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04 October 2023

Economic contagion is likely

By Paul Murphy


Go on – look through to the other side. Peer through the gloom, ignore the carnage to your left and right – look straight on, forward, to the future and to what might be.


Easier said than done, you might appeal. And with some justification.


Over the past two weeks, in New York and across the major European stock exchanges, traders and investors alike have witnessed the type of price volatility that comes maybe once in a generation. Not a day goes by without fresh proclamations that Western capitalism, as we now know it, is fast approaching a sticky end.


I am not one to dismiss as overdone the predictions of more dangerous contagion across various parts of the financial sector. If and when one of the big specialist monoline insurers, which helped put an artificial gloss on so many intrinsically dangerous credit derivatives goes bust, then I think a big bank or two will follow suit.


What is more, I personally believe we will see contagion in a general economic sense, that sub-prime woes will spread to car loans, credit cards and so on. And things will spread across borders and continents – no doubt about that – because decoupling is a myth. So there is no particular reason to rush and join the recent crop of commentators popping up to say “things really aren’t too bad. The indicators are not pointing to a protracted slump… cheer up”.


But you can peer through the gloom. You can look ahead to more normal times, and ignore, for the moment at least, whether those normal times might arrive in one, two, or even five years. And if you can do that, adjusting your investments accordingly and forcing yourself to take a long-term view, the rewards can be great.


This simple fact came to mind while reading a thoughtful oil and commodities research report published last week by T Okoshi, an economist at Japanese bank Nomura. Okoshi was carefully evaluating the possible impact on crude prices, metals and soft commodities from changes in investment fashion – notably the growing sophistication and global diversity of wealthy individuals and also sovereign wealth funds. 


One point was striking: “…we look at nine commodities – crude oil, gold, copper, zinc, nickel, aluminum, wheat, soybeans and corn. Annual trading on these markets amounts to $19 trillion (Dh70trn).


Given that daily trading value on global forex markets comes to around $1trn to $1.5trn a day, these markets are still relatively small.” Now look at the two tables from the Nomura report – reproduced here – one detailing major pension funds’ asset allocations to commodities, the other showing the shifts in overall asset allocations of the world’s high net worth individuals.


Two points are worth highlighting.


Firstly, regarding pension money allocated to commodities, not only do the portions remain relatively small in the scheme of things [just three per cent, for example, in the case of Britain’s biggest pension fund, BT], but these investments are either very recent or have yet to be even made. Indeed, while America’s Harvard University Fund aims to have an impressive 13 per cent of its investments in commodities, it does not envisage actually getting there until 2017.


Secondly, as far as high net worth individuals are concerned, we can assume the shift into commodities has barely begun. For 2006, according to Merrill Lynch and consultants Capgemini, some 10 per cent of the assets of the world’s wealthiest people were spread across so-called “alternative assets” – namely structured finance products, hedge funds, derivatives, commodities, private equity and venture capital.


Is it too simplistic to say that the trend here looks like a one-way bet? I, personally, would say “No,” in the longer term. The pension funds cited in Nomura’s report are among the most sophisticated in the world, whose changes in investment approach are gradually adopted by other smaller funds across the world. And, as far as the high net worths are concerned, even in the short term we can speculate that within the “alternative assets” category certain opportunities like structured financial products have rather lost their appeal of late.


But there is an important caveat to make here. Okoshi notes that with the growth of sovereign wealth funds in particular, there is a strong trend towards funds that derive their wealth from the likes of oil and important metals actually investing in oil and metals. While the exact effect is difficult to measure, it may be that oil and commodity prices are being supported to some degree by those who own the resources.


So the Nomura economist is at pains to note that if there is a pronounced and extended global recession, the downward effect on oil and commodity prices could be something of a double-whammy.


But that is getting distracted by all the gloom around us. And I explained above that it was important to stop doing that!



Paul Murphy is associate editor of the Financial Times.