GLOBAL MARKET OUTLOOK
July 24, 2006

Currencies: Fighting in the Middle East dominated currency trading in the past week. Two Israeli soldiers were captured by Hezbollah guerillas in a clash near the Lebanese border. Israel retaliated by attacking Lebanon, bombing parts of Beirut, including Beirut International Airport. Hezbollah then fired rockets into northern Israel, hitting major cities such as Haifa and Nazareth. A number of civilians were killed on both sides of the border.

Currency traders reacted to the fighting by initially buying US Dollars as a safe-haven investment. As the week came to a close, however, it appeared that Israel easily had the upper hand in the battle. It also became apparent that the conflict was not going to spread from Lebanon. Many experts were predicting that the fighting would be over in a matter of a few weeks, or even, possibly, a few days. Consequently, traders reverted to economic fundamentals and the Dollar began to sell off.

Prior to the fighting in the Middle East, any relative strength held by the Dollar had come from favorable interest rate differentials: the US Federal Reserve has continually raised interest rates over the past two years, in the face of strong US economic performance, while other central banks had been hesitant to raise their own rates. With the US rates above those of other developed nations, traders shifted their capital to the Dollar.

This year, however, we have seen the other developed economies begin to improve while the US economy has started to show some signs of slowing. European economies will probably grow at an average of 2.5 percent to 3 percent (annualized) for the remainder of the year, while growth in Japan has exceeded three percent in each of the past two quarters. Consequently, foreign central banks have recently been raising their interest rates while the Fed may be nearing an end to its own increases. As interest rate differentials begin to narrow, the Dollar could lose steam.

The Dollar's course, for the rest of 2006, will certainly depend on US economic performance. In 2001-2002, when the economy last stumbled and business spending dried up, US consumers managed to keep the economy afloat (consumer spending accounts for two-thirds of total US GDP growth). Consumer spending, in general, was propelled by increased consumer debt, with borrowing against both home equity and credit cards making up most of the debt.

This time, the consumer may not be able to support the economy. Higher energy prices, especially gasoline prices, have cut into consumers' budgets, while house prices seem to have topped out, reducing home equity. Higher interest rates could also curtail household borrowing. Higher wages and additional jobs might offset these factors to some degree but, on balance, consumer spending should grow at a slower rate than in the 2001-2002 period. Meanwhile, business investment should grow during the remainder of 2006, but we do not believe it will be enough to offset the slowdown in consumer spending.

Federal Reserve Chairman Ben Bernanke testified before Congress on Wednesday and Thursday and his comments were encouraging to Dollar bears. While Bernanke remains concerned about inflation, he also indicated that he thought the economy was showing signs of a slowdown. Thus, traders now believe the Fed will not raise interest rates again when the Fed next meets in August.

Thus, had the Middle East remained quiet, we probably would have seen the Dollar again start to weaken. We feel that the Dollar, at current levels, could be near its highs of the year.

One factor, which has concerned economists in the past, but which, we believe, should not be a concern, is the US current account deficit. We believe that growth in the deficit should slow as foreign economies begin to improve and US exports to those countries expand. In addition, foreign investors should continue to be willing to finance the deficit. May was a case in point: net foreign purchases of US securities totaled $69.6 billion in May, more than the $63 billion supposedly needed to finance the deficit, well above the $58.4-billion level expected by economists, and substantially above the $51.1 billion worth of net security purchases in April.

Precious Metals: Gold initially followed the Dollar higher, on news of the Middle East fighting, reaching a high of 676 dollars on Monday, July 17. But, by the end of the week, gold had fallen back to 634 dollars, a decline of almost seven percent from Monday's high. Silver prices never reacted to the Middle East news, trading in only a one-dollar range throughout the week, and closing at 11.17.

Traditionally, over the years, gold has been the pre-eminent safe-haven investment. But over the past several decades, gold's role in that regard has been usurped by the Dollar.

This year, gold prices have staged an impressive move up, at one point increasing more than 75 percent in reaching a high of 730 dollars an ounce (in May). As gold rallied, the "gold bugs" have come out of the woodwork (as they seem to do on any price rally). "Now was the time to re-insert gold into one's portfolio."

After reaching 730, prices suffered a correction falling all the way back to 542 in June. As prices recovered from that low, however, the gold bulls the correction as simply another buying opportunity.

But, we feel gold's failure to follow through from Monday's highs underlines gold's underlying weakness as a long-term investment. We would prefer to place our funds in financial investments.

Stock Markets: World stock markets have also moved in trading ranges over the past few weeks. Most markets sold off initially on the Middle East news but, like the currencies, reverted to fundamentals as the week wore on. Most world markets took their lead from the US markets.

US stocks drew their strength from the hope that the Federal Reserve could be finished raising interest rates. Bernanke's comments Wednesday and Thursday kindled that hope. But over the past few months Bernake has frequently waivered and so have the markets. Now the markets will rise and fall on the economic news.