Political Games Shakes the Markets. Gold Hit New High!

July has been a disturbing month for many investors. We have the issue of the US Debt Ceiling, concerns about the Euro debt crisis and the slowdown of china economy. Old and new worries came together and we have one of the most volatile month for year 2011. When I talk to some investors, they are worried on how the current situation will turn out and whether a second market crash is coming, 2 years after the recovery in 2009. Let touch on these concerns one by one.

US Debt Ceiling Crisis

The US Debt Ceiling Crisis is the result of partisan politics in the US government between the Democrats and Republicans. The inability of the two parties to agree on the policies accompanying the issue of rising the US debt ceiling and the looming dateline of 2 Aug before the US government defaults on its debt obligations is creating a lot of uncertainty in the world market. If the US government is unable to raise the debt ceiling, US will not be able to borrow more to meet its financial obligation and they will have to default on some of the promised payment. What are the implications of a US debt default? It will probably bring forth financial Armageddon that probably will rival that of The Great Depression. Just to give an example of what may come: Should the Americans default on their debt obligation, global investors will start to sell US treasuries as US can no longer honor the coupon of these obligations. With a mass panic sale of US treasury, the US dollar will drop drastically and US will fall into recession again. Asia, with most of their foreign reserves in USD, will be hit the most as the value of their savings falls tremendously. With the recession in US, exports driven Asian countries will definitely fall into recession. This time, China will be hurt badly and will not be able to function as the second engine of growth as we have seen in the recent recovery. Europe with its already serious debt problem, will no doubt fall deeper into the debt abyss. Credit around the world will dry will and it will probably take a dozen years before the economies around the world can recover to its past glories. The only light in this disaster will be gold, which is the only physical currency of the world..Gold has risen to a historical new high as a result of these fears in the recent days.

In any case, any respectable politicians and economists should understand the seriousness of the issue and will not let such a situation come to pass. The problem is that the debt ceiling issue has became a leveraged gun, used to threatened the other side and to win political points for the US 2012 election. The politicians are betting that the other side will blink first and consent to whatever conditions their party has proposed. They are betting on the world’s financial health in exchange for power. Sometimes, I would ask myself if a responsible autocratic government works better.  

Debt Crisis in Europe

The situation in July for the European debt crisis got worse before it got better. In the earlier part of the month, there are rumors that the contagion from Greece will cause Italy and Spain to collapse too. Yield on their government bond jumped in response to these concerns. In order to regain confidence in the EU bloc, the EU coalition led by fiscally positive Germany announced that they will, “Put an End to the EU debt crisis once and for all.”  They announced new measures previously blocked by Germany and the market rallied on the news. The EU debt crisis fade into the background as the focus is reoriented at the US debt ceiling crisis. My prediction is that the crisis will rear its ugly head once again in the near future and cause financial recoil again. For now, it seems that the situation is in control.

Growing Pains: China

Leading indicators in China has pointed to a soft landing for the economy rather the hard landing many economists has predicted. However, inflation in the country remains stubbornly high and the central government has no choice but to raise interest rates. However, the government is fearful that any excessive rise in interest rates will curb growth so much that it many lead the country into a hard landing. My guess is that the China government will raise interest rates not more than one or twice in the near future in order to balance between growth and inflation.

The recent collision of China’s high speed train has lead to a major market correction as hopes of China exporting the technology are dashed. There are analysts saying that the Chinese is building too fast, too much without regard to technology and safety measures. The China government has derided these commentators until the recent incident. The Chinese has been hoping to export their high speed rail technology competing with Germany and Japan, as the world is demanding an alternative and more energy rapid transport as high fuel prices are pushing the prices of air tickets up. For your information, the Japanese high speed rail Shinkansen has not had a single accident since its founding in 1964. Train related stocks fell rapidly while airline stocks rallied as investors believe that travelers will put their faith back into plane technology and lead to more demand in air travel.

Reading the Trends

Here is my conclusion after this month events. US will not default and this crisis should pass as eleventh hour politics will save the day. The crisis in Europe will be muted for a while as the world sits back and watch how Germany take a more active role in the bailout. Any political hesitation will bring the crisis back out in the open again. The China market should do well until the rest of the year barring anymore toy poisoning, train collision, company fraud etc. Of course that is not possible, China being China but after such a long slumber party in the stock market, the undervalued China market will realize its profit potential sooner or later. My position in Oil, Gold and Indonesia will stay put for now as they have performed extraordinary well this month. Will be looking to take profit sometime in the near future but with these markets having a great run, I see no point taking profits too early. The bulk of position should stay put in Asia and emerging markets. Thailand is one of the better performing markets but the political situation does not inspire great confidence. I have been watching the US situation like a hawk and will be moving the funds into US later in the year as soon as US dollar stops falling like a dead bear from 7 storeys high.

Attached is the chart of my frequently used funds. The best and worst in the fund universe is at the top and bottom as usual.