The market is likely to stay bullish for the next 10 years

By Martin James

The Gulf Cooperation Council (GCC) stock markets have generally recovered from a prolonged downturn, but the overheating of the real estate sector and the subprime crisis might spell fresh trouble.

Gabriel Stein, analyst at UK-based Lombard Street Research says: “Low interest rates are driving a credit boom, which primarily is then used to fuel stock prices and real estate speculation. But the real estate sector is also strangely skewed.”

In most of the GCC states there is substantial demand for low-cost affordable housing, but the majority of new construction is high-cost luxury residences.  “The big risk for the GCC region — in addition to the vagaries of oil and natural gas prices — is therefore the likelihood of a real estate crash,” Stein warns.

“Because GCC pockets are deep, it may take longer to happen. And when it comes, it will be bad news for stock markets dominated by the finance and real estate/construction sectors.”

But the sub-prime crisis and the rise in the cost of construction materials are threatening to take the shine out of the realty market.
Retail investors stung by the stock market collapse had shifted cash from managed funds to assets such as real estate and commodities.
Fund managers estimate that between 50 to 60 per cent of retail investors had pulled out of funds since the markets dived. With the GCC real estate investment priorities still a question mark, billions of dollars are now heading into real estate markets in China and India.

Fund managers say since the kind of returns in the Middle East is yet to be ascertained properly, the decision the investors have is to invest in the US at 6 to 7 per cent returns or venture into Asia where the market is right and one can easily get a 20 per cent return.

Commodities is another segment where investors can turn to. The US$130 billion invested in commodities globally is expected to rise, with the market likely to stay bullish for the next 10 years.

Growth in demand led by China will keep commodities markets strong as both short-term profit seekers and pension funds pour their money into the sector.

The fundamental reason why commodities should do well is that, as developing countries get richer, they use more commodities, more oil, and they eat more food, particularly meat. Industry estimates suggest commodity index-linked investment will grow to about US$100-110 billion by the end of 2006 from about US$85-90 billion currently.

Commodities are not correlated to other asset classes like equities and bonds. So, basically, when equities go down commodities most probably will go up because there is a negative correlation.

Commodities futures are often bought as baskets that include various types of commodity, so large moves in one asset class can affect others.

The closely watched Goldman Sachs Commodity Index is heavily weighted towards oil. Analysts say regardless of a bull or bear market, pension funds — which are looking for long-term stability as opposed to short-term risk — are allocating up to 5 per cent or more of their portfolios to commodities, which often rise in value when other assets fall and vice versa. That way, funds can hedge their losses.

Most of the US$130 billion of global investments were in commodities indices. This amount could double easily in the next three to four years. What funds can do is to diversify their risk by a kind of an insurance against any major shock affecting the prices of other asset classes like equities or bonds.