Executive summary
The recent uncertainties experienced by the financial markets have seen many investors shift their wealth from riskier investments to more secure ones where returns are guaranteed and predictable. The prices of stocks have declined with investors incurring massive losses in their investment values and losing confidence in the future performance of the market. All the major economies have experienced inflationary pressures and this has hindered planning. The gold market has consistently experienced increased gold bullion prices because of the strong demand from central banks in an attempt to diversify their reserves in gold. The price of gold has been on the increase over the last five months and is projected to maintain an upward momentum over the next twelve months when the world economy is expected to fully recover from the effects of the recent global recession. Most of the investors have resorted to short-term fixed interest investments like commercial papers and certificates of deposit where returns are guaranteed and where the investment is liquid. The price index of commercial papers has increased over the past six months and is likely to maintain this trend in the next twelve months. There is a speculative trend in the property market where investors are currently buying low-priced houses with the hope of making capital gains when the prices increase as the economy recovers. However, the European debt crisis is likely to affect the recovery of the housing market and the ASX 200 negatively. The debt crisis in European countries will increase the demand for commercial papers and gold bullion in the next twelve months.
Introduction
The Global financial markets are engulfed with uncertainty on the future performance of different financial assets, including both the short-term fixed interest securities. The performance of the gold market has also presented challenges to financial analysts who have been following the latest developments. The prices of many stocks on Bourses have significantly declined with investors incurring massive losses in their investments. The ongoing economic crisis in Greece and a few other countries in the European Union have seen many of the investors divert their investments from financial stocks like shares to short-term securities like commercial papers where the returns are predictable and guaranteed.
Physical gold is traded in the form of bullion, but imitation coins, medallions, and jewelry of high gold content are also traded. Gold bullion refers to gold that has already been transformed into bars, either in crude form or as defined by weight. Each financial market defines the acceptable weight and the fitness of the gold bullion that would be traded in the market. The gold bullion market usually puts a floor on the price offered by the suppliers from the mining industry, the spot price, or the mutually agreed forward price.
The gold bullion market is different from the stock or bond markets as it often moves in the opposite direction. However, in times of uncertainty, it can be correlated to the stocks and bonds depending on the factors prevailing in the economy. Bonds are debt instruments designed to pay interest to the investor. Their return is in the form of interest which is proportional to the risk that the investor is willing to take. Stocks are shares invested in numerous companies that are similar to bonds. An investment in stocks usually earns dividends often payable to the investors from the earnings of the company and the benefits from capital gains which are made when the shares are sold after their prices have increased over time. The price of stocks is equal to the discounted value of the present value of its estimated dividend payments. In contrast, gold bullion does not grow in value and must compete for investment capital with bonds and stocks. The returns for gold bullion are the capital gains made when the prices increase in the global gold bullion market. Gold does not perform well in a bullish market hence the prices for gold remain high when the prices of the stocks are declining.
Overview over the past 6 months
Gold Market
Gold prices hit a record high of $ 1,264.90 an ounce in late June 2010 when the ability of many European countries to finance their debt worsened and destabilized the Euro in the global financial markets (Padro, 2011). In the period between 2010 and 2011, gold production in Australia has increased by ten percent as a result of strong demand in the financial markets. Export volumes have increased by 19% to 449 tonnes over the last six months (Barisheff, 2011).
On average, gold prices have risen by seven percent over the last six months to a median of $ 1,228 an ounce. According to the World Gold Council, the gold market has been bullish over the last six months with the global gold demand in the first quarter of 2011 totaling 981.3 tonnes which was an eleven percent increase from the 881 tonnes demanded in the first quarter of 2010. The average quarterly gold prices in the first quarter of 2011 hit a record high of US 1,383 per ounce in the London market for the eighth consecutive year on the increasing trend. Demand for jewelry in the first quarter of 2011 registered a gain of seven percent from 521.3 tonnes to reach 556.9 tonnes with India and China forming the largest markets for gold jewelry (Padro, 2011).
Gold supply fell by 4 percent to 872.2 tonnes in the last six months, from the high of 912.1 tonnes in 2010.
