A September rebound

- "Equity markets rebounded nicely in September, sending the S&P 500 and the S&P/TSX into positive territory for the year to date. However, there is still fog on the recovery track. First and foremost, there is no clear guidance on the extension or otherwise of the Bush tax cuts set to expire at the end of this year. Households remain in limbo as to whether their disposable income will take a hit in three months."
- "Uncertainty about tax policy is weighing on both consumer and business confidence. Volume retail sales have stalled in recent months and investment is decelerating. The ongoing softness of recent economic data has led to a period of downward earnings revisions for both S&P 500 and S&P/TSX. This is likely to last the rest of the year."
- "Fortunately the Federal Reserve has committed to provide more liquidity if needed. The prospect of new round of quantitative easing by the U.S. central bank will in our view guard against a double dip. We continue to see the U.S. economy accelerating in the first half of next year. Our asset mix is unchanged from last month. Equities remain market weight for the time being as we wait for the political dust to settle in the United States."
- "Unconventional action by the Bank of Japan and the Fed’s new commitment to provide more liquidity if needed show a new tolerance for competitive depreciation of national currencies. This significant development argues for relative strength in precious metals. We are upgrading our allocation of gold stocks to overweight. At the same time we are reducing our holdings of Industrials to market weight."

World: Monetary policy eases further

- "Global growth will moderate in 2011. Emerging Asia will remain the driver. With inflation on the whole still tame and, especially, with developed economies slowing, the major Asian central banks are probably not being reckless in giving monetary policy a further expansionary turn."
- "With the U.S. economy halfway back to its previous peak, cyclical forces are fading. A fog of uncertainty about next year’s tax rates is modifying the behaviour of households and businesses. The U.S. is entering a slow-growth trap, with real growth unlikely to exceed 2% annualized in the second half of 2010."
- "The Canadian recovery has reached maturity. Real GDP, employment and domestic demand have all passed their pre-recession peaks. On the other hand, U.S. growth is slowing just when Canada has moved from recovery to expansion and the first signs of cooling have appeared in domestic demand growth. We expect Canadian GDP growth to slow from 3%-plus in 2010 to its approximate cruising speed of 2% in 2011."

China’s 12th Five-Year Plan: Investable shift from growth quantity to growth quality

- More evolutionary than revolutionary "With the aftershocks of the Global Financial Crisis and “global imbalances” still reverberating through international markets, and with China having recently attained the status of the world’s second-largest economy, investors are looking toward October’s release of China’s 12th Five-Year Plan for key guideposts. Yet investors may need to temper expectations. With China well along in its market development, the days are gone when Beijing could exactly determine China’s economic path; and much of the new plan’s thrust should be a continuation of the economic rebalancing initiatives laid out in the 11th Five-Year Plan (2006–10) – a policy bias already well known to markets, and thus in many cases largely priced into listed equities."
- Investable themes – from growth quantity to growth quality "Still, we believe China is marking a path where the quality of growth – in terms of composition, efficiency, and environmental impact – now commands more attention at the margin than sheer quantity. This includes efforts to rebalance aggregate demand toward domestic consumption and service-sector activity from export manufacturing and investment. This implies reduced material- and energy-intensivity, to be effected in large part through higher factor costs – such as wages, energy/utility tariffs, land, and (potentially) capital costs. While these initiatives will generate relative winners, they may also imply downward pressure on margins generally, and a decline in China’s overall profits-to-GDP (which rose precipitously over the past decade). As in recent years, we expect to see continued emphasis on rural reform and Western-regional development – a policy bias that will continue affecting patterns of consumption, credit growth, and construction / investment activity, among others."
- The search for net-yet-fully priced plays "We distil these themes into a select list of ‘Top 25’ Five-Year Plan stocks (Figure 3, page 4). Key among these are names involved in 1) new energy vehicles, 2) clean power (including gas, wind, coal-to-liquid), 3) western-regional development and/or urbanization into lower-tier cities, 4) urban rail build-out, 5) medical system expansion, 6) private consumption and retail mall development, and 7) financial innovation. Yet, as noted, many of these themes are already well known to the market. In the effort to identify outstanding value, we filter our ‘Top 25’ for 1) historical PER discounts larger than the current MSCI China discount of 8%; 2) historical P/BV discounts of 30% or more; and/or 3) a PEG ratio (based on three-year 2010–12E CAGR) below MSCI China’s 0.6x PEG. By these standards, relative value among Five-Year Plan beneficiaries is found in Dongfeng Motor, ABC, Minsheng Bank, Sinoma, Guangshen Railway, Mindray, PetroChina, Longyuan Power, Dongfang Electric, Shenhua Energy, and China Coal Energy."

