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Stick with bonds and look East Back  
Aidan Clare is encouraged by rumblings in the bond market and remains keen on the Far East, at least for now.
At the turn of the year this column suggested that a re-emergence of inflation would be the surprise of 1999. Since then oil has been up nearly 75% from its lows and commodities like copper which fell from $3065/tonne to $1375/tonne over 5 years, are up over $200 from their lows. Commodity currencies like the Australian and Canadian Dollar have soared and the bond markets reaction has been a creaping bear which has eroded all of the October crash gains and some more. US 30 year treasuries are now back to levels last seen in Autumn 1997. The surprise in many ways is how little notice this has received.

I suspect however that bonds are close to their lows for now. One piece of encouragement comes from the gold market. Gold which is a good forward indicator of the bond markets fortunes, saw its largest one-day fall in 5 years recently on the back of an announcement that the UK intended selling half of its gold reserves. For many years the global central bank community has done its utmost to keep gold soft, not just because they see it as an historical reserve asset class but also because it acts as a refuge in inflationary times. As such gold strength (as last seen in 1992/93) can be an early indicator of bond falls (in 1993/94, the worst bear market of the last two decades). For this reason, a soft gold market is favoured by central bankers, and this has partly motivated recent sales. Ironically the UK’s announcement should have been ‘old hat’ to the gold market, as most countries have taken similar steps over the last few years. However, the fact that it hit gold hard suggests to me that new lows beckon and bonds therefore look good for now.

The stock market has continued higher with the Dow ratcheting up another 1,000 point hurdle at 11,000. The Far East, not just Japan and Hong Kong, continues to outperform and remains my favoured area. A pause in the US market appears likely at minimum now though, especially with bonds close to their bottom. I expect a trading range in the US equity market in late May/early June on the Dow Industrials.

Y2K has fallen from the market’s eye though I think it has been a component in commodity price rises of late. I expect it to rear its head more widely again over the summer with stock markets being a potential target, but more of this next month.

The Euro has shown little sign of positive reaction to the events of recent months. One might have thought that the departure of Lafontaine and the substantial rate cut would have helped. The first confirmed a more independent ECB, the latter move being confirmation that ECB would play its part in restoring European growth. Neither has had much impact. Often one of the clearest market signals comes when an instrument fails to rally against positive news. The story for the Euro therefore, is likely one of long term losses unless Europe can restart its anemic economies. As with Japan, this will require a sea change in attitude and substantial labour market restructuring which is a long way off. For now the Euro however looks technically oversold, so I see a good chance of it revisiting levels of 1.1100 USD and 0.6800/50 GBP (i.e. a 3-4% rally). Thereafter however, the future looks bleak and new lows versus both currencies should be seen.

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