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Sovereign Wealth Funds, Volatility and Markets


A number of ramifications will emerge from SWFs and currently concerns from protectionist measures to financial stability are being discussed.

Sovereign Wealth Funds: What They Are And Why They Matter

The recent correction in the stock market has many worried that liquidity will dry up as private equity deals diminish from their torrid pace. While this may be true, the new darlings of investment – the "sovereign wealth funds" – may pick up the slack.

Sovereign wealth funds (SWF) are basically pools of money derived from a country's reserves and set aside for investment purposes that will benefit the country's economy and citizens. The funding for SWF comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources.

Government investment funds have been rising and China's recent investment of $3 bln into Blackstone (BX) and the purchase of Barclay's (BCS) by the China Development Bank (CDB) (which also came with a board seat) shows how they want to develop their economies and will give China access to operations in emerging markets.

The numbers are staggering. For perspective, it was only five years ago governments were sitting on $1.9 trln in foreign currency reserves. This has grown to $5.4 trillion, which is more than triple the amount in the world's hedge funds. This excess cash is being moved into sovereign wealth funds and will change the landscape going forward.

A number of ramifications will emerge from SWFs and currently concerns, from protectionist measures to financial stability, are being discussed. The U.S. government has stated that the spread of sovereign wealth funds could create new risks for the international financial system.

One theme running through the SWF story is the idea that countries are diversifying from U.S. dollars and placing their funds in other, more tangible higher-yielding investments. They want to diversify their holdings and this is not bullish for the US dollar. This adds to the move by other countries that are beginning to accept other currencies for purchases of oil and other products.

I have long held the view that we will see increased volatility in many asset classes going forward. The growth of SWF could be a factor in this as Mr. Lowery of the U.S. Treasury has warned that SWF could fuel financial protectionism and has said "little is known about their investment policies, so that minor comment or rumors will increasingly cause volatility in markets."

We all know markets do not like uncertainty and we are entering a period where "deep opaque pockets" will be making bigger and more ambitious purchases through state owned companies such as Gazprom and the CDB.

Why Are Natural Resources Important For SWFs?

My focus with regards to SWF is the natural resource sector. It is well known that China is basically resource poor and needs to import many of its commodities to feed, house and mobilize their 1.2 bln people. With China set to move up the food chain it is only natural that it would use the SWF to secure its commodity needs by directly buying into companies that produce natural resources.

In a recent interview Marc Faber was stating that China will have to import most of their commodities and he looked at the price of coffee as an example and said "If the Chinese just go to the per capita consumption level of, say, the Taiwanese or South Koreans, they will take up the entire coffee crop of the world."

As both China and India grow, the demand for commodities will increase. The voracious appetite for commodities should continue and I would expect the next 5-10 years will see continued advances in many of the natural resource prices and related stocks.

Water stocks, food, timber, mining and oil should continue their bull markets and look for these SWFs to move in this direction as well to secure their commodity needs for the future. Remember, 1 bln people currently use 2/3 of the world's natural resources. 5.6 bln people use the other third. Meanwhile 3 bln are discovering capitalism and want "stuff."

During this time, while the stock market is taking some heat, I am gathering my list of names in each sector and will share these with you going forward each week.

Water, oil and energy, food and metals are still in bull markets and I expect another leg higher in many of these will occur sooner rather than later.
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