Italy: Public finances on track

- "After the solid performance in 1H 2010, we have revised slightly up our GDP growth call from 0.9% to 1.0% in 2010, and from 1.0% to 1.1% in 2011. However, our outlook envisaging a moderation of growth in the second half of this year remains safely in place."
- "Data on the labor market remain mixed and do not suggest that a genuine turning point has been reached yet. The unemployment rate seems close to peak, but recent dynamics of inactive people and labor force are less encouraging."
- "Even taking into account the statistical discontinuities introduced in June by the Bank of Italy, bank lending to households and non-financial corporations recorded a further improvement in recent months, confirming that the credit recovery is proceeding on the expected path."
- "After the remarkable surge in July, Italy’s CPI inflation edged down mildly in August to 1.6% yoy. The core inflation differential vs. the eurozone has widened over the past year. Producer prices accelerated further but surveys suggest that some moderation might lie ahead."
- "In the Focus section we analyze the details of the budgetary correction that had been unveiled in May and that was approved by the Parliament during the summer. The commitment on expenditure-cutting measures is encouraging, but implementation risks call for close monitoring ahead."

Fed has more flexibility after last week’s statement

- "Last week, NBER officially declared the end of the US recession in June 2009. Ironically, it was the same week in which the Fed said that it’s prepared to take additional action if needed (p.2, p.3 & p.4)."
- "This week’s focus is on the US ISM manufacturing index on Friday, on the euro zone CPI estimate on Thursday, and on the UK manufacturing PMI on Friday (p.2, p.3 & p.4)."
- "The Chart of the Week shows the Federal Reserve’s and Bank of Japan’s total assets outstanding as a percentage of nominal GDP. Last week’s FOMC statement showed that the Fed is ready to act if needed. The possibility that the Fed will purchase additional Treasuries in the coming months has therefore clearly increased. Indeed, it feels as if these ‘unconventional’ monetary policy measures are getting almost conventional given that the Fed already engaged in quantitative easing in 2008. The chart shows that the Fed acted aggressively as financial markets were in a deep shock that year. The chart also shows that while the BoJ has acted far less aggressive over the last few years, the total assets/nominal GDP ratio is still well-above that of the Fed. Over the last few months, the Fed slowly moved towards last week’s message that they are “prepared to provide additional accommodation”. Financial markets likely interpreted this as if additional quantitative easing will be coming (soon). Consequently, the USD depreciated last week to 1.35 against the euro. In addition, the downward trend of the USD on a trade-weighted basis that started in 2002 seems to be still intact. That said, although it remains uncertain whether the Fed (if they act) will be as aggressive as in 2008, additional QE could result in a further drop of the USD."

