Monthly Market Outlook and Global Financial Repression Risks

Monthly Market Outlook
August 2012
As the enormity of the LIBOR-manipulation scandal begins to unfold,
it is tempting to hope that the non-existence of the gold allegedly
backing the hyper-leveraged, unallocated “paper” gold schemes –
and even some allocated schemes – will be the next scandal to hit
the banksters. The banks can’t create bullion out of thin air, unlike
paper currencies. If word got out, the naked shorts would be taken
to the cleaners – hanged or folded?!

The Henley Outlook
August 2012
THE WEALTH MANAGEMENT PROFESSIONALS

The Henley Outlook
August 2012

Overview

ASSET CLASS HOUSE VIEW REMARKS

Fixed Income Investment Grade

High Yield
Student accommodation only
Property

High dividend stocks preferred
Equities US

Japan

UK

Europe Ex UK

Australia

ASEAN
Broad equity exposure
Greater China including the region preferred

India

Other Emerging Markets

Commodities Energy

Precious Metals

Industrial Metals

Agriculture
Selective strategies only
Alternative Investments

Key: Positive Neutral Negative

The Henley Group Limited The Henley Outlook: 2
An SFC Licensed investment advisor in Hong Kong Hong Kong, Singapore & Shanghai
Suite 2004-08, 20/F, St George’s Building, 2 Ice House Street, Central, Hong Kong
info@thehenleygroup.com.hk www.thehenleygroup.com.hk

The Henley Outlook
August 2012

Global Overview
As the enormity of the LIBOR-manipulation scandal begins to unfold, it is tempting
to hope that the non-existence of the gold allegedly backing the hyper-leveraged,
unallocated “paper” gold schemes – and even some allocated schemes – will be
the next scandal to hit the banksters. The banks cannot create bullion out of thin
air, unlike paper currencies. If word got out, the naked shorts would be taken to
the cleaners – hanged or folded?!

After range-bound trading for nearly a year, twelve-month returns on gold bullion
turned negative in July for the first time in years. Silver – gold on steroids – has
been down for some months. We are always testing and questioning the asset
allocations in our portfolios, and I wanted to share with you some of our reasons
for remaining wedded to the monetary metals:

1. Financial repression, a term used to describe several measures employed by
governments to channel funds to themselves, which, in a deregulated market,
would go elsewhere. In the current environment, it means negative real interest
rates – and even negative nominal interest rates now (!) – and a bond bubble,
achieved through market interventions/manipulations (for example: Fed funds rate, quantitative easing, Operation
Twist, Plunge Protection Team et al). Negative real interest rates are the perfect environment for gold. Kevin Warsh,
after his retirement from the Board of the US Federal Reserve last year, revealed that central banks are now so heavily
influencing asset prices that investors are unable to ascertain market value. Hear, hear.
2. Central banks have started buying gold again after a thirteen-year interlude. Asian central banks in particular,
notably those of China, Russia and India, are buying unusually large quantities of gold (and silver) bullion in what is
perhaps the most physical manifestation of the shift in the balance of power from West to East.
3. Re-monetisation of gold. It is proposed that, on 1st January 2013, banks will be able to classify gold on their balance
sheets as risk-free capital, instead of giving it the 50% haircut under current rules. This should cause a significant
increase in demand for bullion.
4. Supply and demand. Annual mine production (about 2600 tonnes) is relatively unimportant to the price. Almost
every ounce of gold ever mined is still available for sale at the right price. In that sense, the supply is always high, and
the decision not to sell at current prices is as important to the price as the decision to buy. For the time being there
are more buyers than sellers, but this is masked by the paper games being played in the derivatives markets, which
are setting, instead of discovering, prices. The tail is wagging the dog. For the time being.
5. Insurance against the risk of hyperinflation/hyperdevaluation. Paper money only has a value because its users are
confident that the money can be exchanged for a certain quantity of goods or services in the future. If this confidence
is eroded, hyperinflation becomes a threat.

If holders of cash start to question the future purchasing power of the currency and switch into real assets, asset prices
start to rise and the purchasing power of money starts to fall. Other cash holders may notice the falling purchasing
power of their money and join the exit from paper into real assets. When this self-reinforcing cycle turns into a panic,
hyperinflation arrives.

