Quarterly Investment Report - Qtr ending September 2006

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

Whilst by no means can we be categoric, our pessimistic predictions for the UK/world economy now appear to be becoming a reality.

The MPC raised rates by a quarter of one percent to 4.75% on 3^rd August against a background of rising UK inflation - CPI inflation picked up to 2.5% in June, and was expected to remain above the 2.0% target for some while.

At long last, the relentless rises in US interest rates appear to have brought about an end to US house prices rises. We expect the MPC to raise UK rates again in November and anticipate that that will bring a similar consequence to the boom in UK property values.

The following edited extract from a Speech by John Tiner, Chief Executive, FSA made at the FSA Annual Public Meeting on 27^th July makes interesting reading:

“The data remains mixed but there is evidence, for example, to suggest an increased risk of sharp, and possibly coincident, corrections in a number of asset classes and areas………added to this are the risks arising from unprecedented levels of consumer borrowing not just at home but in the US and elsewhere. The secured lending market in the UK continues to remain sound but heightened concerns are emerging in the unsecured market, especially among younger people who generally cannot look to the rising housing market to cushion their risk. This, coupled with the evidence from our financial capability baseline survey earlier this year that just over half the population aged over eighteen are not prepared to meet unexpected challenges like a drop in income, as well as the need to provide for their retirement, makes for a worrying picture that could quickly become a reality if, for example, the labour market was to deteriorate significantly.”

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 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. Rising US interest rates. Falling US Treasury prices.

Positive: UK rate rises may peak at 5% later this year.

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 perhaps to be 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 turn. 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.