The continuing strength of oil prices again took centre stage as West Texas crude hit USD55 per barrel. Essentially, higher oil prices are considered to be increasing the chances of lower global growth in 2005. Having backed up in late September and early October, 10 year US Treasury bond yields fell once more by 11 basis points to close the month at 4.02% - close to their lows for the year. High yield corporate and sovereign bonds had another positive month as spreads continued to narrow. August 2004 was the second largest US Current account deficit ever (USD54bn). Due to this the US dollar showed signs of renewed weakness. It fell by 3.8% against the yen and by 2.4% against the euro in October.
Bond market exposure remained at a low level throughout the month in line with our strategically cautious stance. As evidence began to build suggesting that there might be a renewed downtrend in the US dollar we sold US dollars against the euro.
Having sharply reduced the fund's interest rate exposure when 10 US Treasury yields reached c.4.2% we have been frustrated by the subsequent move down to 4% on the back of Oil price strength and investor positioning.
However, our analysis suggests that expectations of economic weakness in 2005 are overdone and are at any rate fully reflected in bond prices at the moment which as a consequence offer poor value and little in the way of a risk premium. At the time of writing we note that yields have bounced back to 4.18 in early November post the US presidential election and the announcement of a strong US employment report. Data tends to ebb and flow and it would be unsurprising if we were to get a run of stronger data. Our central case remains for a trend growth outcome in the US in 2005 and for more positive outcomes elsewhere as the recovery deepens. Persistent Oil price strength could threaten this scenario. Although we believe that energy prices are in a secular up-trend, prices have clearly overshot in the nearer term and should ease back further. After a period of consolidation, the US dollar appears to be reverting to its primary downtrend and the breaching of various technical levels have caused us to re establish US dollar short positions, primarily against the euro. However we note that given the extent of the US dollar's decline to date the valuation argument is less compelling and that Asian central banks are unlikely to change their policies of resisting a material strengthening of their currencies in US dollar terms.

The dominant macro influences over the quarter were weaker than anticipated, economic data in the key economies which gave rise to concerns about a general deceleration in economic growth rates an surging oil prices which breached $50 per barrel in October. Stronger oil prices, if sustained, could potentially reduce consumer spending power and depress growth. Inflation data moderated with US headline consumer prices rising a modest 0.1% for each of the three months comprising the quarter. All in all, the backdrop was positive for bond markets which extended their gains of the second quarter. Overall 10 year US treasury bond yields fell by 46 basis points to 4.13% at the quarter's end briefly touching 4% in October. The Federal Reserve Board increased official rates by 25 basis points and bond yields actually fell. This has only occurred on one other occasion in the last 35 years. Credit markets continued to perform strongly. The JP Morgan EMBI+ (sovereign) Index rising by 9.4% over the quarter and the Merrill Lynch Global High Yield (corporate) Index advancing by 4.8%. Currencies traded in relatively tight ranges with the exception of the Yen which fell by 5.6% against the US Dollar over the quarter.

Bond market strength was used as an opportunity to lighten the fund's interest rate exposure. Credit exposure was also reduced to meet regulatory requirements. A more US Dollar centric currency stance was adopted.

In retrospect, we were somewhat too quick to revert to our strategically bearish stance on bond markets. However, the undershoot of our target of 4.25% on 10 year US treasuries is unlikely to be sustained if we are correct in our assumption that the recent evidence of economic deceleration is part of the normal ebb and flow of data around a primary trend which remains one of sustained economic expansion.

Our valuation models continue to indicate that fair value levels for US 10 year Treasuries remain above 5%. Currently markets discount a move to a 3% Federal Funds rate by the end of 2005 which we believe to be a low probability outcome. The key currency crosses have remained range bound over the summer which suggests that a break one way or the other could occur at some point over the fourth quarter or in the first quarter of 2005. Comparative economic fundamentals point to a resumption of the US Dollar's primary bear market trend.