Non-commercial investors turn marginally long EUR

- "The latest IMM data cover the week from 14 to 21 September."
- "JPY longs remained in place after the BoJ intervention: The intervention from Bank of Japan that sent USD/JPY from 83 to almost 86 was not enough to square long JPY positions. IMM data show that speculative JPY net longs remained in place last week, reaching 20 percent of open interest. The market looks increasingly likely to re-test the central bank as USD/JPY is gaining downside momentum."
- "Non-commercial investors turn marginally long EUR: For the first time since December last year speculative investors are net long the euro. Net long positions have reached 3 percent of open interest, as improved risk sentiment - and increased concerns about the potential effect of QEII on the dollar – has sent EUR/USD higher to trade near 1.35. IMM data indicate that there is plenty of room for a further build-up in EUR longs, although we suspect that investors will be cautious adding too much EUR exposure as long as Euroland debt uncertainties remain high."
- "Commodity currencies still vulnerable to position squaring: September’s risk rally, which has seen the S&P500 index gain almost 10%, has coincided with a further build-up of long positions in the commodity currencies. Net longs are now at 69 percent in NZD, 50 percent in AUD, and 29 percent in CAD – indicating that these high beta currencies are becoming increasingly vulnerable to a potential position unwind. A trigger for this could be a sell-off on the stock market, which our equity analysts see a high risk of over the coming months."

Fed QE2? Fun for bonds, pain for the buck

- FI Strategizer: "After the last FOMC meeting, 10Y US and Bund yields are almost back to end-August levels. To justify lower yields from here, a worsening growth outlook (unlikely given next week's data), more stress in the EMU periphery, or additional hints on QE would be needed."
- EU Portfolio Strategy: "Hopes for QE2 provided strong support to EGBs this week. The EMU index is up +4.79% YTD and the excess return of our active portfolio is +20bp. It is difficult to find arguments in favor of a trend reversal: we stay moderately long duration."
- MM: "We expect investors to only partially roll over the EUR 93bn coming from expiring 6M and 12M LTROs. Excess liquidity and maturity of ECB operations will likely fall. Expect a moderate increase in MM rates."
- Italian 4Q funding: "We present a detailed analysis of Italian 4Q10 funding. Supply pressure should focus mainly on the short end and the 10Y, while it should be limited at the extra-long end."
- Trade Idea: "We suggest switching from OBL Apr15 into OBL Oct15 given the appealing benchmark roll. Furthermore, on the Spanish curve, the 15Y has cheapened to an interesting level vs. the 10Y and 30Y."
- FI Special: "We discuss how much haircut is discounted in current periphery spreads vs. Bunds."
- Supply Corner: "Next week, there are no redemptions in the EMU. Gross supply should be rather subdued, ca. EUR 9/12.5bn, mainly coming from Italy. The US will issue USD 100bn in Treasuries at the 2Y, 5Y and 7Y."
- Inflation: "The September flash estimate should show an acceleration from 1.6% to 1.8% yoy. The move should be totally energy-driven."
- FX Strategizer: "The FOMC statement, hinting at a possible restart of QE, instilled a negative bias in the US dollar, but selling pressure may be partly mitigated by local risk factors, FX trading should thus stay choppy."
- EUR: "Risks that our long-run target of 1.36 may be reached much sooner than expected are concrete if US data disappoints, but renewed EMU woes, involving primarily Ireland, may still slow the EUR-USD rise."
- JPY: "Risk of aggressive BoJ intervention if USD-JPY retests 83 should discourage heavy USD-JPY sales, even in case of a firm Tankan survey. EUR-JPY still capped above 113-115."
- CHF: "The USD-CHF drop below 0.98 should spill over to EUR-CHF and frustrate any recovery attempt even if EUR-USD remains firm. Selling both USD-CHF and EUR-CHF on a rally is still recommended."
- GBP: "Cable may still benefit from the weak USD towards a 1.5850 test. EUR-GBP should mostly remain capped above 0.85-0.86."
- Pacific Rim: "Commodity currencies should remain favored against the USD, but a partial correction is required before buying them back."
- Nordics: "More consolidation is expected for EUR-SEK between 9.15 and 9.25. EUR-NOK to offer selling opportunities above 7.93-7.95."
- TICS Monitor: "Long-term net inflows to the US amounted to USD 61bn. Last month's appetite for Treasuries & Agencies was reconfirmed."