Commercial papers
Faced with concerns about long-term liquidity, many investors in the bonds markets have shifted their investments from floating interest investments to short-term fixed interest instruments like commercial papers. Commercial papers guarantee a fixed rate of interest hence the return in the investment is predictable, unlike the investments in stocks where the return is governed by the prevailing economic conditions which influence the profitability of the businesses. Commercial papers also offer a good level of liquidity since they are easily traded in the financial markets without losing their face value. Commercial papers have become one of the most common debt instruments in the world financial markets because of the advantages to the issuers and the investors (Caouette, Altman, Narayanan & Nimmo 2011).
Currently, financial market players have different perceptions of the risk in the market which has resulted in low yields in other investments. The commercial paper market is influenced by credit quality, monetary policies, and the level of business activity in the economy. The short-term interest rate which affects the commercial paper is the Fed Funds rate and its movement in comparison with the three-month commercial paper rate. In the last six months, the total U.S commercial paper outstanding increased by 10.4 billion to reach a level of $ 1.17 trillion in May, however asset-backed commercial paper decreased by $ 2.6 billion (Padro, 2011).
Property market
The property sector was significantly affected by the recent global financial crisis which resulted from the Sub-prime mortgage lending and caused a decline in house prices. The global property market for both residential and commercial houses has enjoyed a recovery because of the stimulus packages and other monetary policies instituted by governments to end the prolonged recession (Nenova, 2010). As return expectations increase across the globe, the property market will see higher housing prices. Transaction volumes have increased during the last six months and the momentum is expected to accelerate through the next twelve months due to the improved transparency and integration in the financial markets dealing with housing loans.
The growth in the property market has been estimated to be around 1.9 percent for the U.S market and 1.2 percent for the European market (Kotok, Sciarretta &Stephansen, 2010). The European property market has experienced slow growth in recent months due to concerns about the Euro currency crisis and sovereign debt which some countries are unable to repay. Global investment volumes in the property market are estimated to exceed the US $ 440 billion for the year 2011. With the recent inflationary pressures and unclear economic outlook in most economies, many investors have returned to invest in the property market because of their low prices, which has led them to speculate for higher prices in the future. In the Asia-Pacific region, investments in the property market are projected to increase by about fifteen percent in the next 12 months. House prices globally have increased by 4.7 percent since the start of the year (Gaffney, 2011).
The ASX 200
The level of trading in the ASX 200 has been declining over the past six months due to low investor confidence in stocks. This has been driven by an uncertain economic outlook about the future performance of most of the companies operating in the economy. The dip in the prices of many stocks has also been attributed to the reduction in dividend payout by most companies and the limitation of the buy-back programs. The high Australian dollar and interest rates have also affected the ASX 200 in a negative by making the stock market less attractive to investors. The high dollar value implies that Australian shares become relatively expensive to foreign investors thus reducing foreign investment. On the other hand, high-interest rates imply returns that are less risky thus holding cash-based securities.
Outlook over the past 5 years
Gold market
Gold and silver prices have been increasing over the past five years at a rate of ten percent. The increase is driven by a rising in demand which has outpaced the supply from the mining companies. The increase over the past five years can also be attributed to the increased purchases by central banks that have been using gold as a risk free reserve (Resource World, 2009).
In 2005, investments in BHP were better compared to physical gold because of the dividends got. However, BHP has been lower than ETF gold in terms of share price but BHP was the better investment in the past five years. The ASX performance in the last five years has not been impressive. For instance, the meltdown in 2008 made the gold prices soar up leaving a gap between the oil industry, gas sector, and the ETF gold. This has remained this for the last 2 years. Over the past five years, the performance of the ASX 200 has not been impressive because many companies have resorted to the use of dividend reinvestment plans as a means of clearing debts not issuing new share capital, and raising their capital position (Wasiliey, 2011). Share price performance in the 12 months preceding March 2009 was negative 33 percent which was a decline of $ 423 billion in the value of the Australian listed equities.
