Henley Financial Market Outlook

Monthly Market Outlook February 2012

The Henley OutlookFebruary 2012

THE WEALTH MANAGEMENT PROFESSIONAL

The financial world watches like a deer caught in the headlamps as Greece plays another game of chicken, this time with some of its hedge fund creditors in the negotiations on private-sector involvement in re-structuring its sovereign debt. Time is now fast running out. Will one side pull the pin, or will one side cave in?

2The Henley Group Pte Limited30 Cecil Street, #23-01 Prudential Tower, Singapore [email protected] www.thehenleygroup.com.sgA MAS licensed investment adviser in Singapore

The Henley Outlook: Hong Kong, Singapore & Shanghai


Fixed Income Investment Grade

High Yield

Property

Equities US

Japan

UK

Europe Ex UK

Australia

ASEAN

Greater China

Brazil

Other Emerging Markets

Commodities Energy

Precious Metals

Industrial Metals

Agriculture

Alternative Investments

Key: Positive Neutral Negative

Overview

Student accommodation only

Selective strategies only

ASSET CLASS HOUSE VIEW REMARKS

Broad equity exposure including the region preferred

The Henley Outlook




Global Overview

“’HOW dId yOU GO bANKRUPT?’ bILL ASKEd.‘TWO WAyS,’ MIKE SAId. ‘GRAdUALLy ANd THEN SUddENLy.’”“The Sun Also Rises” (1926), Ernest Hemingway (1899-1961)

The financial world watches like a deer caught in the headlamps as Greece plays a game of chicken with some of its

hedge fund creditors in the negotiations on private-sector involvement in re-structuring its sovereign debt. Time is now

fast running out. Will one side pull the pin, or will one side cave in?

Greece is now thought to be demanding that its creditors swallow losses on par value of up to 90%, as we forecast here

last August (not the 50% “agreed” at the October summit). Some hedge funds are holding out because, rather than

swallow such losses in a so-called “voluntary” deal, they would prefer Greece to default and trigger payouts on the loss

insurance (credit default swaps) which the hedge funds have bought, turning their losses into profits (and bonuses).

So high are the stakes that I expect a way will be found to buy the hedge funds out (probably in secret) so preventing

a default that would trigger the credit default swaps, and without the associated and very real risk of many dominoes

around the world toppling – not least among those the European Central Bank itself.

It is a complex game with a large number of players with numerous different motives - and more than one hand grenade.

Meanwhile, in the interbank market, the year has started with a slight improvement in the stresses in the system. The

new President of the European Central Bank, Goldman Sachs alumnus, Mario Draghi, has wasted no time in both reducing

interest rates and injecting nearly half a trillion euros into the European banking system in its Long-Term Refinancing

Operations (three-year loans at 1.0%). This takes some of the pressure off sovereign and bank financing pressures at a

time when France, Italy and Spain alone need to refinance EUR 425bn of sovereign debt before the end of April. Yields

have fallen. Even so, nine European sovereigns and even more banks have had their credit ratings downgraded in recent

days. It’s not pretty.

“IT’S A bATTLE OF THE POLITICIANS AGAINST THE MARKETS. bUT I’M dETERMINEd TO WIN THE bATTLE.” Angela Merkel, 06May10

Directly or indirectly then, the European Central Bank is giving euro zone governments and banks the money that the

rest of the world has been taking away. As a result, its balance sheet has expanded by the equivalent of more than USD1

trillion in six months, to USD 3.5tn. This compares with the US Federal Reserve’s balance sheet of “only” USD 2.9tn.




Over the past three years, the central banks have succeeded in engineering a decline in interest rates. The trouble is,

eventually, the cost of servicing your rising debt reaches the limit of your income, and you cannot borrow any more, even

at rates close to zero. When the borrowing stops, the printing begins.

We are now in that transition.

There will be another round of European Central Bank Long-Term Refinancing Operations this month. It is expected to

be just as huge as the first.

The inflationary/debasement dangers, which such balance sheet expansion represents, should not be underestimated.

The US, UK, European and Japanese central banks are all walking a tightrope between, on the one hand, injecting

enough liquidity into the system to restore integrity to the banking system, and, on the other, printing too much and

causing a hyperinflationary collapse. We must all hope their sense of balance is impeccable!