Treading water before breaking the range

- "Lead indicators lost some momentum over the summer; the ISM has softened and the Euroland PMIs have started to come down from their highs. But arguably the equity market has moved to discount this ahead of the softening. Returns on equities have been on the weak side this year especially in the context of very strong earnings growth; the SXXP is up 5% year to date. We see a number of positives that should help support European equities in 2011:
1. We expect the US growth picture to improve modestly through 2011 and for concerns about a double dip to fade. Our US economists’ forecast 1.5% annualized GDP growth in 1Q2011 but by 4Q2011 they forecast growth of 3.0% annualized. The drivers of growth should also become more sustainable, US growth in 1H2010 was driven by inventories and fiscal policy whereas by end-2011 we expect more private sector demand. This more solid foundation for growth should ultimately stave off
fears of a double dip that have plagued markets for the last two years.
2. Loose monetary conditions: Our US team expects the funds rate to stay in a zero to 25 bp range through year-end 2011, as economic growth averages less than long-term potential rate and inflation continues to recede. They also expect the FOMC to resume unconventional policy easing – most likely by purchasing at least US$1 tn in Treasuries.
3. European economic growth remains robust. Despite the slight moderation in the survey data, the level of growth remains strong and there is evidence that the cycle is moving away from pure dependence on exports; in the last quarterly GDP breakdown, Germany and France saw a strong investment recovery.
4. Equities still provide attractive potential returns as the risk premium embedded in share prices remains high in our view. We expect some of this value to be realized through buybacks, increased dividends and/or M&A. Companies have strong balance sheets and plenty of firepower and increasingly those companies making strategic acquisitions are rewarded.
5. Earnings estimates have been revised up through 2010 and we also expect 2011 to be another strong year for earnings. Global growth on our economists’ forecasts remains high and companies still have catch-up growth to come through from the downturn, capacity utilization is still low in many sectors. We have updated our profit model and forecast 23% earnings growth in 2011 versus 16% for the bottom-up consensus.
- "Given this picture we upgrade – or probably fairer to say roll-on – our 12-month price target for the SXXP to 320 from 300. This would provide 23% price returns on European equities from the current level, 26%-27% including the dividend. We expect this to be driven by strong earnings growth rather than a rerating in the market, as is typical in this phase of a market recovery. It would still leave the market 20% off the highs in mid-2007."

Flow of funds for Q2/CY2010: continued expansion in the private sector’s financial surplus

- Flow of funds for Q2/CY2010: continued expansion in the private sector’s financial surplus
• "Amid the remaining uncertainty about the economic outlook, Japanese firms have continued to favour debt restructuring"
• "Importantly, their appetite for liquid financial assets, i.e. cash and deposits, has remained robust, constraining business fixed investment"
• "Foreign direct investments, such as direct and portfolio investment, have continued to increase and are now 11.5% of total financial assets, the highest level since 3Q08"
• "The financial surplus in the private sector, including households and depository financial institutions, amounted to 46.5 trillion yen (40 trillion yen in Q1/CY2010), well exceeding the government sector’s financial deficit of 34.7 trillion yen"

- Another drop in manufacturers’ capacity utilization
• "Capacity utilization rate among manufacturers dropped for the second consecutive month to the lowest level since last December"

- Demand for Funds Remains Weak
• "Bank lending continued to drop, falling 2.0%yoy in August, reflecting the weak demand for funds among the private corporate sector"