The classic examples of hyperinflation are Germany in the 1920s, Hungary after the Second World War, and Zimbabwe,
where hyperinflation ended in 2009. Indeed, hyperinflation is not that rare: there were twenty-eight cases of hyperinflation
in the last century.


The Henley Outlook
August 2012

Hyperinflation has little to do with
“normal” price inflation, nor is it an
escalation of “normal” inflation.
“Normal” inflation is a steady and
continuous decline in the purchasing
power of money, which is ultimately
attributable to an increase in the
money supply.

Hyperinflation is different. It is a
collapse of confidence in money,
which results in an accelerating flight
out of money into real assets and
goods, and thus an accelerating loss
of the purchasing power of money.
Think of China’s current attitude to
the dollar, but turned up a notch or
two.

Without exception, the cause of
hyperinflation is the creation of
money to finance a public budget deficit. Ringing any bells?

When those deficits become unsustainable, austerity is touted as the cure. Austerity is deflationary, recessionary, and
painful. If the austerity necessary to balance the budget is deemed too painful, a government can choose either to
default (keep watching this space!), or to inflate the currency (and this space too!).

If the country concerned has its own currency, it will usually choose to inflate. If government finances do not improve
sufficiently as a result, confidence in the currency may evaporate at some point and hyperinflation may arise. So, although
counter-intuitive, hyperinflation is more closely related to deflation than to “normal” high inflation, as hyperinflation can
be viewed as the result of a failed attempt at printing money to avoid the deflation that would be caused by austerity.

Which brings us, of course, to Spain, Greece and – let’s be honest – to most of the unsustainable, developed world: the
euro zone, the UK, Japan and the USA.

As gold starts to re-enter the financial system, perhaps the powers that be, with their backs against the wall, will announce
(probably on a Sunday evening, preferably sometime soon!) an official re-valuation of gold to devalue the dollar and re-
capitalise both the central and the commercial banks. Using the Bretton-Woods method, somewhere north of USD10,000
per ounce would be about right. But I’m guessing that it will not happen before the Chinese have more fully hedged their
dollar position!

Peter Wynn Williams
Investment Director
pww@thehenleygroup.com.hk


The Henley Outlook
August 2012

Cash & Currencies

USD Index (Source: Bloomberg)

Summary
• The GBP is winning the competition of being the ‘stronger’ weak currency! Even though the UK is in recession
(and now worse than thought), the GBP is trading at its highest level against the EUR since October 2008. This
is largely due to the ultimate continued weakness of the Eurozone.
• The USD has been stable and generally stronger; the EUR is trading at two year lows against the greenback.
• AUD pushed higher in July peaking at 1.04 against the USD. The data out of China suggests that the economy
is not slowing as fast as thought and Australian data has been solid so suggesting that this trend may continue.
With moderating inflation, interest rates are expected to stay as they are. AUD/USD to remain range bound.
• JPY has once again strengthened against the USD, now trading around 0.78, this is not desirable for Japan and
may result in further action by the BoJ.
• The SGD has been stronger against the USD in June and July after the MAS tightened its exchange rate policy.
It is now at its strongest level against the GBP since September last year, when it was at the lowest level on
record.

HENLEY ASSESSMENT:
Negative USD, Strongly Negative GBP and EUR over medium-to-long term against trade-weighted
basket of currencies. The euro is unlikely to continue in its current form as we are consistently seeing
weakness in the euro zone economies due to the euro. The strengthening JPY is likely to result in
intervention from BoJ. SGD strength is expected to continue against the western currencies.


The Henley Outlook
August 2012

Fixed Income
Positives
• PBoC cut benchmark lending rate by 31bps and deposit rates by 25bps. China surprised the market with its timing as
this was the second rate cut within one month. PBOC will likely cut its reserve requirement ratio two to three more
times in the remainder of 2012.
• Inflation pressures are well contained in the US and the euro zone allowing room for further easing measures. Interest
rates will remain low for the foreseeable future as economic recovery is anaemic in most developed economies.