Rather than just hope, however, like a broken record, we continue to urge our clients to accumulate gold and silver in their

portfolios. The monetary metals have proved themselves over millennia to be the ultimate hedges against inflation. Year

to date, the dollar has already fallen 9% versus gold, and 16% versus silver.

Chancellor Merkel may be determined to win the battle; but – not for the first time – the markets may force a different

outcome.

In this Year of the Dragon, please mind the flames!

Peter Wynn Williams

Investment Director

[email protected]




USd Index (Source: Bloomberg)

Cash and Currencies

Summary• Risk off saw the USD stronger against all major pairs.

• The troubles in Europe are perceived to be a greater risk than troubles in USA at present and therefore the EUR is

suffering as a result.

•AUD fell below parity with the USD and is trending lower. Poor data from China has cooled the outlook for Australia’s

exports.

• The SGD weakened against the USD, underlying intervention is trying to keep the SGD from gaining against the USD.

• Illiquidity tends to occur around the festive season as few participants are in the market. This can lead to heightened

volatility and sharper moves. Equally, traders may be looking to enhance their profits for the year before their bonus

is calculated!

HENLEY ASSESSMENT:Unchanged. Negative USD, GBP and EUR over medium-to-long term against a trade-weighted basket of currencies. The euro is unlikely to continue in its current form.




Fixed Income

Positives• ECB surprised the market by injecting the largest amount of credit into euro zone banking system. As a result, 523

banks borrowed a total of EUR 489bn (USD 639bn) at rate of around 1% for an exceptionally long period of three years.

• Euro zone banks parked a record of EUR 452bn at the ECB as they favoured the safety of central banks’ deposit facility

over lending to each other’s on the interbank market.

•Germany paid a negative return at its debt auction for first time as European debt crisis worsened. Apparently, some

institutional investors are willing to pay the German government to keep their money rather than earning a return on

their investment. Germany auctioned EUR 3.9bn (USD 5bn) of six-month bills at an average yield of minus 0.0122%.

Negatives• Credit ratings agencies continued to undermine rescue efforts in euro zone. Though hardly any surprise, S&P’s

downgraded nine sovereign countries which include stripping France and Austria of their triple-A ratings. Investors will

further scrutinise credit worthiness of the EFSF bailout fund and commercial banks in the region.

•Negotiation on debt restructuring between Greek government and its private creditors broke off after failing to agree

how much money investors will lose by swapping their bonds. A disorderly default by Greece is still an imminent threat.

HENLEY ASSESSMENT:

Negative. Most bond investors were cautious on the outlook of sovereign bonds of Portugal, Ireland, Italy, Greece and Spain (PIIGS), but one year ago not many would have expected the contagion fears spreading to France. Yield spread between 10-yr France sovereign and its German counterpart rises to more than 200bp for the first time since EUR was created. Germany failed to get sufficient bids at an auction of USD 8.06bn of 10-yr bonds, giving rise to heightened borrowing costs in Europe and lower EUR on concerns of debt crisis in euro zone. In this perspective, European debt crisis has worsened.

We believe political risk will remain high and credit will further tighten in Europe in H1 of 2012. Besides the struggling sovereign nations, European financials are also required to settle/rollover USD 700bn of public market debt over the next nine months (as shown in graph above) in rather challenging market conditions. THG is concerned about the deleveraging process in the overall developed markets.




Property

Positives•As property prices continue to rise in Singapore, the Government has just announced an Additional Buyers Stamp Duty

(ABSD) for private property of between 3% and 10% for Singaporeans, permanent residents, and foreigners, to slow

down the rise of the property market. The ABSD is in addition to the current Buyer’s Stamp Duty of 1% to 3%, and the

government have stated it is designed to moderate investment demand for private residential property, and to prevent

future volatility. Foreign purchasers, who accounted for 19% of all private residential property purchases in the second

half of 2011, will now pay an additional 10% ABSD for any residential property purchases.

• Knight Frank reported that Central London luxury home prices gained 0.8% in December, representing a 14th

consecutive month of rises. This demand for prime property is a reflection of ongoing global economic uncertainty,

and a smaller number of properties for sale. Prime Central London prices gained 12.1% in 2011, and are up 40% since

the market’s low in March 2009.