Dovish FOMC puts more downward pressure on the USD

- "The FOMC’s hint that more QE may be coming in November sent the USD into a renewed decline against all the traditionally more risky currencies, with the EUR, AUD and Scandis leading the way. It is hard to oppose this trend short term even though the USD is reaching very cheap levels. The USD made a new historic low against the CHF this week, but it seems likely that more risk positive currencies will perform better next week as a more positive risk tone emerged at the end of the week. The AUD is in focus as parity approaches, but there is better value in the NOK and SEK. GBP should also be a strong performer as EU related payments are expected to push EUR/GBP lower. The US ISM on Friday will be the main data focus, with some chance of a USD recovery both on a weak and a strong number."
- "The USD fell against all of its G10 counterparts after a more dovish Fed FOMC statement and decent global macro data boosted demand for high yielders and commodity currencies. Along with the NOK and AUD, the SEK and EUR were the best performers, logging gains of between 2% and 3.5% vs the greenback. Sterling strengthened vs the CAD and USD but dropped 2.3% vs the EUR. GBP has now dropped 3.3% since the start of the month and now trades at levels last seen right after the general election in May (0.8550). The BoJ declined to comment whether it intervened but a spike up to 85.30 in USD/JPY on Friday left little to the imagination. Chinese premier Wen met with US president Obama but resisted pressure on country’s slow progress on strengthening the yuan."
- "The FOMC kept policy unchanged but subtle shifts in the accompanying statement revealed greater concern over the present suboptimal level of inflation, giving the market fresh ammunition to believe that a new and potentially more far reaching asset purchase initiative is unavoidable. UK data were fairly thin on the ground, with lower house prices and falls in mortgage lending underlining the soft path in housing market activity. The public finances showed a marked £15.3bln rise in August borrowing as a result of higher interest payments. The MPC minutes revealed no change and showed member Sentance repeating his preference for an immediate rise in Bank rate."
- "Core bonds staged a turnaround from last week with the FOMC statement triggering a buying spree in the long end, resulting in flatter 2y/10y and 10y/30y yield curves. Failing to establish a foothold near one-moth highs, yields and swaps plunged on Wednesday on speculation of Fed easing down the road. Profit taking in risk assets and record spreads for Ireland and Portugal over bunds also stirred demand for G3 paper. 5y swaps closed below 2.10%, having traded as high as 2.29% on Monday. The 2y/10y swap curve flattened back below 180bp. The 3mth libor/Ois spread held steady at 23bp. Telefonica issued £400mln 2029 at 170bp and GdF sold £700mln of 2060 at 115bp over. Coventry Building Society and GE Capital also issued £400mln in 2022 and 2017 maturities."

The Decoupling Debate And Its Consequences

- "If decoupling just means a bigger growth differential between emerging and advanced economies, then decoupling is becoming more and more apparent: we expect Emerging Markets to generate 2.3 ppts of the world’s 3.7% GDP growth rate this year, and a bigger share next year."
- "More EM growth is coming from domestic spending, and this should reinforce concerns about inflationary risks. Although some EM inflationary pressures can be absorbed by rising imports, we think that some dangers may lurk here, partly because of the consequences of the 2010 global food price shock."
- "A number of EM central banks should be hiking rates over the next several months, but resistance to rate hikes among a number of EM central banks appears to be growing. One crucial reason for this is likely the fear of higher levels of unwelcome capital inflows."
- "So the dilemma is this: either you keep rates too low and raise the risk of asset bubbles; or you hike rates and suck in yield-seeking capital inflows. Either way, emerging currencies seem bound to strengthen over time, in spite of more aggressive fx intervention by many EM central banks in the short run. One consequence of this is likely to be more experimentation with controls on capital inflows."

Pension Solvency and the Long-End

- "Government bond yields fell sharply in August, contributing to a further easing of financial conditions. US 10-yr Treasuries reached our forecast of 2.5%, before bouncing higher. Valuations are now roughly ‘fair’, according to our Bond Sudoku model."
- "The prospect of further quantitative easing by the Fed, amid ongoing uncertainties over the trajectory for growth, argue against a quick reversal of the rally. But, based on our global macro projections, we think the cyclical trough for bond yields has already been seen. We forecast a steeper US 2s-10s curve than the forwards are discounting. We would position for a flattening of the 10s-30s Gilt curve against Germany. This ‘box’ spread has co-moved with the level of rates lately."
- "The rally over the past month was amplified by asset-liability management flows, particularly in continental Europe. We have commented on these dynamics in our weekly Bonds Snapshot publications. Here we present our updated Pension Solvency Indices, which help track changes in solvency positions through time and across regions."
- "Peripheral EMU markets have been volatile again, but the market has been much more discriminating than it was in May-June. Ireland is under pressure because of the contingent liabilities from banks. Portugal and Greece are suffering from growth concerns. But Italy and Spain are now participating in the rally. We have recommended long positions in 10-yr Italy vs. France, and in 30-yr Greek bonds, which already discount a substantial credit risk premium."

