stage two of the gold bull market is just beginning
"A war breaks out in the Caucasus, pitting Russia against a close ally of the United States. Inflation reaches a new peak in the euro-zone. The CPI reaches the highest in Britain since Bank of England independence. Rampant inflation sweeps the developing world.

"Yet gold crashes. It has failed to deliver on its core promises as a safe-haven and inflation hedge, at least for now. Why?

"Four possible answers:

1) Nobody seriously believes that Russia will over-play its hand. The world could not care less about Georgia anyway. Ergo, this is a bogus geopolitical crisis.

2) The inflation story is vastly exaggerated in the OECD core of countries that still make up 60% of the global economy. The price of gold is already looking beyond the oil and food spike of early to mid 2008 (a lagging indicator of loose money two to three years ago) to the much more serious matter of debt-deflation that lies ahead.

3) The seven-year slide of the dollar is over as investors at last wake up to the reality that the global economy is falling off a cliff. Indeed, the US is the only G7 country that is not yet in or on the cusp recession. (It soon will be, but by then others will be prostrate). As an anti-dollar play, gold is finished for this cycle.

4) The entire commodity boom has hit the buffers. Looming world recession (growth below 3% on the IMF definition) trumps the supercycle for the time being.

"Gold has fallen from $1030 an ounce in February to $807 today in London trading. It has collapsed through key layers of technical support, triggering automatic stop-loss sales. The Goldman Sachs short-position that I have been observing with some curiosity has paid off.

"For gold bugs, the unthinkable has now happened. The metal has fallen through its 50-week moving average, the key support line that has held solid through the seven-year bull market. This week is not over yet, of course. If gold recovers enough in coming days, it could still close above the line.

"Well, my own view is that gold bugs should start looking very closely at something else: the implosion of Europe. (Japan is in recession too.)

"My guess is that political protest will mark the next phase of this drama. Almost half a million people have lost their jobs in Spain alone over the last year. At some point, the feeling of national impotence in the face of monetary rule from Frankfurt will erupt into popular fury. The ECB will swallow its pride and opt for a weak euro policy, or face its own destruction.

"What we are about to see is a race to the bottom by the world's major currencies as each tries to devalue against others in a beggar-thy-neighbour policy to shore up exports, or indeed simply because they have to cut rates frantically to stave off the consequences of debt-deleveraging and the risk of an outright slump.

"When that happens - if it is not already happening - it will become clear that the pillars of the global monetary system are unstable, infested with the dry rot of excess debt.

"Gold bugs, you ain't seen nothing yet. Gold at $800 looks like a bargain in the new world currency disorder."

Source: Ambrose Evans-Pritchard, Telegraph, August 12, 2008.

BCA Research: Gold - soon to find a floor
"Gold should soon find support, despite the setback in crude oil prices and a steadier dollar.

"Historically, precious metals are highly correlated with the dollar (negatively) and oil prices (positively). As the oil strength and dollar weakness of the past year unwind, gold has faced downward pressure.

"However, several factors suggest that gold should soon find support and begin to edge higher in both absolute terms and relative to oil. Specifically, the setback in crude prices will help to alleviate inflation angst at the major central banks. This, coupled with rising economic pressure on the ECB and BoE to abandon their hawkish stance may bring lower European real interest rates, which is bullish for gold by increasing the supply of fiat money.

"In addition, gold ETF demand is recovering after a brief pullback and our model indicates that the 'fair value' of gold is in the low $900/ounce zone and rising.

"Finally, gold tends to be less sensitive to a global economic slowdown than industrial metals or energy.

"Bottom line: Gold is likely to find support around $850/ounce and then edge higher. The gold/oil ratio should continue its oversold bounce over the next few months."

Source: BCA Research, August 12, 2008.

Frank Holmes (US Global Investors): Commodities are oversold
"Faced with slowing global growth, macro investors began dumping commodities and commodity-related stocks, with small- and mid-cap stocks hurt the most. This commodities sell-off, which began in July and has continued into August, also corresponds to the long-term seasonal cycle in which prices for many commodities tend to bottom out in late summer before rebounding in the fall.

"The unwinding of the long energy/short financials trade also has been a big driver of recent share price performance. The combination of rules to eliminate naked short selling on financial stocks, a backlash against higher commodity prices and potential government intervention aimed at speculators in the futures market, along with calls for pension funds to divest their commodity holdings, all converged in mid-July.

"We remain optimistic about the long-term picture for natural resources. However, the short term will remain volatile due to uncertainties in global currency exchange rates and future derivatives write-downs by investment banks and other financial institutions. We've seen that when the banks and brokerages have to raise capital to address their derivatives problems, it triggers abrupt liquidity squeezes that increase short-term volatility, especially in emerging markets and small-cap equities. The recent confrontation between Russia and Georgia has brought about heightened geopolitical tensions, which have contributed to volatility in currency markets and introduced significant uncertainty over the current world order.