However, this is very much the consensus view. In the meantime Asian countries continue to recycle their current account surpluses predominantly into the US Treasury market providing strong support for the US Dollar. Consequently we remain agnostic and will require a strong technical signal to re-establish US Dollar short positions.

The period of consolidation and recovery in World bond markets which had characterised the seven months up to the end of March 2004 came to an abrupt end in April. Yields rose steeply in most markets in April and May before levelling off in June. Over the quarter 10 year government bond yields rose by 75 basis points in the USA, by 41 in Japan and by 39 in the Eurozone. In the eye of the storm, 10 year US treasury yields touched 4.87%, over 100 basis points above their end March levels. The sell off was triggered by data suggesting that job creation in the US had stepped up a gear and that the onset of the process of rate normalisation was likely to occur sooner than earlier consensus expectations. The impact of mortgage convexity hedging and the reversal of carry trades combined to produce a particularly abrupt adjustment which took bond markets generally into heavily oversold territory. With the exception of the Yen which rallied by 4.7% against the Dollar currency movements were relatively limited over the quarter. Both the Euro and Sterling fell in Dollar terms whereas the Rand strengthened by 1.5%.

The fund benefited from being defensively positioned in terms of interest rate and ex US Dollar exposure in the first two months of the quarter. Thereafter we saw a compelling opportunity to materially increase interest rate exposure at both underlying fund level and by adding to the funds investment grade bond exposure outright. Bond markets had become heavily oversold and the consensus almost universally bearish. Latterly we have sought to reduce the fund's US Dollar exposure in favour of Euros, Yen and the Rand in the belief that following a phase of counter trend recovery, the US Dollar has the potential to weaken further.

Looking ahead we expect a further decline in bond yields as US growth expectations are scaled back and the painful reality of a steep US yield curve reasserts itself. This is likely to present an opportunity to revert to our preferred bearish strategic stance. Credit exposure will be scaled back for regulatory reasons. Higher yielding corporate bonds have rallied well recently and the scope and their risk profile is less attractive. We look for further confirmation of US Dollar weakness to add to the fund's non US Dollar positions.

Although less severe than the sell off in April, US bond yields rose further over the month of May. 10 year US Treasury Bond yields rose from 4.5% to 4.67%, briefly touching 4.85% before rallying at the end of the month. The US Dollar was slightly weaker falling by 3.6% against Sterling and by 1.9% against the Euro.

Bond markets are now arguably oversold in the near term. Bond investors are generally cautiously positioned and shorter term market operators have largely been forced out of their 'carry trades'. As regular readers of this piece know, we have adopted a very defensive stance with regard to exposure to interest rate movements, given the total return nature of the Fund. However, the recent sell off has arguably gone too far too fast and we took the opportunity to add back some exposure on a purely tactical basis. This we did by adding to our US Bond exposure taking the allocation to the Investec USD High Income Bond Fund up from 17% to 30%. The overall duration of the fund remains short.

Strategically we remain bond negative but that appears to be a consensus position right now. The balance of probability suggests range trading and the steepness of the curve makes it painful to be out of the market for many.

Minimum Investment R2 000 lump sum or R500 monthly If our move proves premature we will cut the position quickly but the prospect of an unwinding of part of the recent sell off is high, despite an unsupportive fundamental economic backdrop.

The US Dollar has fallen back after a strong rally from it spring lows. We are inclined to be strategically negative but the picture is by no means black and white. Interest rate differentials have been a key negative for the US Dollar but they are distinctly less so now that US Dollar rates are on the path towards normalisation.

The overall tone for April was set on the second day of the month when the US non-farm payroll numbers came in far higher than market expectations. Market participants went from believing in a benign Fed for the balance of the year to worrying about an imminent US rate tightening cycle. 10-year US Treasury bond yields backed up and at the time of writing have reached 4.79% - a rise of almost 110 basis points from their March low point. Other bond markets followed suit and the moves were generally material but more muted. Overall, the J.P. Morgan US Government Bond Index fell by 3.4%. The US Dollar strengthened across the board rising by 9.4% in Rand terms, by 5.7% in Yen terms and by 2.5% against the Euro.