The implications of extended QE

- Overview: "A raised probability of further QE by the Fed extends the potential upside for US Treasuries slightly. We recommend unwinding short UST versus Bund trades but retain our outright short Bund recommendation."
- US Rates: "With an increased likelihood of further Fed balance sheet expansion we examine the likely structure of such a move and its potential impact."
- Euro Rates Strategy: "On a relative basis we are more worried about Portugal than Ireland. We suspect the market will find it much easier to believe in the risk/reward of being short Portugal than long. Italy remains our long of choice."
- Sterling Rates Strategy: "Speculation of further QE in the UK looks overdone. We suggest fading the recent strong performance of short-term sterling contracts and the belly of the gilt curve."
- Global Inflation Strategy: "TIPS break-evens are vulnerable if market expectations for QE are disappointed. 10yr euro real yields look historically attractive versus TIPS. Euro linker issuance for 2010 is around 80% complete."
- APAC Rates Strategy: "We continue to recommend flattening trades in Asia: 7s30s swap curve flatteners in JPY and 3s10s via futures in AUD."
- Flow Analysis: "Buyers of Europe remain more confident than buyers of the US, where net demand has been weak recently. In Europe, Italy, followed by Germany has seen the strongest net buying over the past month."
- Month-End Index Projections: "We expect a significant increase in the EGBI at the end of September. At a country level we see the largest weighted duration increases in France, followed by Italy and Germany."

TOPIX Core 30 outlook and key points

- "The TOPIX Core 30 briefly fell to 441 on 1 September before subsequently rebounding. Concerns about a further downturn spread when the index broke through the November 2009 low of 457, but ultimately it did not fall that much, indicating that investor pessimism may have peaked. With the wave count pointing to a consolidation phase ahead of the next rally, we think the index will lack direction until around Oct–Nov, when the next nearterm (four-month) cyclical bottom is due. However, we think there is greater potential for a rally now that forex intervention by the government and BOJ has brought yen appreciation to a halt. Whereas defensive stocks have outperformed since April, the charts have started to point to a turnaround for economy-sensitive and export-related stocks. As such, we think investors would do well to gear themselves for a change in market trends."

• "Defensive stocks in the ascendancy since April, but this may change: Defensive stocks have been in the ascendancy since April, but we are gradually starting to see signs of change. For example, Kansai Electric Power [9503] posted a new high for the year in September, bucking the downturn in the  market as a whole, but technical indicators such as the RSI (25-days) started to flash red, and performance relative to the TOPIX also showed signs of peaking out."
• "Charts already giving off positive signals for some economy-sensitive and export-related stocks: By contrast, some economy-sensitive and export-related stocks have started to show signs of bottoming. Indeed, some charts have already begun to give off positive signals. For example, Shin-Etsu Chemical [4063], Komatsu [6301], Nissan Motor [7201], Honda Motor [7267], Canon [7751], and Mitsui & Co [8031] have broken through the upper limit of the resistance band (cloud) on the daily Ichimoku Kinko Hyo equilibrium chart, and their MACD based on share prices relative to the TOPIX has moved into positive territory or moved upwards within negative territory. Companies such as Nippon Steel [5401], JFE Holdings [5411], Sony [6758], and Mitsubishi Corp [8058] appear likely to join this group in due course."
• "Other stocks for which charts are giving off positive signals: Meanwhile, the charts have started to give off positive signals for stocks other than those sensitive to the economy and exports, including Japan Tobacco [2914], Astellas Pharma [4503], Tokio Marine Holdings [8766], Mitsubishi Estate [8802], Nippon Telegraph and Telephone [9432], and NTT Docomo [9437]."
• "No need for excessive pessimism despite ongoing downside risks for some stocks: By contrast, we see ongoing downside risks for some stocks, including megabanks such as Mitsubishi UFJ Financial Group [8306], Seven & i Holdings [3382], Toshiba [6502], Toyota Motor [7203], and East Japan Railway [9020]. However, we see no need for excessive pessimism, as most are stocks that look to be trading in their bottom range over the longer term and/or stocks with limited downside risk, based on technical indicators."