Commercial papers
Commercial papers operate in three categories: asset-backed commercial papers, financial commercial papers, and corporate commercial papers. Corporate commercial paper is mostly used by firms to finance short-term needs of the working capital and inventory management, while the asset-backed commercial paper is mainly used in structured investment vehicles to securitize long-term assets (Greer, 2006). Demand for commercial papers is driven by the demand from money market funds and mutual funds which are generally personal savings. It has been stable for the last years. However, in 2007the asset fixed commercial paper rose becoming more popular as it reached $68 billion. Since the US credit crisis, it has not been steady as it has been fluctuating occasionally.
Property market
The residential property market has been steady over the last five years compared to others in the world. The Australian bank reserve has ensured that the market stays steady even with the recession and financial uncertainties. It experienced a peak level in 2007 when the investment volumes in houses were valued at US $ 795 billion (International Monetary Fund, 2009). The commercial segment of the property market experienced a housing bubble from the early 1990s to 2007 when the housing bubble collapsed due to toxic loans and other mortgage-backed assets (Gibbons, 2006).
The housing bubble had been fueled by the availability of cheap credit which was made available by the global inflow of cash and other monetary policies which, in turn, expanded the money supply in the economy. From 2007, the commercial housing prices began to decline which meant that the mortgage borrowers could not afford to resell their houses and pay back their loans. Many borrowers had to default resulting in the sector experiencing massive losses. The US government and several governments in the Eurozone instituted measures aimed at the avoidance of mortgage foreclosures of the mortgages and this helped in reviving the sector (Funston and Wagner, 2009).
ASX 200
The ASX 200 has not been that impressive in the last five years and it even avoided the recession that hit most of the economies in the globe. The ASX 200 has been falling and rising with the last and the property market in Australia has remained stabilized although it has been seen as overvalued to 63%.
From the chart above it is evident that ASX 200 was steadily moving well until it was affected by the global market uncertainty which was a result of the credit crisis in the US. However, after hitting the lowest level in 2009 it moved again upwards because of the mining sector stability.
Outlook for the next 12 months
In the next twelve months, the prices of gold will keep increasing due to the uncertainty of the global investment climate. This is due to the low economic growth being witnessed in major economies which have not fully recovered from the negative effects of the recent global recession and financial crisis. Most firms find it difficult to access finance in the financial markets through the issue of new capital due to the low share prices which will force them to issue short-term fixed interest investments like commercial papers to secure financing (Padro, 2011). The ASX 200 index fund will experience massive growth in the next twelve months due to the mixed returns which are likely to be reported in the different companies. Some companies will experience growth in share prices as the Australian economy recovers from the effects of the global recession and the US property market. However, the properties in Australia have been estimated to be overvalued by 63%.
The reasons which will make the prices of gold and silver increase are the current inflationary pressure which has eroded the returns of many financial assets. The debt crisis in most European countries has made many investors lose confidence in the performance of treasury bonds for the coming years hence most of them have been putting their wealth in short-term fixed-interest investments where the returns are predictable. The price index of short-term fixed interest investments like commercial papers and certificates of deposits will continue to increase due to the strong demand which has been witnessed in the market. Interest rate uncertainty in the financial markets will force most investors to prefer liquidity hence they will be more willing to invest in securities where the returns are guaranteed (Padro, 2011).
Potential reasons for observed performance in the short term
Gold Market
The World Gold Council has predicted that the demand for gold will expand in the coming months due to socio-economic factors which will attract many investors to invest in gold as well as uncertainty in the U.S economy and the movements in the dollar (International Monetary Fund, 2008). Another factor likely to drive demand for gold and increase gold prices is the global concern about the European sovereign debt crisis which has threatened to collapse the Euro. Global inflationary pressures and the tensions witnessed in North Africa and Asia have also affected investments in major world markets hence more investors will prefer to hold on to their wealth in the form of gold. There is also an increasing momentum in the demand for jewelry in China and India due to the beginning of wedding festivals which will spur the price of gold upwards. Many of the central banks have turned to buy gold as a method of diversifying their reserves since this option has no counterparty risk. The financial panic that has been hitting the market because of the recession would lead gold rush which has high chances of attaining unseen levels (Gibson 2006). Many investors will run for gold for safety measures when the economy is being faced with financial weakness.
