Recession & The UK Economy

1 October 2008

Managing Director, Worldwide Financial Planning Writes:

You will perhaps remember an article I wrote in June this year. In it I put our current situation down to greed across the board. It has been most interesting that without fail, every financial commentator and fund manager I spoke to believed that supply and demand was behind the rise in market prices of oil and food i.e. commodities. I must admit to feeling like a mouse swimming against a raging current with my belief that the whole thing was driven by speculation.

The key point about the article was that commodities had remained at their average level until in 2003, they boomed. They all soared by virtually the same price with oil popping from $30 to $147. Common sense says we either had a 400% increase in population (aliens I assume) or supply had fallen by 80%. Neither were true and I pointed to the truth - investments in commodity index traded strategies had stood at $13billion in 2003. That’s the highest it had ever been. The total amount invested at May 2008 was a staggering $260 billion.

Thankfully Michael Masters presented to the Senate and this may well have unearthed the problem we have today.

One of the problems we have in society is greed and the investment banks, with their swash buckling stupidity are now being bailed out because of the potential impact they may all have in terms of packs of cards. Is it really fair? Obviously not.

It is their excessive risk-taking that has caused this situation. They have caused havoc by betting short on stocks and vice versa. Betting short simply means they move a market by betting a stock will fall. This causes unrest and as such destabilises the market. It is not the same as buying and selling stocks and shares, this is normal market behaviour and whilst causing volatility in price movements, can do no harm.

The other side to this is long speculators i.e. those who bet on the price going up via derivatives. A derivative is basically a bet on the market going up and pays a multiple of the price movement. Worse still are those who leverage to invest. Leveraging is where they basically borrow cash to invest. This creates abnormal market conditions and can drive a price upwards unnecessarily.

The downside for those who bet up or down is that when it goes the wrong way, they lose a fortune. If you marry that to their investment into buying up mortgage debt that had only one future, the lot was due to come crashing down.

For those who didn’t believe it, the evidence is now firmly on your lap. Oil bombed from $147 to $90 (all the aliens must have gone home). On Monday last week, Royal Dutch Shell announced it had increased oil production - the response? Oil increased by near 25% the following day! Explain that one.

As always no supply and demand problem here. The nervousness that so much cash was being pumped into the market by the US government, which would have an inevitable downward effect on the dollar, scared investors into oil (a normal safe haven against a falling dollar).

This creates the same inflationary problems again. Is it time to now ban this type of speculative trading? Is it time to regulate these individuals and organisations into non existence? I really hope so.

At this point all the noise is positive - many of the big US banks are agreeing that greater regulation is now essential and the fact that the US government is pumping in cash gives them that power. Mr Darling has also agreed and this week could see the rest of the world shoring up the financial banks. The alternative is not pretty.

If you have a financial query call Peter on 0800 0112825, e-mail info@wwfp.net

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'
Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
The value of shares and investments can go down as well as up.