Negatives

Sources: Bloomberg, Standard Chartered Research

• ECB and BoE loosened their monetary policies but investors remain cautious. ECB cut interest rates by 25bps to a
record low of 0.75% and reduced its rate paid on overnight deposits to zero. Peripheral bond spreads in the euro zone
widened. BoE added a further GBP50bn to its QE program. Based on previous BoE estimates, it could add 0.5% to GDP
and 0.3-0.4% to inflation if it has the same pound-for-pound effect.
• ECB continues to increase its exposure to the peripheral countries and their banks. As shown in the graphs above, Spain
and Italy have borrowed heavily from ECB in recent months. Under the provision of the Emergence Liquidity Assistance
(ELA) program, ECB also lent directly to peripheral banks as their deposit base eroded. Spanish 10-year bonds hit euro
record of 7% despite the pledge of EUR100bn (USD125bn) funding by the IMF. Moody’s also downgraded Spain’s
credit rating to Baa3, one step above junk, citing the bailout contributing to the Spanish government’s debt load.
• Lack of AAA sovereigns drove investors to Australian government bonds. Yields on all Australian notes maturing in
two years or longer fell to record lows in June. With its 10-year bond dipped below 3% for the first time, Australia still
offers higher yields than comparables of Germany and Canada.

HENLEY ASSESSMENT:
Negative. ECB, BOE, PBoC and BOJ are all very busy fighting deflation and stimulating growth. Many investors
are cautious over the outlook for slower growth. Financial markets are not yet convinced that ECB measures
are sufficient to save the peripheral nations. Meanwhile, the real economy is struggling everywhere, from
US and European job numbers through Japanese consumption to emerging market growth. In line with the
pattern seen with other export-reliant countries, Korea lowered its 2013 GDP growth forecast to 3.8% from
4.2% projected in April. Bank of Korea reduced its 2012 inflation estimate to 2.7% from 3.2%.


The Henley Outlook
August 2012

Property
Positives
• Safe-haven buying continues to support prime central London property. Prices rose 0.8% in Jun12, contributing to
annual growth of 10.5%, according to Knight Frank. Prices have risen 48.4% since the post credit crisis low in Mar09,
and are now 13% above the price peak of Mar08. Over the last three months growth has been more robust in the lower
price bands, ie, sub GBP1m (3.3%) and GBP1m-2.5m (3.2%).
• Home prices in major Indian and Brazilian cities continue to surge following strong economic growth over the last
decade. Data reflects that Delhi home prices surged 24.4% in 1Q12 but have been flat since. In Sao Paulo, prices
climbed by 18.7% in 1Q12, followed by 2.6% in the latest quarter. There are concerns that both markets are overvalued.
For example, in Sao Paulo and Rio de Janeiro, prices may be 50% overvalued after rising 140% since 2008.
Negatives
• We remain cautious regarding a recovery in the US residential property market. Presently the data is mixed and
any recovery is likely to be very slow, despite record low interest rates (currently around 3.6% for a 30-year fixed
mortgage). On the positive side, The S&P/Case-Schiller Index of home prices had its third consecutive monthly gain
in April. However, the National Association of Realtors (NAR) reported that existing home sales declined 1.5% to a
seasonably adjusted rate of 4.55m in May from 4.62m in April. That is 34.2% above the July 2010 bottom but far
short of the 5.5m level that NAR considers healthy.
• China cut benchmark interest rates for the second time in a month and allowed banks to offer bigger discounts on
their borrowing costs. Coming so soon after the initial rate cut, the suggestion is that the economy is weaker than
officials thought. The National Statistics Bureau reported that China’s home sales transactions rose 41% in June from
the previous month, as buyers were encouraged by the government’s interest rate cuts. However, housing sales fell
6.5% in the first half from a year earlier.
• House prices in Spain plunged 12.6% in 1Q12 from the same period last year. This is on top of the 20-30% fall since the
start of 2008. S&P suggests that economic fundamentals point to a further decline of 25% in property prices before
the market levels out.
• The UK (ex London) residential property market continues to struggle as lenders restrict credit, and households are
squeezed by a double-dip recession. According to property search website Rightmove, July has seen sellers drop their
home prices by 1.7%, the largest amount for a July since 2008; although prices are 2.3% higher than they were a year
ago. New sales are running at 56,220 per month on average according to the Land Registry, with Rightmove seeing
102,000 homes come onto the market during the same period; so new sellers are outnumbering actual sales by two
to one at present.