•With interest rates likely to remain low in many countries, properties commonly enjoy positive rental yields, compared

to the cost of finance.

Negatives • In the US residential property market, the seasonably adjusted Case-Shiller Index fell by 7.42% from a year earlier, and

by 1.61% in the latest quarter. The index’s co-founder Robert Schiller recently commented to Reuters: “I do not know

what will happen, but I don’t see any reason to predict a recovery now.” Freddie Mac expects the US housing market to

decline over the following months, due to the large inventory of houses with delinquent mortgages.

•According to Lloyds Banking Group, UK property values dropped 0.9% to an average of GBP 160,063 in December, the

lowest since July 2009. Values fell 2.2% in 2011. The Bank of England has suggested the problem is rising unemployment

(at a 17 year high), and the Euro-area debt crisis, which is undermining confidence, and property demand. This is at a

time when banks are expected to toughen lending terms because of strains in funding markets.

• Chinese home prices fell for the fourth consecutive month in December (0.25% month on month) after the Government

reiterated plans to maintain property curbs. However the price falls are steep in some areas. Average prices in Shanghai

are down around 40% from their peak in mid-2009. In Beijing, nearly two years of inventory is clogging the market, and

more than a thousand real estate agencies have closed this year.

• The Hong Kong Government has suggested that the cooling measures enacted to slow the rise of residential property

prices may be eased in 2012. This follows the news that Hong Kong’s property prices dropped to a six-month low,

reflecting the success of the government’s policies. Samsung Securities Asia expects property prices in Hong Kong

to drop by 10% to 15% next year, but they are unlikely to see any sharp corrections as mortgage rates (although still

rising) are still below average rental yields, and the mortgage loan to value ratios are still low by historical standards.

HENLEY ASSESSMENT:Neutral.Propertypricesgenerally,aftersignificantfallsin2009,stabilisedin2010and2011.Propertyvalueshaverecovered in selected areas such as Asia, but fundamentals remain weak elsewhere. However, we still consider some specialised property assets (such as student accommodation/ground rent income) to merit inclusion in our portfolios. Other than these investments, we would suggest that clients do not invest further at this time.




Equities

US

Positives•US economy highly flexible, resilient and leads world in technology and innovation.

• Federal Reserve has forecast rates unchanged until at least late 2014.

Negatives•Deterioration of US fiscal position continues (national debt: USD 15.3tn).

•Housing market in depression, foreclosures rising again (median home price in Detroit: USD 6000).

• Real incomes falling (down 7% in four years), total unemployment rising.

• Political system dysfunctional, no appetite for tax increases or spending cuts (election year).

HENLEY ASSESSMENT:Negative. Going into 2012, challenges facing US economy are growing, but Congress appears unable or unwilling (or both) to do anything. There is a growing popular perception that the system is broken and that the markets are bothriggedandblatantlycorrupt.Theglobalenvironmentisdeflationary,andtheonlyavailableresponseismoneyprinting/currency debasement/inflation – classic, textbook recipe for hyperinflation sooner or later (cp,WeimarGermany 1923, Zimbabwe 2009). Increasingly, the only rational option may be to opt out.

JAPAN

Positives• Japanese machinery orders in November rose 14.7% compared to previous month, beating expectations by nearly

10%. The significant increase is attributed to overseas orders from businesses, such as rebuilding Japanese factories

in Thailand after the flood.

• Japan’s economy rebounded from a recession in Q3 by expanding 1.5%. The world’s third largest economy grew by

an annualised 6% after three consecutive quarters of contraction. Net exports contributed 0.4% to GDP growth, first

positive contribution in five quarters due to rebuilding efforts after the earthquake and tsunami. Private consumption

grew a stronger-than-expected 1.0%.

• JPY 12.1tn (USD 157bn) additional budget is now in the government to be passed by end of November. Recovery in

Japan will largely depend on the effect of public spending in its largest rebuilding effort since WWII.

Negatives• Corporate governance is on the spotlight with the accounting scandal of Olympus continuing to appear in the headlines.

