Quarterly Investment Report - Qtr ending June 2007

Foreword

Certainly there is never a time where there aren’t positive and negative factors affecting either the global economy, the UK or individual securities for that matter. The art is balancing these “for and against” factors and deciding which is likely to dominate and thus cause downwards or upwards movements in stocks.

Commentary

UK inflation, as measured by the Consumer Prices Index (which started in 1997), hit a new high of 3.1% at the beginning of the quarter. Another key measure of inflation (now somewhat sidelined following the adoption of the CPI by the UK Government as its principal inflation measure), the Retail Price Index, jumped to 4.8%, it highest level since July 1991. These movements signal likely further increases in UK interest rates and some analysts have base rates at 6% within a couple of months. Certainly a further ¼%/½% rise by the end of May has been factored into the prices of existing fixed interest securities, but no more than that.

The CPI's movement outside the +/-1% target range prompted the first explanatory letter from Mervyn King to the Chancellor and this makes interesting reading. The Governor details that around half of the recent increase in inflation can be attributed to rising household energy and food costs, but as the former occurred in the main nearly a year ago, they will shortly fall out of the annual account and thus he expects CPI inflation to fall back within a couple of months. However, he goes on to identify risk in areas such as rising output prices (with businesses attempting to redress their profit margins following increases in their input costs) and wages. Our opinion is that the rising cost of home acquisition is likely to put significant pressure on wages.

Outlook

As we see it, the following are the major positives and negatives affecting individual asset classes/Sterling:

Sterling

Negative: Rising UK inflation.

Positive: Rising UK interest rates. US$ will have to fall further to correct US trade deficit.

Our view: That the £ will strengthen against the US$ and remain broadly static against other major currencies.

Variable interest

Negative: Rising UK inflation.

Positive: Rising UK interest rates. Safe haven relative to other asset classes. Base rate still above inflation.

Our view: Hold existing deposits. Add to cash through asset disposals.

Fixed interest

Negative: Rising UK government borrowing. Rising UK inflation. Rising UK interest rates. Rising US inflation. Falling US Treasury prices.

Positive: UK rate rises may peak in the near future.

Our view:  Reduce fixed interest holdings.

Equities

Negative: High levels of consumer debt. Rising bankruptcies and repossessions. Rising raw material costs.

Positive: Expected UK GDP growth in 2007 in the region of 3%.

Our view: Sell cyclical stock. Hold defensive stocks.

Index-linked

Negative: Relatively low UK inflation rates.

Positive: Rising inflation.

Our view: Hold index-linked gilts. Buy 2^nd line index-linked securities.

Commodities

Negative: Significant rises have already occurred in commodity prices. China’s consumption of oil and raw materials may reduce. Threat of a world economic downturn.

Positive: Increasing demand of late for raw materials especially in growing economies such as China. Limited refining capacity for oil.

Our view: Hold commodities.

Gold and Silver

Gold

Negative: Denominated in US dollars.

Positive: World economic uncertainty.

Our view: Hold Gold.

Silver

Negative: Declining use in photographic film as digital photography gains popularity. Increased mining of lead, copper and gold on the back of higher prices will lead to an increase in silver production as a by-product. Denominated in US Dollars.

Positive: Increasing demand given increasing applications for the metal in areas such as power generation, water purification applications and biocides. Just off an all time low relative to Gold. Last year was the 14th in a row that demand for silver outstripped supply. Silver ETF has now been launched on the US market.

Our view: Buy Silver, albeit that gaining exposure is difficult.

Property

Residential

Negative: Ratio of UK property values to earnings is substantially above its historic trend. Penal UK Stamp Duties. High levels of consumer debt. Rising repossessions and insolvencies. Rising UK interest rates.

Positive: Anticipated influx of EU workers into the UK. More buoyant private rental sector with First Time Buyers being either unable to get onto property ladder or awaiting a fall in prices at bottom end of market.

Our view: Sell residential property.

Commercial

Negative: Penal UK Stamp Duties. Rising Gilt yields. Weakening tenant demand in certain areas/sectors (retail and manufacturing). Analysts predict little capital growth in the immediate term. Many investors now committing funds to this asset class. Worsening economic background. Rising UK interest rates.

Positive: Expected UK GDP growth in 2007 in the region of 3%. Stronger tenant demand in certain areas/sectors (offices).

Our view: Sell commercial property.