HENLEY ASSESSMENT:
Neutral. Property prices generally, after significant falls in 2009 have stabilised between 2010 and 2012.
Property values have recovered in selected areas such as Asia and London but fundamentals remain weak
elsewhere. However, we still consider some specialised property assets (such as student accommodation/
ground rent income) to merit inclusion in our portfolios. Other than these investments, we would suggest that
clients do not invest further at this time.


The Henley Outlook
August 2012

Equities
US
Positives
• US economy highly flexible, resilient and leads world in technology and innovation.
• Federal Reserve has forecast rates unchanged until at least late 2014.
• Further monetary easing in 2H12 will boost asset prices in nominal terms.
Negatives
• National debt: USD15.9tn and rising; debt to GDP: 104%and rising. Absurdly unsustainable.
• Housing market in depression. Prices at 10-year lows.
• Retail sales and consumer confidence both falling.
• Political system dysfunctional, possible fiscal cliff and debt ceiling to negotiate at end of 2012.

HENLEY ASSESSMENT:
• Negative. Renewed economic contraction is being reported, including the first quarterly downturn in nominal retail
sales since 2009. Is the fiscal cliff already here? Moreover, the official recovery since 2009 is simply a statistical
illusion created by the government’s use of understated inflation, which results in overstated economic growth. There
is a growing risk that the next easing by the Federal Reserve will trigger a massive dollar selling crisis and begin the
process of a rapid upturn in domestic consumer price inflation. Any boost to asset prices could be short lived. Broad
economic activity remains likely to bottom bounce for the foreseeable future.

JAPAN
Positives
• JPY strengthened to JPY78.1 due to “haven demand” driven by the European crisis. We are still expecting Japan’s
currency to weaken further in the medium term over prospects of more interventions.
Negatives
• Japan’s current-account surplus plunged 62.6% from a year earlier to JPY215.1bn (USD 2.7bn), the lowest level
since at least 1985. Machinery orders declined by 14.8%, the most in more than 10 years. Month-to-month changes
in machinery orders can be volatile; it may well be a sign that Japanese companies are becoming cautious about
investment amid the current global economic slowdown.
• Fitch cut Japan’s sovereign rating to A-plus citing Japan’s spiralling debt problem.

HENLEY ASSESSMENT:
Neutral. Prime Minister Noda overcame significant resistance as he pushed the bill to double Japan’s
consumption tax to 10% by 2015 through the lower house. Though a more credible plan to reduce government
debt burden is now in place, Noda is moving quickly to tackle the deficit financing bill which would allow the
government to sell bonds needed to fund almost half of its budget. Japan’s government could run out of
money by October for all state spending including salaries, pensions and unemployment benefits over a
stalled parliament.


The Henley Outlook
August 2012

UK
Positives
• The Bank of England voted to expand its asset-purchase program by GBP50bn to help contain borrowing costs.
• UK inflation unexpectedly fell to its lowest in 2 1/2 years in Jun12 as clothing prices plunged. Consumer prices rose
2.4% from a year earlier, the least since Nov09 and down from a 2.8% gain in May12. From May12, prices fell 0.4%,
the biggest June decline since records began in 1996.
• The trade deficit fell to GBP2.7bn in May12, compared with GBP4.1bn in Apr12, according to figures from the Office for
National Statistics (ONS). This was helped by a boost in exports.
Negatives
• The IMF cut its British growth forecasts for 2012 and 2013 by 0.6% each to just 0.2% and 1.4% respectively — well
below the figures predicted in Mar12 by Britain’s official forecaster, the Office for Budget Responsibility.
• The growth downgrade for this year was the largest of any country with the exception of India as reported in the latest
world economic outlook update.
• Barclays Bank admitted to rigging LIBOR interest rates between 2005 and 2009 and was fined GBP291m as a result
of its involvement. Its traders were found to have put pressure on the LIBOR “submitters” to change the LIBOR rate to
help mask losses and help improve their own financial positions.
• The Markit/CIPS purchasing managers’ index (PMI) for the service sector fell to 51.3 in Jun12, down from 53.3 in
May12.