• Japanese government sold an estimated record JPY 7.7tn (USD 100bn) in its currency intervention, but its effect turned

out to be short lived as JPY is now trading at below JPY77.

• Japan’s sovereign debt is set to surpass JPY 1,000tn (USD 12.81tn), or 200% of its GDP by the end of this fiscal year.

HENLEY ASSESSMENT:Negative.Nikkei 225dropped15.6% in 2011andunderperformedmost equities in theAsia Pacific region.Weexpect the slower growth environment likely to persist and more mergers and acquisitions by Japanese companies in 2012. The growth potential lies in the cash-rich conglomerates as they expand their foreign investments on the backdrop of strong JPY and low interest rates.




UK

Positives•UK services, manufacturing and construction gauges showed growth in Dec11, indicating that the economy has

improved slightly.

• BoE maintained its benchmark rate at 0.50% and held the asset purchase target at GBP 275bn following its policy

meeting.

•Although BoE is expected to ultimately increase its gilt purchases, it is predicted that it will delay announcing any plans

until February when it reviews economic prospects and issues its quarterly inflation report.

Negatives•UK’s GDP contracted by -0.2% in 4Q11, mainly due to manufacturing and construction. Services flat.

• Industrial production dropped in Oct11 and Nov11 attributed to declines in the output for mining, quarrying and

utilities sectors.

• Imports from countries outside the EU hit another record high. UK has found it hard to wean itself off imports despite

a fall of about 25% in the value of the pound since the recession.

HENLEY ASSESSMENT:Negative. With demand showing few signs of revival, economists and financial market participants expect the asset-purchase programme to be extended to at least GBP 325bn. A core problem has been deficient growth, which has persistently fallen short of expectations and kept unemployment at high levels. The BoE has revised its expectations of the future level of UK GDP 16 times running in each of its quarterly forecasts over the past four years. It is this assumption of persistently low growth from the government forecaster – not the weakness in the recovery thus far – that has forced ministers to prolong the austerity drive.

EUROPE Ex UK

Positives• ECB provided banks nearly half a trillion euros of three-year money in Dec11, called LTRO, and will make a similar offer

in Feb12.

• ECB President Mario Draghi stated that a massive liquidity injection is helping the euro zone’s banking system

substantially and supporting confidence in the bloc’s economy.

• Italy sold EUR 12bn of Treasury Bills, meeting its target, with the rate on the one-year bills plunging to 2.735% from

5.952% at the last auction of similar- maturity securities in Dec11.

•German exports gained in Nov11 and business sentiment in France climbed from a two-year low in Dec11.

Negatives• S&P’s lowered the top ratings of France and Austria one level to AA+, with “negative” outlooks, downgraded Italy,

Portugal, Spain and Cyprus by two steps and cut Malta, Slovakia and Slovenia by one level.

•Hungary received its second sovereign-credit downgrade to junk when S&P followed Moody’s in taking the country out

of its investment grade category in Dec11. The yield on its 10-year notes rose 21 bp, the highest since Jun09.

• Private-sector bondholders in Greece have warned that time is running short to clinch a deal on a voluntary debt

exchange, which is necessary to secure international aid and avoid a messy bankruptcy when a major bond redemption

comes due on 20Mar12.

HENLEY ASSESSMENT:Strongly negative. Mario Draghi has announced boldly that the euro zone is “showing some signs of stability” after the injection of liquidity from LTRO. However, his victory lap over his efforts to improve liquidity and stabilise European credit markets seemed premature as more than 90% of the cash was deposited back to the ECB instead of being used forlending.S&P’sdowngradesarelessanegativeverdictonthefiscalpositionsoftheindividualcountriesandmoreanindication of the shortcomings of the euro zone’s collective leadership in dealing with the crisis.




AUSTRALIA

Positives•US commitment to keep interest rates at virtually zero for some time are creating clear a drag on USD. With risk

appetite buoyant, commodity prices remain strong and equities climb, encouraging traders to invest in high-risk, high-

yield assets such as AUD.

• Interest rates likely to start rising again to curb increasing inflation due to demand pressures and skilled labour scarcity

driving up the pace of price rises.

