View more on these topics

Commodity chest

Commodities have seen huge rises, driven by demand from countries such as China and India

All asset classes are at or near all-time highs – even gold. The justification for the complacent attitude seems to rest on central banks not repeating past mistakes while global-isation enables growth in China, India and others, together with technological change, to continue to reduce prices and inflation in the western world.

This works until demand in the developing world starts to exert upward pressure on prices. This is so far only apparent in commodities and because the 1994 commodities boom proved non-inflationary, it is assumed that the present boom will have little impact either. However, there are similarities in the demand for commodities with Japan’s voracious appetite for commodities from 1963 to 1973 and that proved to be very inflationary.

Gilts have benefited from low inflation, low interest rates, ample liquidity and the liability-driven nature of UK life and pension funds. Yields have fallen to levels not seen for many years. Historically, such low real yields on a sustained basis are unprecedented.

Given that low real yields are only acceptable in a low growth, low inflationary scenario, it is surprising that investors are relaxed at the very low spread over gilts offered by corporates that are unlikely to flourish in such an environment.

Companies have performed very well since the nadir of March 2003 when gilt and dividend yields coincided. Cost-cutting and lack of investment during a period of loose monetary and fiscal policy are a great combination for the bottom line. Indeed, corporate returns on equity are at historically high levels. But such low gilt yields suggest that it cannot get much better for corporate UK.

Yields on index-linked gilts are expressed in real terms. The 50-year index-linked gilt, issued last September, was priced to offer a real yield of only 1.11 per cent and currently yields 0.71 per cent. Perhaps the rationale is that, if inflation is such a threat, then a premium should be paid for the inflation guarantee given by the Government and, therefore, current linkers are not dear.

As the conventional 50-year gilt yields only 3.9 per cent, it would appear that investors’ inflationary expectations are extremely modest. Commodities have seen huge rises over the last two years, driven by lack of supply and huge demand from new entrants to the global economy, particularly China and India.

China’s share of global demand growth was 50 per cent in 2003 and of similar magnitude last year and now accounts for close to 20 per cent of all demand for metals. Demand growth from China is also a major reason for recent oil price spikes. This has had a positive impact on equity indices, especially in the UK, where oil has a significant weighting.

For their part, UK equities have performed far better than most experts predicted during the dark days of 2000 to 2003. To an extent, they have benefited by default as gilts and corporate bonds appear fully valued and property has passed its peak. Part of the US Federal Reserve model compares the earn-ings’ yield on equities (the inverse of the p/e ratio) against the yield on treasuries.

This methodology applied to UK gilts has been supp-ortive of equities for some time and provides a reason-able check on relative valu-ations. Corporate balance sheets are healthy and private equity firms have record amounts of cash at their disposal.

It is, therefore, not unreasonable that equities have the upper hand at the moment but the equity risk premium (excess return of equities relative to gilts) is not particularly attractive if gilts are overvalued.

To a lesser extent, major Western equity and bond markets have a similar backdrop to the UK. Asian and emerging markets have a more dynamic and better demographic (Japan excepted) outlook but whether they can move independently of western markets, especially the US, remains to be seen.


Yorkshire to launch new 10-year fixed rate mortgage

Yorkshire Building Society is launching a new 10-year fixed rate mortgage at 4.69 per cent.The deal will be available in branch, online and by telephone from Friday January 27.Interest is charged daily, and loans are available up to 95 per cent LTV. ASU insurance is included free for the first six months.There is a 495 […]

Prescient gains 1000th client

IFA firm Prescient Financial Intelligence has just witnessed its 1000th client 16 months since its launch in August 2004. The firm, with offices in Exeter, Glasgow, London and York, employs a strategy of targeting small asset managers and discretionary fund managers that are lacking the financial services capability to provide Sipp and IHT solutions to […]

The Exchange integrates with Personal Touch

Personal Touch has integrated its Toolbox back office and administration system with The Exchange, as part of a major business transformation.The network of 2000 advisers made the decision after switching its focus from portal development to distribution.It will introduce The Exchanges Exweb product to its advisers as well as establishing formal links with Mortgage Brain […]

Standard questions scheme admin role

Product providers which do not take on the role of scheme administrators on their packaged pension products after A-Day must justify their annual management charges, says Standard Life head of pensions policy John Lawson. He says Scottish Equitable’s decision not to assume the newly created roles of scheme administrator or authorised scheme practitioner means that […]


News and expert analysis straight to your inbox

Sign up


    Leave a comment


    Why register with Money Marketing ?

    Providing trusted insight for professional advisers. Since 1985 Money Marketing has helped promote and analyse the financial adviser community in the UK and continues to be the trusted industry brand for independent insight and thought leadership.

    News & analysis delivered directly to your inbox
    Register today to receive our range of news alerts including daily and weekly briefings

    Money Marketing Events
    Be the first to hear about our industry leading conferences, awards, roundtables and more.

    Research and insight
    Take part in and see the results of Money Marketing's flagship investigations into industry trends.

    Have your say
    Only registered users can post comments. As the voice of the adviser community, our content generates robust debate. Sign up today and make your voice heard.

    Register now

    Having problems?

    Contact us on +44 (0)20 7292 3712

    Lines are open Monday to Friday 9:00am -5.00pm