HENLEY ASSESSMENT:
Negative. On the face of it, BoE has not got a lot in return for the GBP125bn it has spent since the autumn. The
narrowest measure of the money supply – in effect, cash on bank balance sheets – has risen by 58% since Sep11
while lending to households and companies has risen by just 0.2% in that time. The BoE is hoping that the asset
purchases and further steps such as the “funding for lending” scheme – will finally encourage banks to lend, and
firms and households to borrow and spend, despite the fact that British banks are already holding idle liquidity
worth around GBP500bn, which is 30% more than regulators have formally required them to hold.

EUROPE ex UK
Positives
• European governments will jump-start as much as EUR100bn in emergency loans to shore up Spain’s banks and may
move the costs off the Spanish government’s balance sheet to shield the euro region’s fourth-largest economy from
the debt crisis.
• The European Financial Stability Facility (EFSF) is to make a first EUR30bn payment by the end of this month but that
money is simply an emergency reserve, of which EUR20bn will eventually be diverted into the mid-November payment
and EUR10bn will be kept back as a protective cushion.
• The ECB cut its overnight deposit rate from 0.25% to zero while it also reduced its main refinancing rate to 0.75%
from 1.0%.
Negatives
• Moody’s last night cut Italy’s bond rating by two steps to Baa2 from A3 and put the country on negative outlook,
saying that a further downgrade is possible. That was just two steps above junk and one step higher than Spain. The
rating downgrade was made because Italy faces higher funding costs, slower growth, and contagion risk from Greece
and Spain.
• Germany’s Federal Constitutional Court announced today that it will rule on the constitutionality of the European
Stability Mechanism (ESM) permanent bailout fund and the fiscal pact on 12Sep12, meaning the ESM will be delayed
from going into operation by at least two months.
• A gauge of investor confidence in Germany, the currency bloc’s biggest economy, slid to minus 20 this month from
minus 16.9 in Jun12.


The Henley Outlook
August 2012

HENLEY ASSESSMENT:
Strongly negative. Equities account for 55% of capital resources in both the US and Europe, but European
banks are much more important to the economy, accounting for about 40% of financial resources allocation,
as compared to about 20% for US banks. Going forward, the credit crunch in Europe will get worse before it
gets better. European banks are not as well capitalised, but much more leveraged than their US counterparts,
and the credit crunch in the euro zone has barely begun. To bring capital ratios up to a level equivalent to the
US average, the largest European banks will have to either raise EUR900bn in new capital or cut back their
asset base by EUR9tn.

AUSTRALIA
Positives
• Unemployment is at 5.1%.
• Interest rates are falling, the RBA cash rate is now at a lowly 3.5, and is likely to fall further. Lower domestic interest
rates should prompt more domestic investors to put their money to work in ‘riskier’ assets, like shares and property,
rather than cash.
• Economy expanded at an annualised pace of 4.3% in 1Q12.
• A cut in Chinese interest rates, giving the Chinese government more room to stimulate the economy. Global commodity
markets are highly dependent on Chinese demand.
• Housing approvals rose 27% in May.
• June new motor vehicle sales, at 113,000 units, was the highest month on record.
• Government finances are rated triple-A and the budget deficit is relatively small.
Negatives
• Average debt levels of households are high.
• Exposure to base metals’ sector and reliance on commodity trading with China.
• Share market is more than 40% below highs of 2007 (though this can be seen as a positive!).

Henley Assessment:
Upgrading to positive for clients with a long-term view and prepared to accept short term volatility. Investors
– in Australia – should heed this warning from the chief investment officer of the USD53bn fund manager
First Trust Portfolios, Robert Carey: “Individual investors tend to get in when the markets are red hot and they
tend to get out when the markets are at the bottom,” he said. “It’s been one series of issues after another,
but, ultimately, fundamentals will weigh out and overwhelm any sentiment that people have.” And by that
time, much of the early profits will have been made. Trying to time the market – successfully – is immensely
difficult. I’m yet to see evidence it can be done in a repeatable way. Instead, riding the market’s waves
has successfully provided returns of between 9%–11% per annum (with dividends reinvested) over the last
century. Lumpy, bumpy and uncomfortable waves, I’ll grant you, but a rate that has provided impressive
compound returns over time.

