Gilt-edged growth certain … as long as there's a lid on oil prices

IN DECEMBER the Investment Club's paper and pencil analysis (papa) advised you to fill your boots with bonds. The club went for the big gamble and invested 100 per cent of its funds in gilts. What might derail our investment stance in 2010?

Inflation is the Investment Club's most feared enemy. If inflation goes up then bond prices go down.

The price of oil rising is perceived to be the main cause of inflation but can be mitigated, to some extent, by the pound's value increasing against the dollar, because oil is priced in dollars. If the stock market goes down then that helps underpin the value of government debt because of its safe haven status. With an idea of what might happen to these indices in 2010, we will know better how secure the club's investments are.

Papa had been looking for a top in oil during 2009 of about $90 a barrel. But it has not happened, and both price momentum and supply and demand fundamentals are now beginning to act against the oil price. After its nadir of $33.73 a barrel in December 2008, it surged up to $71.71 by June 2009, before its first pull-back to $58.25. If price momentum was building you would expect at least the same amplitude increase again to $96.23 a barrel. However, this was not to be. Should it sink much below $69 in February it will fall through its previous low and the uptrend is over.

The fundamentals are not much better. Oil prices of over $35 a barrel from 2004 to 2008 have encouraged increased supply that is expected to climb 10-12 per cent by 2017. This growth equates to about ten million more barrels of oil a day, which easily absorbs any projected increase in consumption from China and India. On these estimates there may be a glut of oil and low prices, not a scarcity and high prices. Therefore, on this analysis, I would be looking for oil prices of about $40 to $50 a barrel by the end of this year.

Unfortunately papa's prescience track record on the pound/dollar exchange rate is poor, so one can not hold too much store by it. At present, though, if the pound falls below $1.59 this month, it should be on its way down to the $1.40 region.

However, the oil price and thus inflation should be held in check and the club's unit value rise.

Finally, papa sees the FTSE index falling below 4,500 by the end of 2010. This being the case – and our projections about the pound rising against the dollar and oil prices falling are right – the Investment Club's gilt holdings should continue to increase in value from last month when the unit price value rose 3p to 2.58. Next month's plan for the Investment Club is masterly inactivity.