•Mining boom remains alive and well and, if anything, is strengthening with the terms of trade continuing to rise and

set to further boost mining sector profits. Impact feeding through economy via higher wealth levels and dividend

payments, higher employment, higher tax receipts and higher business investment.

Negatives• Strong AUD making it very difficult for tourism, agriculture, wine and other exporters to compete. As a result, the

economy is now very reliant on one industry.

•Any slowdown in Chinese and Indian growth (and related commodity demand) will send base metal prices and the AUD

tumbling.

•As interest rates rise to address inflation may very well result in the highly-leveraged Australian property bubble

bursting, putting bank balance sheets under a lot of pressure.

HENLEY ASSESSMENT:Negative. The global economy is now cooling which will hurt Australia’s economy which is highly linked with the rest of the world. Falling commodity prices are not making matters any better and in particular Chinese demand for raw materials looks set to moderate near term.

ASEAN

Positives• Indonesian domestic consumption contributes approximately 62% of the economic output. According to Bank Indonesia,

thecountryisexpectedtoachieve6.5%GDPgrowthin2011and6.3%in2012onaYoYbasis.Inflationarypressureshave

eased to 3.8% in December, the lowest since April 2010 while the reference interest rate was kept at record low of 6%. Bank

Indonesiahassufficientroomtoaccommodateeconomicgrowthgivenhighratesofinflationnolongeranimminentthreat.

• Indonesia sovereign ratings up from BB+ (non-investment grade) to BBB- (investment grade) was attributed to the improved

economicperformance,betterfiscalpositionandstrengthenedeconomicfundamentalsofthenation.

• Thailand’scabineton27December2011hasapprovedtheTHB350bnpost-floodbudgetproposedbythegovernmentto

improve infrastructure and water management in the country. The purpose of this budget is to avoid any repetition of the

massivefloodingthathashappenedinrecentmonths,andtorestoreinvestors’confidence.

Negatives• Philippines’ November exports contracted 19.4% YoY, with electronics exports declined 34.5% YoY, following a 36.5%

YoY drop in October. Philippines consistently underperformed other NJA electronic exporters, particularly in 2011.

• Thailand’s cabinet has also agreed to the government’s proposal to transfer the THB 1.14tn debts incurred from the

1997 financial crisis banking sector bailout into the Bank of Thailand (BoT) balance sheet. This may help to reduce

Thailand’s debt-to-GDP ratio however, it may force BoT to print more money to repay the loan causing higher inflation.

• Singapore’s economy shrank for the second time in three quarters as manufacturing eased, increasing pressure on

policy makers to spur growth as they forecast slower expansion this year. Singapore’s manufacturing sector declined

for the sixth straight month in December.




HENLEY ASSESSMENT: We remain neutral. Although they are exposed to a sharp slowdown in the developed world that can affect exports, but we continue to think domestic demand within ASEAN will hold up better.

GREATER CHINA

Positives• China’s CPI inflation eased to a

fifteen-month low of 4.1% YoY

in Dec from 4.2% last month,

broadly in line with market’s

expectations. It was due to

deceleration of non food prices

growth. Food prices picked up

from 8.8% YoY in Nov to 9.1%

YoY in Dec. CPI for the fiscal

year averaged 5.4%which was

above Beijing’s official annual

target of 4%.

• Pilot program for RQFII and mini-QFII scheme was launched which allows qualified investors to raise RMB funds in

Hong Kong and invest in China’s security market. This provides an opportunity for offshore RMB flowing back to China’s

capital market.

• Loan growth gained 15.8% YoY in Dec, after a straight decline for eight months, compared with 15.6% gain in Nov.

The growth was due to stronger lending in Dec and the lower base from last year. More liquidity freed to the banks

encourage lending due to the RRR cut. M2 gained 13.6% YoY in Dec compared with 12.7% gain in Nov. Both loan and

M2 growth beat market consensuses.

Negatives• Exports in China grew 13.4% YoY (in line with market consensus) while imports grew 11.8% YoY in Dec (worse than

market expectations). The deceleration growth in imports reflects the slowdown in domestic investment demand and

weaker commodity prices. For the fiscal year, exports gained 20.3% and imports gained 24.9%.