ASEAN
Positives
• Malaysia’s exports rebounded, growing more than economists estimated in May after falling for two months, giving
the central bank scope to keep interest rates unchanged (3%) even as Europe’s debt crisis threatens demand.
• Thailand had its biggest IPO since 2006 when Tesco Lotus (TLGF) Retail Growth Freehold & Leasehold Property Fund
raised THB18.4bn (USD583m) in March. In the Philippines, GT Capital (GTCAP) Holdings Inc., owned by billionaire
George Ty, raised PHP18.8bn (USD449m) in April in the country’s fourth-largest IPO ever.
• With IHH’s sale overtaking Banco BTG Pactual SA’s April IPO, Malaysia accounts for two of this year’s three largest
first-time offerings.
Negatives
• Singapore’s economy unexpectedly contracted last quarter as manufacturing fell, adding to signs of a deepening
slowdown in Asian expansion as Europe’s debt crisis curbs demand for the region’s goods. GDP fell an annualised 1.1%
in the three months through June from the previous quarter.


The Henley Outlook
August 2012

Henley Assessment:
Neutral. Gains in IPOs may be short-lived. Europe’s sovereign-debt crisis and falling commodity prices weaken
the outlook for exports. International Monetary Fund said in an April report that five economies in the
Association of Southeast Asian Nations (ASEAN): Indonesia, Thailand, Philippines, Malaysia and Vietnam,
along with China and India, will outpace the rest of the world over the next two years. In 2013, the ASEAN-5
will grow 6.2%, compared with 2.4% in the US, 0.9% in the euro area and 1.7% in Japan.

GREATER CHINA
Positives
• The central bank PBoC’s second interest rate cut within a month came as a surprise and is widely regarded as a sign of
mounting economic problems. As we expected last month – more interest/bank reserve rate cuts may still be needed,
but the important message is that the central bank is clearly trying to move ahead of the curve to prevent further
economic slowdown.
• China’s headline inflation dropped to 2.2% in June, the lowest since Feb10.
• Currently, some of the negative developments have already been priced in. Valuations for Shanghai A-shares are
deeply discounted.
Negatives
• China’s preliminary GDP figures released in July showed
the ecomomy expanded by 7.6% YoY in the 2Q12. The
chart on the right shows that the relationship between
China’s GDP growth and that of electricity production has
deviated significantly over the year. The sharp slowdown
in electricity consumption certainly more precisely reflects
the weakening in overall growth.
• The Chung-Hua Institute for Economic Research
downgraded its forecast for Taiwan’s 2012 economic
growth to 2.36%. Taiwan exports fell for the fourth
consecutive month in June to USD24.36bn.

Henley Assessment:
Neutral. A deeper concern among investors is whether the Chinese economy will be able respond to the
government’s growth-boosting measures and will begin to stabilise or accelerate beyond the near term.
However, we think China’s overall fiscal situation is much stronger than most other major economies – and
this strength gives the Chinese authorities enough firepower to boost domestic demand. In addition, Chinese
stocks are currently valued very “cheaply”.

India
Positives
• India’s central bank, Reserve Bank of India (RBI), raised the limit of external commercial borrowing to USD10bn; the
overseas investment in government bonds has been increased from USD15bn to USD20bn.
• Government expects to raise more than INR200bn by disinvesting their stake in 15 state-owned companies.
• IKEA announced its entry in the Indian market with an investment of EUR.1.5bn across 25 stores, this would facilitate
in boosting the investment confidence of FIIs.
Negatives
• The country’s benchmark inflation – the Wholesale Price Index (WPI) rose from 7.23% in April to 7.55% in May, whilst
food inflation shot up to 10.74% from 10.49% year-on-year.
• Owing to lower growth and heightened inflation, Fitch has downgraded India’s outlook from stable to negative. S&P
already gave a negative rating in the previous month.
• INR continued its downslide, hitting an all-time low of 57.32 against the USD on 22Jun12.


