Adamant: Hardest metal
Tuesday, March 18, 2003

Merrill Sees High Oil Prices, Low Growth As Iraq Looms

sg.biz.yahoo.com Wednesday March 19, 1:58 AM By Mike Esterl Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Don't bet on oil prices crashing to earth or the U.S. economy surging anytime soon. Nibble at Latin American debt but steer clear of their stocks. And treat the foreign exchange market as a huge wild card.

That was the cautious assessment of Merrill Lynch in Tuesday's "War Trade" conference call on how to make money - and avoid losing it - in emerging market equities, bonds, foreign exchange and oil as the U.S. prepares to invade Iraq.

Mike Rothman, the investment bank's senior energy market strategist, warned clients that extremely low global oil inventories - about 130 million barrels below normal levels - will curb any plunge in crude prices even if war in the Middle East is a swift and tame affair.

Crude prices on the New York Mercantile Exchange dropped below $33/barrel Tuesday, down from a recent high of $39.99/barrel in February, after U.S. President George W. Bush late Monday gave Iraqi leader Saddam Hussein 48 hours to leave the country or face military action.

But Merrill Lynch is sticking to its 30-day target price range of $35.50-$46/barrel and a 60- to 90-day range of $27-$33/barrel - far higher than the sudden drop to $20/barrel in early 1991, immediately after a U.S.-led coalition began its first full-scale invasion of Iraq.

"There really is not fat comparable to what we saw 12 years ago," said Rothman, citing output shortages in Venezuela and the threat that Iraq will torch its own oil fields.

Higher oil prices are underpinning Merrill Lynch's forecast that the U.S. economy will grow an anemic 2% in 2003. That in turn could limit the upside of beaten-down emerging market equities - which have shed 7.6% in dollar terms so far this year according to Morgan Stanley's MSCI index - as companies scale back earnings forecasts amid weak consumer demand.

"Iraq is just the latest in a series of excuses why the global economic recovery has failed to materialize," said Ed Butchart, the bank's chief emerging market equities strategist.

Merrill Lynch is recommending a defensive posture in emerging market equities, preferring emerging Europe and Asia over Latin America, where economic growth has been weakest.

The firm has a neutral recommendation on Turkey, which neighbors Iraq and has been scrambling to decide whether to allow the U.S. to use its military bases. "The outlook is effectively almost changing on a day-to-day basis," said Butchart.

Merrill Lynch is more bullish on emerging market debt - but more cautious than most investors, who have plowed into the asset class in recent months, pushing the year-to-date return on the J.P. Morgan Emerging Markets Bond Index-Plus to 6.6%.

"We are neutral the market," said Tulio Vera, the bank's chief emerging market debt strategist, who cautioned that risk aversion could flare up again if the U.S. invasion of Iraq doesn't go smoothly.

Risk aversion levels in the emerging market bond market are currently at their lowest levels since early 2001, Vera added.

Merrill Lynch has overweight recommendations on the bonds of a handful of smaller Latin American countries, such as Colombia, Peru and Ecuador, where economic growth has been strongest and debt spreads still have room to tighten after regional solvency issues peaked last year. It's market weight on Brazil and Mexico, and underweight Venezuela and Turkey.

Yianos Kontopoulos, the bank's chief global foreign exchange strategist, is forecasting a period of great volatility and unpredictability in major currencies after the U.S. dollar rallied sharply Monday.

He said investors have been unwinding recent bearish positions on several currencies but that it's still too early to tell where they are headed in the near term.

"Basically we're still standing at a cusp and it's possible to move in both directions," said Kontopoulos.

But he cautioned investors from piling into the recent rally in the Mexican peso, which strengthened Monday at MXN10.77 to the dollar after sinking to a historic closing low of MXN11.22 on March 4.

"I think at levels of around MXN11, it's probably something that's consistent with at least the current macroeconomic picture," he said.

Some investment banks have been scaling back their growth forecasts for Mexico amid continued shakiness in the U.S. economy, which absorbs more than 80% of Mexican exports.

-By Mike Esterl, Dow Jones Newswires; 201-938-4026; mike.esterl@dowjones.com

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