• China’s monthly trade surplus was at USD 16.5bn up from USD 14.5bn in Nov. For the fiscal year, trade surplus was at

USD 154.9bn (2.1% of GDP), the third consecutive year of a declining trade surplus, down from the high of USD 298bn

(6.6% of GDP) in 2008.

• Taiwan’s export growth slowed in Dec to 0.6% YoY from 1.3% in Nov, worse than market expectation, due to deceleration

in mineral and transportation equipment exports. Exports to China fell 4.0% in Dec compared with 3.3% in Nov. Trade

surplus narrowed from USD 3.2bn in Nov to USD 2.3bn in Dec.

•Hong Kong’s export growth in Nov slowed to 2.0% YoY, lower than market consensus, compared with a decline of 11.5%

YoY in Oct. Retail sector has been resilient and the real payroll per person in retail trade sector rose 8.2% YoY in 3Q11

compared with an overall 1.6% increase for all industries.

HENLEY ASSESSMENT: Neutral. Inflation in China continues to show signs of easing but it is still early to make a conclusion. Nevertheless, a deflationary environment allows more room for policy easing. Trade growth in China is expected to slow further in 2012 and combined with falling commodity prices, imports may see more deceleration. Election in Taiwan and Hong Kong pose political change for 2012.




bRAzIL

Positives•Over the last two decades the poverty rate in Brazil has halved. With this, income inequality (measured by the Gini

coefficient) has also fallen sharply, declining on average by 1.2% a year. This is in contrast to most western developed

economies where the disparity between the poor and the wealthy has been increasing in recent years. Ultimately

pulling more people out of poverty and creating a larger middle class will be very beneficial for Brazil as it continues to

develop its own internal markets.

Negatives• BRL remains very volatile against USD.

• Brazil’s stock exchange has suffered from capital outflows this year amounting to USD 6bn – the second-worst

performance among emerging markets after China.

• The Brazilian Bovespa index has fallen 22% this year, compared with a 0.3% decline in the S&P 500 and a 3.4% decline

in the FTSE 100.

HENLEY ASSESSMENT:We remain neutral on Brazil. The country is in the enviable position of being self sufficient in many commodities and has a large and growing middle class. However, Brazil is reliant on commodity prices and evidence suggests emerging markets are far from immune when the going gets tough in the developed world: this is evidenced by the equity returns YTD in the Bovespa.

OTHER EMERGING MARKETS (SOUTH KOREA, INdIA, RUSSIA)

Positives• Russia’s key refinancing rate was lowered by 25

bps to 8% in Dec given downside risks to growth

and easing inflation concerns. CPI inflation in Nov

decelerated below market consensus to 6.8% YoY

compared to 7.2% in Oct.

• Korea’s CPI remained at 4.2% YoY in Dec

unchanged from Nov’s reading. For the fiscal year,

CPI was 4.0% up from 3.0% in 2010.

• India’s industrial production rebounded from the

worst month since Mar09, better than market

expectations, increasing 5.9% in Nov YoY compared with 4.7% decline in the previous month. Food-price index fell for

a second straight week at 7.40%, declining 2.9% in the period ended 31Dec YoY.

Negatives•According to Russia’s Ministry of Finance, its federal spending in Dec amounted to nearly 20% of the annual federal

budget spending compared with 18% in Dec10 and 15% in Dec09. This led its budget surplus to an equivalent of 0.8%

of GDP. The rise in fiscal spending was due to capital outflows and conversion of savings into foreign currency.

HENLEY ASSESSMENT:Neutral. According to Financial Supervisory Service, the average capital adequacy ratio of 18 Korean banks dropped 0.23% to 14.17% while the Tier 1 capital ratio declined to 11.45% as at end of Sep11. This deterioration may attribute to increase in loans, but it is indicating an early sign of weakening in banks’ capital ahead of Basel III adoption in 2013. Inflation in India remains a concern and interest rate may be kept unchanged unless there are signs of inflation easing in 2012.




CommoditiesENERGy

Positives• Long-term supply sources uncertain as several exporters are turning into importers.

• Tension is increasing between Iran and the West.

•Debasement of currencies will support real assets.

Negatives• The macro outlook remains fraught with risk.