Spanish Banks: Deleveraging and the misallocation of capital

- "We are cutting our rating on SAN to Neutral from Outperform and reducing our target price to €11.75 from €12.25. While SAN has emerged as one of the main winners in the current financial crisis, we are concerned that it is now so big that structural growth is likely to decline and it may face marginally declining returns. We note Brazilian profitability might be slowerthan-expected."
- "We continue to have a cautious view on the Spanish economy and the domestic banks. An overleveraged private sector and structurally high unemployment are likely to affect banking results. We think the banking system is facing a significant deleverage process and the adjustment in the real estate sector is not yet complete which will likely translate into higher credit losses. We think the structural profitability of the banking system has been permanently impaired and we do not expect the domestic banks to meet their cost of capital in the next two years at least. Money illusion relating to negative real interest rates is partly responsible for the lack of recognition of certain credit losses and for unusually high (and unsustainable, in our view) net interest income relating to the carry trade."
- "The Cajas sector has started restructuring but this might be a long process. We think the market is underestimating the execution risk and costs associated with the integration process. We believe some institutions might lose money and require extra equity over time."
- "SAN is one of the leading banking franchises in Europe, in our opinion, but we believe that any excess capital generated is likely to be directed to increase size through non-organic growth; this strategy may not necessarily create value for shareholders in the long term. We believe it would be more difficult for the shares to continue to outperform."
- "Stock Calls: We maintain our Underperform rating on all the pure domestic Spanish banks we cover and our Outperform rating on BBVA."

Why The Gold Price Rally Will Continue

- "Gold prices hit a new all time nominal high this week. We believe this rally has further to run. Indeed at the end of June we highlighted why gold prices would need to surpass USD1,455/oz to be considered extreme in real terms and hit USD2,000/oz to represent a bubble."

- "For the time being we believe the drivers of this rally are fundamental rather than speculative. However, we admit physically backed gold ETFs are playing an important role in the gold market."

- "However, we view interest rate and exchange rate trends as gold price bullish. Indeed history would suggest a collapse in the US dollar can not be dismissed out of hand. Moreover central banks have become a new source of gold demand while gold mining companies remain committed to closing their hedging programmes."

Moving closer to QEII

- Market Movers ahead
• "We expect the US ISM to decline to 54.5 after the surprise increase in August."
• "In Euroland, PIIGS will probably remain on the radar screen. On the data front, focus will be on inflation."
• "In Asia, the release of China’s two manufacturing PMIs and Japan’s Tankan will be in focus. We expect a confirmation that the Chinese economy is currently bottoming out and a gain in the Tankan index for Japan’s large manufacturers."
• "A lot of data out of Sweden including retail sales, PMIs and the NIER surveys."
• "In Norway particularly credit growth and retail sales should attract attention."
- Global Update
• "The FOMC statement struck a more dovish tone than expected. We now see a new round of quantitative easing as the most likely outcome."
• "In the Euro area, focus has centred on Ireland and worries about the costs associated with restructuring in the banking sector."
• "The global slowdown is now being felt in the manufacturing sector in core Euro area countries. German PMI and Ifo expectations posted declines."
• "Tensions between the US and China have intensified. The US is unhappy about the slow appreciation of the yuan."
• "In Japan, the prospects of new quantitative easing in the US has led to a stronger JPY. This puts pressure on both the BoJ and the Ministry of Finance."
- Focus
• "In this week’s focus article we take a closer look at Danish house prices. Prices are currently in line with the level predicted by our fundamental model. This is however all due to the historically low level of interest rates." 

