ArabianMoney.Net

Reckoned to be world’s largest sovereign wealth fund, Abu Dhabi Investment Authority has become more transparent with the publication of its first ever annual review.

Managing director Sheikh Ahmad bin Zayed Al Nahyan said: ‘considerable uncertainty remains about the outlook for 2010. Most pressing is the sustainability of the economic recovery’.

Rally over?

Readers of arabianmoney.net will know that this fear remains uppermost in the minds of many local investors. From an investment perspective the durability of the rally in financial markets over the past year is the most immediate worry and a correction is widely expected by experts.

ADIA does not reveal the value of the assets it has under its management in the new report. A report from the UN cited ADIA assets at $329 billion at the end of 2008 after losses of $183 billion in the global financial crisis. And given the recent recovery in financial markets a figure closer to half a trillion dollars is now generally accepted, although it could be as high as $800 billion.

But the ADIA report does give an indication of its geographic spread: North America and Europe 60-85 per cent; Asia and emerging markets 25-45 per cent. By asset class 46-66 per cent is held in equities, 10-20 per cent in government bonds, five to 10 per cent in hedge funds and up to 10 per cent in cash.

ADIA was formed in 1976 to invest the surplus oil revenues of Abu Dhabi and has achieved an eight per cent annual return over the past 30 years and 6.5 per cent over the past two decades, according to the new report. Some 1,200 staff work for the fund of whom a third are UAE nationals.

Solid performance

The focus is clearly on achieving solid but not spectacular growth in asset values over the long-term. Abu Dhabi has only very occasionally dipped into this huge fund during periods of low oil prices.

Sovereign wealth funds may have only recently been noticed by the international press as they came to the aid of some banks in the early days of the global financial crisis. Buying on the dips might be standard investment theory but actually these investments have proven some of the worst ever for the sovereign wealth funds.

Nobody gets it right ever time and there is good reason to be cautious about the sustainability of the recent recovery.

Warnings from credit rating agencies like Moody’s that the US and UK are in danger of losing their AAA ratings could be the final straw that persuades central bankers to jack up interest rates by a marginal amount this week.

An article on the financial website arabianmoney.net last week that cited senior banking sources as predicting a 0.25% rise in the Fed funds target overnight rate on Tuesday, has set pulses racing (click here).

Fed cred

But few commentators give this source much credence and the tendency is to believe the Fed and its promises of an extended period of low interest rates.

Words can always be twisted, of course. The Fed could jack up rates 0.25 per cent and still claim that it is sticking true to its word, with rates still low and expected to stay low for the foreseeable future.

The impact on financial markets would be instant. The AAA-rating would be assured and bond prices surge. Stock markets would come off their recent highs and this might be greeted as a healthy correction from overvalued levels.

Dangerous complacency

Markets dislike the unexpected but they may have become unduly complacent recently believing that emergency low interest rates are an indefinite phenomenon.

All history says otherwise if only because artificially suppressing the cost of money is inflationary and unfair to those paid low interest rates. It is also bad for government debt ratings and the government has a lot of debt to raise this year.

Standby for a shock announcement from Fed chairman Ben Bernanke tomorrow night. The fear in the market today is that China is tightening but the real gorilla in the front room might be much closer to home.

The Middle East could be enjoying another oil price boom much sooner than expected as Chinese inflation gathers pace after one of the biggest experiments in loose monetary policy in history.

Once an exporter of deflation to the rest-of-the-world, a nasty side-effect of the record stimulus plan in China last year is a surge in inflation that jumped to 2.7 per cent last month. Officials claim this is ‘mild and controllable’. Veteran observers sense an inflation genie let out of the bag.

Handbag shortage

One arabianmoney.net reader recently commented on shortage of handbags in China. This small example is illustrative of too much money pursuing too few goods. Inflation in prices is the inevitable result.

Chinese officials blame rising international commodity prices for domestic price rises. Yet where is that demand coming from but China? The latest oil studies have all concluded that demand is surging in China and flat or falling in the rest-of-the-world.

How long before the cost of Chinese exports begins to increase and this inflation is literally exported to the rest-of-the-word? It can only be a matter of time, and not so long at that.

Gold investors selling last week on fears that interest rates would go up in China are really barking up the wrong tree, as is anybody who thinks the Chinese are not buying more gold themselves.

Oil producing countries have been very content with oil prices in the $70-80 range. But they worry about higher prices because that might give their customers another economic heart attack.

There is also mounting concern about the durability of the Chinese economic recovery and the quality of recent GDP growth. Speculative bubbles inflated by cheap credit have a habit of going spectacularly bust and leaving the formerly rich and successful in deep trouble.

Stimulus risk

No country has ever masterminded a bigger per capita stimulus plan than China last year. It is the boldest ever plan of its kind, and therefore also carries the most risk.

For one thing higher oil prices will be desperately bad news for the developed economies still struggling to emerge from the worst recession since the 1930s, and having saved the world with its massive reflation China risks blowing up its client’s economies with inflation.

Not that the developed economies have been pursuing exactly deflationary policies themselves, and this just adds to the witches brew now imperiling the global economy. If there is an oil price spike now it may be nasty, brutal and short. Gold is the more solid inflation hedge.

Many readers around the world will remember the Wile E. Coyote cartoons from their childhood. The pesky Road Runner character always seems to win in the end.

For the Road Runner read the market professionals of Wall Street. And for Wile E. Coyote the majority of investors and the entire general public. So how close is the Coyote to the edge of the precipice right now?

Coyote moment

You could almost ask any professional investment banker and get the same opinion. The 12-month stock market rally is too long and too strong not to undergo a meaningful correction or even a major crash.

One problem is that as the Coyote finds out when you get to a very high place there is only one way to go. Gravity is a force that cannot be resisted.

Markets also act like the mischievous Road Runner and lead investors up the mountain only to watch them drop off the edge of the cliff. The professionals collect their commissions as you buy into the market, and they collect commissions as you sell out.

It is such an old cycle you would have thought that investors would have learned by now. As children we all used to watch the Road Runner lure the dimwitted Coyote to the top of the mountain and shout out warnings at the television.

History repeats

He never paid any attention, or learnt anything, and always fell to the bottom. He always then picked himself up and got ready to do the same thing again.

In real life we are not cartoon characters and those who risk their wealth at the top of a bear market rally will not have their capital returned. It is gone. Only the market professionals and short sellers win out.

After a stock market event there are always stories about a few hedge fund managers who went short just at the right moment. It is a bit like bribing the Road Runner to help you back down the mountain and keeping yourself intact. And actually real life is rather better for the shorts who actually make a lot of money out of crashes.

There are plenty of articles on this website explaining how to go short in ETFs which anybody with an Internet stock market account can do easily. Arabianmoney has been too early in going short. But don’t end up like the Coyote! And certainly do not stop out your shorts now!