HENLEY ASSESSMENT:We upgrade to positive. Friction between Iran and the West is increasing. The Iranian threat to close the Strait of Hormuz, through which around 17 million barrels of oil is shipped per day, could seriously compromise global oil supply in the short-to-medium term. Reports that Iran is enriching uranium in an underground facility near the city of Qom means that armed intervention by Israel and the US is a distinct possibility in 2012. Open armed conflict would easily push the oil price though USD 150/bbl.

PRECIOUS METALS

Positives• Still no sign that a credible solution to the European debt crisis is within reach.

• Coin sales from the US mint is very robust.

•Gold and Silver are a good hedge against financial instability and possible monetization of sovereign debt.

Negatives• Temporary USD strength will put pressure on the gold price.

HENLEY ASSESSMENT:Positive. Despite the recent volatility, we remain strongly positive on precious metals. Banking stress in Europe remains high. The difficulties experienced by Italian Bank Unicredit in terms of raising equity paints a bleak picture for other European banks that will have to improve their capital positions during the year. We expect central banks and retail investors to add to their bullion positions throughout the year which will support prices. More monetary easing on both sides of the Atlantic remain the most likely policy response to the crisis, leading to further currency debasement and, of course, higher bullion prices.




INdUSTRIAL METALS

Positives•Ample liquidity will support base metal prices.

Negatives•Macro uncertainty and risk aversion will continue to keep base metals under pressure for some time to come.

•A recession in Europe in 2012 is likely which will affect exports in Asia.

HENLEY ASSESSMENT:We maintain our neutral view on base metals. While copper imports by China surged to a record in December on stockpiling, we remain mindful that China will face a difficult year trying to maintain a healthy growth rate amid signs of a weaker housing market. We continue to favour real assets over financial assets and prefer monetary metals over industrial commodities.

AGRICULTURE

Positives• By 2030, the UN estimates that demand for

agricultural products will be about 60% higher

than today.

•Developing markets are seeing an increase in

annual protein intake of 11%–15%.

• In 2030, China’s meat consumption will be more

than double the 1997 levels of 41kg/person.

•We now have about half the arable land per person

that we had 40 years ago.

Negatives• Prices are subject to many uncontrollable risks, eg,

weather and natural disasters, politics and other

pests.

HENLEY ASSESSMENT:Positive: A rapidly-growing global population and the rapidly-developing emerging world underpin the long-term prospects of the agricultural sector globally. However, due to the vagaries of weather, politics and acts of God, this will always be a high-risk sector in which diversification is essential.




Alternative InvestmentsPositives•With 2012 gearing up to be one of the most

unpredictable years in recent times, it could be

easy for hedge fund managers to be distracted

from the ongoing rumble of the regulatory

express. In fact, in the shadow of lurching global

markets, hedge funds are poised for particular

full legislative programme, with key dates for

Dodd-Frank and Fatca in the US; short-selling,

derivatives and the AIFMD in Europe; and

master fund registration in Cayman. Throw

in a handful of significant national elections,

and the 2012 calendar is one most industry

professionals will want to keep an eye on.

•We do not expect 2012 to be less emotional

than 2011. As a result, systematic and model-

based kind of managers could continue to

outperform. Strategy-wise these managers are

to be found in the quant, CTA and global macro

buckets.

Negatives•Unsurprisingly, tempered performance expectations are echoed widely. It is suggested by a global survey from

HFMWeek that a “Focused” or “Cautious” optimism for 2012 hedge fund returns. With interest rates at very low levels

and prices being driven by macro and especially, political factors – rather than fundamentals – it could be difficult for

some strategies of hedge funds to produce alpha that we have seen in the previous decade. Meanwhile, the extreme

volatility we have seen in 2011 has caused some managers to rethink their hedging strategies and reduce basis risk.

• Returns in 2011 ended negative overall, memories of 2008 are not-so-distant and there have been only two reasonable

years in between. Fees are still relatively high and most of investors feel dissatisfied given the low level of performance.

HENLEY ASSESSMENT:Positive. It is still incumbent on hedge funds to prove that they can, in fact, generate returns that are ‘independent’ of whether broader markets are going up or not. So, we can put forward global macro, distressed credit and event driven as widely tipped successes for 2012, while systematic funds are also expected to continue to magnetise investment.

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