A year of drifting… but better times beckon

- "For frontier market equities, 2010 has been a disappointing year. After rallying early in the year, the MSCI Frontier Markets (ex-GCC) index has steadily underperformed the emerging markets index and is flat for the year versus a gain of 6% for GEMs. This puts the frontier markets on track to underperform the larger emerging markets index for a fourth consecutive year."
- "Some success stories, but many markets have struggled. Sri Lanka, Bangladesh, Estonia, Argentina and Kenya have all benefitted from a combination of supportive political developments and a recovery from oversold conditions last year. Many Eastern European markets have lagged, as have Kazakhstan, Jordan and Lebanon."
- "The macro outlook continues to improve. Economic output in the frontier economies is recovering more quickly than expected, with average growth now expected to exceed 4% next year. Inflation has picked up modestly but remains close to historic lows, while current account deficits are back to sustainable levels in most countries."
- "Valuations: still reasonable if not cheap. Frontier market earnings have not rebounded as quickly as they have in emerging markets and thus the region’s discount to EM has closed somewhat. However at 12.3x trailing earnings and 1.7x book value, the index remains at a significant discount to both its own history and EM peers."
- "Low volumes, high correlations. Trading volumes have been muted, and frontier markets are not providing much diversification with the 40-week correlation to global markets now at an all-time high of 80%. We do not expect either trend to last however."
- "With the growth story largely intact, frontier markets look positioned to outperform. Our top markets are Nigeria, Argentina and some of the “value” Baltic/Balkan markets, especially Estonia and Bulgaria. We also like Kazakhstan and Kenya. Preferred frontier market stocks under coverage include: Galicia (Argentina), Halyk Bank (Kazakhstan), Hikma (Jordan), Kazmunaigas (Kazakhstan), Nova Kreditna Banka (Slovenia) and Solidere (Lebanon). Indirect plays on frontier markets that we like include Afren, Aggreko, CETV, Millicom and MTN Group."

India: The four good reasons that explain the hike in the key benchmark interest rates

- "The Reserve Bank of India has just carried out its fifth consecutive interest rate hike since March 2010, continuing the withdrawal of a significant part of the stimulus implemented during the financial crisis. This very gradual monetary policy tightening seems logical in an environment where inflation is relatively high and where prices of financial assets are rising sharply. Furthermore, the interest rate hike does not endanger the domestic financing of the fiscal deficit (which is declining markedly) at reasonable borrowing costs. A likely appreciation of the rupee will probably not adversely affect India’s price-competitiveness for exports, which has improved against India’s trading partners during 2010. If the current macroeconomic environment (i.e. high nominal GDP growth, high inflation, negative real interest rates, lowering budget deficit and rupee stability) persists, more gradual monetary tightening in the months to come will be very likely."

US Mid-Terms: Still The Economy, Not The Tea Party

- "The Tea Party movement, the latest manifestation of a deeprooted tendency in the US, is now set to dominate coverage of the run-up to the 2 November Mid-Term elections."
- "But we doubt that its recent successes in the Republican primaries will have any significant impact on the outcome of the Mid-Terms where the economy will remain pivotal."
- "Overall, it remains our view that the Republicans are likely to secure a majority in the House of Representatives but will struggle to do likewise in the Senate."
- "Irrespective, we anticipate gridlock in Congress through to 2012, even though a Republican majority in one or both houses would be an incentive to reach compromises with the Democrats."
- "Most importantly to sentiment in the short to medium term, we look for agreement to be reached on extending all the Bush tax cuts for 12 months once the Mid-Terms are out of the way."
- "Beyond that, we expect little agreement on fiscal policy other than, possibly, more help at the margins for business."
- "We also expect bipartisan agreement on keeping the pressure on the Administration to take more punitive action against China’s alleged “currency manipulation”."
- "We do not expect possible Republican efforts to repeal healthcare reform to be successful."
- "Legislation to limit carbon emissions now looks unlikely; so the Administration may resort to regulatory measures."
- "Sarah Palin, the Tea Party’s de facto leader, appears to be positioning herself to run in the 2012 Republican presidential primaries. We do not dismiss her chances."