"On a positive note, China announced last week that it was changing policy to increase loan quotas. This is a significant shift in policy; in effect, China is refocusing on economic growth now that inflation there has trended lower. This type of policy action will continue to drive infrastructure spending, which in turn will drive demand for commodities. Another positive is the clear election-year signal by the U.S. government that it will do what is necessary to protect the financial sector and avoid a major recession, including an additional fiscal stimulus package in early 2009.

"We believe this correction, while painful, is healthy and constructive for natural resource markets over the long term. Commodity supplies remain extremely tight, and as global population and emerging economies continue to grow, these trends will be supportive of commodity prices. The risk to this scenario would be major policy changes by the world's most populous countries that would slow infrastructure spending, which we continue to view as unlikely."

Source: Frank Holmes, US Global Investors - Weekly Investor Alert, August 15, 2008.

Ifo: Eurozone economic climate indicator falls further
"The Ifo Economic Climate in the euro area has worsened again in the third quarter of 2008 for the fourth time in succession. The decline in the Ifo indicator is both the result of less positive assessments of the current economic situation as well as clearly more pessimistic expectations for the coming six months.

"The economic climate has further clouded over in nearly all countries of the euro area in the third quarter of 2008. Particularly negative assessments of the current economic situation have come from Italy, Spain, Portugal, Ireland and Belgium. Favourable assessments of the current situation continue to come from Finland, Austria, Germany and the Netherlands, however. In the opinion of the World Economic Survey (WES) experts, the slowing in economic activity will continue in all countries of the euro area in the coming six months.

"At 3.6%, the inflation expectations exceed the ECB target even more so than at the beginning of the year (2.5%). In contrast to the previous survey, the WES experts anticipate an increase in key lending rates in the course of the come six months.

"The US dollar is assessed as undervalued vis-à-vis the euro. In the coming six months, a slight strengthening of the US dollar is expected. Also the Japanese yen and the British pound are seen as undervalued vis-à-vis the euro."

Click here for the full report.

Source: Ifo, August 13, 2008.

James Pressler (Northern Trust): Eurozone economy contracted in Q2
"The three largest Eurozone economies all contracted last quarter, with the largest (Germany) posting a drop of 0.5%, compared with 0.3% for France and Italy. Germany's abnormally-strong Q1 performance (+1.3% from Q4) raised concerns that the growth was largely borrowed from Q2, which would imply an even more precipitous fall, but for the most part this failed to emerge. Nevertheless, these powerhouse countries are now one quarter away from a technical recession, and likely to be followed by other 'zone members before long."

Source: James Pressler, Northern Trust - Daily Global Commentary, August 14, 2008.

James Pressler (Northern Trust): Eurozone economies seeing price acceleration
"... inflation remains just as much a problem as ever, with July inflation for the Eurozone touching 4.1% last month and the main economies still exhibiting some price acceleration. This completes the stagflation scenario that the European Central Bank (ECB) has increasingly recognized over the past few months, and now the central bank is in a bind.

"Today's Eurostat report offers the ECB a chance to hold monetary policy for the near-term - recognizing that growth has slowed considerably but the slowdown appears contained given current interest rates. If the recent fall in oil prices translates into less-threatening CPI figures in the coming months, the ECB will have every justification in focusing its attention on the weak economy with an eye toward easing if necessary."

Source: James Pressler, Northern Trust - Daily Global Commentary, August 14, 2008.

Edmund Conway (Telegraph): Mervyn King issues warning on UK economy
"The economy is now on the verge of recession, the Bank of England has warned for the first time. In his gravest assessment yet, Governor Mervyn King said the economy will start to shrink by the end of the year, the first decline since the early 1990s.

"He warned that households face an 'extremely difficult' year ahead as Britain is hit by rising energy and oil prices and the worst financial crisis 'since the Second World War'.

"Setting out a gloomy diagnosis of the problems facing families, Mr King also warned that:

• Inflation will rise to 5% or above - the highest level in 16 years - ruling out an immediate cut in interest rates.

• House prices will continue to fall in the coming months, despite already suffering the biggest drops in recorded history.

• Thousands more workers will lose their jobs as struggling firms cut back on staff.

"Mr King slashed his forecast for the UK's growth, acknowledging that by the end of this year the economy will be shrinking rather than expanding.

"This last happened in 1992, when Britain was in the midst of a major recession. The Governor added that a technical recession - defined as the economy shrinking for two successive quarters - was more than possible.

"'It is bound to be the case there will be a quarter or two of negative growth,' he said. 'Oil prices are at the highest level in real terms at any point in the post-war period apart from the late 1970s, and we've also seen the biggest financial dislocation since the Second World War.