Commercial paper
Demand for commercial papers is driven by the demand from money market funds and mutual funds which are generally personal savings. With a strong regulatory and monitory policy, it would be possible to move the commercial papers forward. The global markets are the ones that determine the demand for commercial papers as the global market trends determine the fluctuation of commercial papers.
ASX 200
The ASX 200 has not been performing well although it is better compared to other stock markets in the world. This has been a result of the rapid economic growth of China as well as the debt crisis that has hit the US and Europe. An increase in the interest rates and the Australian dollar has also affected the ASX 200 in a negative by making the stock market less attractive to investors. This has made the Australian shares relatively expensive to foreign investors thus reducing foreign investment.
Residential property market
In the short term, the residential property market has been affected. The debt crisis in the European countries may significantly affect commercial housing prices since most of the mortgage loans in the Eurozone are denominated by the Euro. The strength of the Australian dollar and high-interest rates has negative effect as it discourages foreign investors because it
European Debt crisis effect on the whole market
The current European debt crisis will help in increasing the price of the gold bullion since most of the central banks have been increasing their gold reserves instead of keeping the euro which is losing value. The debt crisis in the European countries will also make most of the investors whose investments are denominated by the Euro dispose of them at the prevailing prices instead of waiting for maturity. This will result in further dips in the prices of those investments due to excess supply over the prevailing demand. Most investors in stocks will have to be disposed hence the wealth will either flow to the gold bullion or the short-term fixed interest securities where the returns are predictable and high. Then the bond markets returns would fall as the bond yields fall at the same time as bond prices increases. The European debt crisis has resulted in an increase in the prevailing market interest rates due to low investor confidence in the ability of the countries to honor their debt obligations.
The debt crisis has negatively impacted the ability of the Eurozone countries to secure debt financing from the financial markets hence they have to offer high-interest rates for the treasury bonds to attract investor funds. The debt crisis in the European countries will also slightly affect the foreign investments in the ASX 200 equity fund (Weir, 2006). Most of the investors in the Eurozone may try to move their investments to other countries with portfolios not denominated by the Euro since the eventual collapse of the monetary union may lead to devaluation of the Euro and massive financial assets value losses. The debt crisis in the EU will also affect the property market since most of the mortgage-backed assets in those countries are denominated by the Euro currency. The current global trend of housing prices is on a positive note but the worsening of the fiscal crisis in the Eurozone will affect the housing prices.
Conclusion
The current uncertainty on future economic performance has made investors shift their investments from high-risk investments to low-risk investments where the returns are guaranteed or to physical properties to maintain the value of their investments. High global inflation has affected the cash investments like bonds negatively, with fixed yields. On the other hand, high inflation may be positive for stocks and property investors because of the increasing values of the underlying investments. The economic uncertainty in Europe and U.S, the global recession coupled with the recessionary trends globally, and inflation have led to the fall in the demand for stocks. The prices of the stocks are influenced by the profitability of the different firms and the ability of the firms to pay out dividends. Some companies listed in the Australian ASX 200 stock fund have not been paying out dividends due to their low profitability and restructuring of their dividend payout policies.
The availability of cheap credit fueled by offshore investments in the US-led to sub-prime mortgage lending where the investors and many companies did not assess the underlying risks in different investments in the market. After house prices came down, many investors could not repay their loans leading to high default levels and, ultimately, to the collapse of several financial institutions and massive losses in share values. The Australian property market has been strongest in the OECD region even after being hit by the recession. There are speculative forces in the commercial housing market since most of the investors want to take advantage of the low prices to make gains when the demand increases in the next few months. The debt crisis in the European countries may significantly affect commercial housing prices since most of the mortgage loans in the Eurozone are denominated by the Euro. The strength of the Australian dollar and high-interest rates have a negative effect as it discourages foreign investors because it makes the stock markets cheap. On the other hand, the weakening of the Australian dollar has a positive effect on ASX 200 because Australia is a capital importer. The weak Australian dollar makes the stock market cheap encouraging foreign investors. The overall economy of Australia is characterized by rising gas and electricity prices and capacity limitations due to high wage demands for the workers in the materials companies. This would make sure that investors make profits; this would correct the market performance by pushing it down to its original place.
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