As money moves in search of strength

The GCC stock markets have generally recovered from last year’s downturn, but the overheating of the real estate sector 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 Gulf Co-operation Council 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 warned.
“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.”
Retail investors stung by the stock market collapse have 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.
Real estate funds are benefiting as retail investors migrate towards what they consider a more comfortable asset class.
Bahrain is host to a thriving mutual funds industry. As of December 2006, over 2,100 funds (both off shore and locally domiciled) were registered in Bahrain, representing a 17 per cent growth over the previous year. Of these, 97 were Bahrain domiciled schemes, and 80 were Islamic schemes (including both overseas and Bahrain domiciled schemes). Total assets under management were some $9.3 billion (up nearly 40 per cent on the previous year’s total).
Many of Bahrain’s funds have become real estate funds with focus on Asia and not the US market, where the returns are not as high as they once were.
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. Investors have long been drawn to US investments because most Gulf countries peg their currencies to the US dollar.
After Dubai unleashed a property boom by allowing foreign investment in property in 2002, investors have kept more money in the region to take advantage of rapid growth.
The next frontier is Asia, where Gulf investors are attracted by a growth in demand, upside currency risk, large populations, and a belief that they can eliminate risk with the right local partners.
Commodities is another segment where investors can turn to. The $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 $100-110 billion by the end of 2006 from about $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 $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.

By K S Sreekumar
sreekumar@tradearabia.net