"'What is unique about the present set of circumstances is that both shocks have happened at the same time, and the combination has meant that life is extremely difficult, and will be for the UK economy over the next year.'"

Source: Edmund Conway, Telegraph, August 13, 2008.

Financial Times: Alert as Japanese economy contracts
"Advanced economies received a wake-up call on Wednesday that none were immune to the effects of the credit crisis stalking financial sectors on both sides of the Atlantic.

"In Japan, new data showed the world's second largest economy contracted by 0.6% in the second quarter, its worst quarterly performance for seven years.

"The quarterly decline makes Japan the biggest economy yet to experience economic contraction this year."

Source: Chris Giles, Financial Times, August 13, 2008.

Bloomberg: Nomura's Koo says Japan may already be in recession
Richard Koo, chief economist at Nomura Research Institute, talked with Bloomberg about the outlook for the Japanese economy, the US subprime credit crisis, and prospects for the Japanese government after the cabinet reshuffle.

Source: Bloomberg, August 11, 2008.

Financial Times: China to overtake US as largest manufacturer
"China is set to overtake the US next year as the world's largest producer of manufactured goods, four years earlier than expected, as a result of the rapidly weakening US economy.

"The great leap is revealed in forecasts for the Financial Times by Global Insight, a US economics consultancy. According to the estimates, next year China will account for 17% of manufacturing value-added output of $11,783 billion and the US will make 16%.

"Last year the US was still easily in the top slot and accounted for a fifth of the total. China was second with 13.2%.

"John Engler, president of the National Association of Manufacturers, a Washington-based trade group, played down the effect of the projections. It was 'inevitable' that China would take over on account of its size, he said. 'This should be a wholesome development for the US, for it promises both political stability for the world's largest country and continuing opportunities for the US to export to, and invest in, the world's fastest-growing economy.'"

"The expected change will end more than a 100 years of US dominance. It returns China to a position it occupied, according to economic historians, for some 1,800 years up to about 1840, when Britain became the world's biggest manufacturer after its Industrial Revolution."

Source: Peter Marsh, Financial Times, August 10, 2008.

Forbes: China's July wholesale prices up 10%
"China's wholesale inflation in July accelerated to its highest rate in 12 years, adding to the government's headaches as it tries to rein in surging consumer prices, according to data reported Monday.

"The producer price index was up 10% in July over the same month last year, the highest rate since 1996, the Xinhua News Agency said, citing the government's statistics bureau. The index measures the price of goods as they leave the factory.

"Analysts have warned that rising costs for energy and raw materials would push up Chinese wholesale prices, squeezing thin profit margins for companies and adding to pressure for retailers to raise consumer prices.

"The July rise in the producer price index, or PPI, exceeded analysts' expectations and was a sharp jump over June's 8.8% rate."

Source; Joe McDonald, Forbes, August 11, 2008.

Bloomberg: India inflation accelerates to 16-year high of 12.44%
"India's inflation soared to a 16-year high and may accelerate further after the government approved wage increases for civil servants.

"Wholesale prices rose 12.44% in the week to August 2, after increasing 12.01% in the previous week, the commerce ministry said in New Delhi today. Economists were expecting a 12.2% gain.

"Prime Minister Manmohan Singh's cabinet today approved an average 21% salary increase for about 5 million government employees. That may give the central bank little choice other than to raise interest rates again after three increases since June, economists said.

"'We expect inflation to remain elevated and reach 13.5% by December,' said Indranil Pan, chief economist at Kotak Mahindra Bank Ltd. in Mumbai. 'We are looking at a 50 basis point increase for both the repurchase rate and the cash- reserve ratio by year-end.'

"The Reserve Bank of India last month raised its benchmark rate by a half point to a seven-year high of 9%."

Source: Kartik Goyal, Bloomberg, August 14, 2008.

Bloomberg: Argentina's debt rating cut by Standard & Poor's
"Argentina's foreign debt rating was cut by Standard & Poor's on concern slowing economic growth will crimp tax revenue while mounting investor mistrust in inflation data erodes confidence in the government.

"S&P lowered Argentina's rating to B, five levels below investment grade and in line with countries including Jamaica and Paraguay, from B+.

"Argentina faces 'increasing economic challenges,' S&P analyst Sebastian Briozzo wrote in a statement. 'Inflation and fiscal and financial strain have increased while the likelihood of the government taking prompt corrective measures to staunch the loss of creditworthiness remains low.'

"Argentine bonds tumbled last week after President Cristina Fernandez de Kirchner defended the government's inflation data. While government data puts annual inflation at 9.1%, S&P said 'private estimates suggest that it might actually be about 24% to 28%'."

Source: Drew Benson, Bloomberg, August 11, 2008.

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