The Henley Outlook
August 2012

HENLEY ASSESSMENT:
Neutral. India is struggling with a series of domestic issues – governance deficit, corruption and policy
paralysis. Growth has to be sacrificed if RBI continues to focus on an inflation-centric policy. The continuous
bickering amongst coalition partners witnessed during the recent presidential election suggests that the
rulers are more interested in scoring political points over one other rather than addressing the fundamental
issues that concern the country’s dwindling economy.

Other Emerging Markets (South Korea, Russia, Brazil)
Positives
• Despite the US historically producing almost six times more corn than Brazil, the US is turning to Brazil for help with
corn supplies as low stocks and the worst drought in half a century haunt the world’s leading grain exporter. US meat
producers have arranged to ship Brazilian corn to the US east coast as it has become cheaper than supplies from
the US Corn Belt. This situation is unparalleled and in many ways is analogous to Saudi Arabia importing oil, and
illustrates how desperate the current US drought is.
• Emerging market (EM) equity returns are set to outpace
developed market returns over a five-year horizon. However,
discrimination will be key for investing in the EM space.
Ranking countries using valuation indicators and growth
data shows that many markets are cheap for a reason.
For example, Argentina may appear cheap but growth
is expected to weaken sharply. Meanwhile, Thailand is
expected to have the biggest improvement in growth, but
it has relatively poor valuation. Importantly, a broad range
of expected returns among EM bourses highlights the
challenge of investing in these countries: it is important to
understand the dynamics of each country because EM is
not a homogenous asset class.
Negatives
• In China, private sector credit has risen from 107% of GDP in 2007 to 127% last year, according to Capital Economics,
a consultancy. In Brazil, Turkey and Poland, private sector credit has meanwhile risen by as much as 20 percentage
points of GDP. Countries with slower credit growth are the exceptions. South Korea, for example, has held back because
of an earlier painful credit boom, and India because of high interest rates, induced by persistently high inflation.
• Elsewhere, though, the credit surge is in full flow. The latest data show private credit grew in April at annualised rates
of 20% or more in Colombia, Indonesia, Turkey and Russia. Although these countries are relative latecomers to the
credit binge, Brazil has been partying from the start. Private credit is still growing 23 per cent a year, even though
borrowers are now struggling, as seen in rising delinquent car loans.

Henley Assessment:
Neutral. Whilst there have been developments in EM to create their own internal markets, at present they
do still remain sensitive to a slowdown in western economies through exports. In addition whilst the sector
as a whole has much higher forecasted growth rates and a younger more dynamic population, any fallout in
the current sovereign debt crisis will undoubtedly affect these markets also. The current rise in debt levels in
certain EM countries is also a worrying trend.


The Henley Outlook
August 2012

Commodities
Energy
Positives
• Iran’s nuclear ambitions remain uncertain.
• Production costs going forward expected to remain high due to complexity of developing new fields.
Negatives
• Ongoing debt concerns in Europe and signs of a slowdown in China are adding to negative sentiment.
• China’s crude imports in June sagged to 5.29m bpd, the lowest daily rate this year and 12% lower than in May,
reinforcing concerns about slowing demand for oil.

HENLEY ASSESSMENT:
We remain neutral. Talks between Iran and western powers are inconclusive. Tension in the Middle East
remains, where the conflict in Syria now resembles civil war. Recent trade data coming out of China suggests
that the economy is slowing down. Beijing is now ramping up state spending to prop up growth. Continued
monetary easing and a breakdown in relations between Iran and the west will support prices, while the macro
is still gloomy.

Precious Metals
Positives
• Gold and Silver are a good hedge against
financial instability.
• Central banks remain keen buyers of gold with
Turkey’s central bank raising its reported gold
holdings by 5.692 tonnes in May to 244.986.
Negatives
• Temporary USD strength put pressure on the
gold price.
• Gold is a liquid asset that can easily be sold by
investors to cover losses elsewhere.
Source: Casey Research. World Gold Council

HENLEY ASSESSMENT:
We remain strongly positive on precious metals. In Europe bond yields remain stubbornly high, certainly too
high for the PIIGS to fund themselves in the long run. The situation in Europe is still an utter mess, and policy
makers do what they can to instil confidence in the market. In the short run, they may have some success, but
the can is getting heavier and heavier and at some stage it will become too heavy to kick further. The failure
of futures broker PFG Best in the U.S, and the fact that client assets once again appear to have gone missing,
highlights the lack of integrity in the financial system. Physical gold and silver, with no counterparty risk, is
the first line defence for investors who wish to defend themselves against political mismanagement and bank
system fragility.


The Henley Outlook
August 2012

Industrial Metals
Positives
• Currency debasement will support real asset prices.
Negatives
• The health of the global economy remains uncertain.
• Trade data from China suggest that the economy is slowing down.

HENLEY ASSESSMENT:
We maintain our neutral view on base metals. China, the most important consumer of many raw materials,
continues to see a slowdown in its economy and in June inflation slowed to 2.2%, the lowest figure in 29
months. In the commodity sector we still favour other areas.

Agriculture
Positives
• UN’s Food and Agriculture Organisation
estimates there will be over 9bn mouths to feed
on the planet by 2050.
• Middle-class consumers in BRIC economies
are increasingly demanding more varied, and
protein-rich foods. As affluence increases protein
from beef, sheep, poultry, pigs, and fish may in
turn displace grains in diets.
• Urbanisation and life expectancy is expected to
increase.
Negatives Source: The Fertilizer Institute
• Prices are subject to many uncontrollable risks,
eg, weather and natural disasters, politics and other pests.

HENLEY ASSESSMENT:
Positive: A rapidly-growing global population and the rapidly-developing emerging world underpin the long-
term prospects of the agricultural sector globally, at the same time the supply of arable land is limited.
It is estimated by the World Bank that worldwide 445m hectares of land are currently uncultivated and
available for farming, compared with about 1.5bn hectares already under cultivation. On the other hand, soft
commodity prices are subject to many factors that are difficult to forecast such as drought or flooding. We
suggest investors take a diversified approach when investing into this sector.


The Henley Outlook
August 2012

Alternative Investment
Positives
• Most of long-bias fund managers posted
positive returns in June with the exception
of directional trading managers.
• The environment for hedge funds remains
broadly the same: choppy, technically-
driven, policy-driven and mean-reverting.
Therefore, short-term traders/managers
are well prepared for this battle and in
fact, it is the perfect time to for them to
outperform.

Negatives
• Hedge funds were down 2.3% in 2Q 2012
according to Eurekahedge Hedge Fund
Index, making it the worst second quarter
on record for the industry. Source: Eurekahedge

• Total asset under management (AUM) for
hedge funds decreased by USD8.2bn, bringing the size of the industry to USD1.73tn. Most of the decreases in assets
were due to performance-based declines, accounting for USD6.62bn of the decrease.
• Systematic trading managers produced some of the worst monthly returns in recent history with losses attributable to
short positioning the euro and long exposure to bonds.

HENLEY ASSESSMENT:
Positive: Apparently, there seems to be an increased willingness for central banks to act now, following the
disappointing data in the recent months. Policy action across the western economies is relatively uniform
and constrained by low growth and fiscal cuts. Therefore the increasing macro correlations over the summer
provides opportunities for trading managers to make money.

General disclaimer and warning

The Henley Group Limited (“The Henley Group”) has produced this document for your private use only and you must not distribute it to any other person
in Hong Kong. Re-distribution or reproduction in whole or in part of this document by any means is strictly prohibited and The Henley Group accepts
no liability for the actions of third parties in this respect.Funds not authorized by the Securities and Futures Commission may involve more risk and
distribution or re-distribution of information relating to such funds to the public of Hong Kong may constitute an offence under the Securities and Futures
Ordinance.Notwithstanding that the information contained herein has been obtained from sources which The Henley Group believes to be reliable, The
Henley Group makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy, completeness or correctness.
The information in this document, including any expressions of opinions or estimates, should neither be relied upon nor used in any way as indication of
the future performance of any financial products, as prices of assets and currencies may go down as well as up and past performance should not be taken
as indication of future performance.


Monthly Market Outlook and Global Financial Repression Risks

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