The Fund was well positioned to weather the storm with low duration and a strong bias towards a recovering US Dollar.

As things stand, bond markets are oversold in the short term but not yet cheap from a strategic perspective. Our estimate of fair value for 10-year US Treasuries is circa 5.25%. In similar cyclical circumstances bond yields have tended to overshoot and there is no reason to suppose that this one will differ, particularly given a deteriorating inflation picture.

We are likely to remain strategically short in terms of duration until US interest rates are well into the normalisation process.

Unsurprisingly, the reversal of carry trades has caused credit spreads to widen, particularly in an emerging market context. Our exposure is mainly to European Corporates which we feel should still deliver an attractive return relative to cash and investment grade bonds. Turning to currencies: As highlighted before we are currently in a period of US Dollar stabilisation and recovery. Interest rate negatives have receded and carry trade exposures to currencies such as the Australian Dollar are being reversed. The Euro has currently found support at approximately 1.18 but interest rate differential developments and investor positioning suggest that this move can go further. Consequently we intend to retain a very US Dollar centric stance in the near term.

Developed government bond markets were little changed in November. 10-year maturity U.S. Treasury bond yields rose from 4.3% to 4.32% and remain in a relatively tight 4.15% to 4.40% range. Euro bond yields rose from 4.32% to 4.46% over the month but also remain in a sideways trading pattern. Higher yielding bond markets continued to perform and the Merrill Lynch Global High Yield Index rose by 1.7% during November. Currency movements generally outweighed bond market returns and the US dollar fell against both the euro (-3%), the Australian dollar (-2.3%) and the rand strengthened sharply by 7.9% in US dollar terms.

Exposure to both Australian dollars and euro's was increased during the month. The latter move was prompted by the euro's break up through its May 2003 highs against a background of the rejection by European Finance Ministers of the European Commission's attempt to enforce the terms of the stability pact on Germany and France where actual and prospective fiscal spending has continued to breach the 3% of GDP limit imposed under the Maastricht Treaty. This implies a more growth oriented policy stance in key parts of the Eurozone. At first glance such a flagrant rejection of a key component of the stability pact underpinning the euro (originally insisted upon by Germany) would seem to be negative for the currency.

However, we believe that stronger European growth rates are a better guarantee of currency stability and strength than the continuing economic stagnation that fiscal retrenchment would originally have implied. We continue to anticipate an increasingly robust global economic environment. Whilst growth investment is likely to slow in the United States, this is from an unsustainably high level and it is likely to remain well above trend rates in 2004. Economic strength in the US and China is already boosting growth rates elsewhere in the world which should accelerate further. With the exception of some sectors, capacity utilisation rates remain moderate and inflation rates should consequently remain subdued. However, looking further ahead, we believe that it would be a mistake to be too optimistic given the extent of liquidity injected into the world financial system in recent years and the prospective shift in the terms of trade from the developed towards the developing world. The buoyancy of commodity prices in general and gold in particular tends to point in this direct. Consequently, we expect government bond markets to remain under pressure and overshoot fair value levels during 2004. Consequently our strategic policy stance continues to be characterised by minimal duration in the context of the Investec Global Opportunity Income Fund of Funds. Abundant liquidity, declining investor risk aversion and falling default rates should remain supportive for high yield bonds although spreads offer less scope for further capital outperformance. Currency strategy will continue to be anti US dollar, albeit in the context of a fund with a low volatility dollar total return mandate. This stance is currently very much the consensus that makes us wary in the near term, particularly given that the US dollar is as oversold as it was back in May 2003 after which it corrected strongly. Fundamental support is likely to remain lacking and return options outside the United States are now more compelling and plentiful leading to an uncomfortable reliance on Central bank US dollar purchases to offset a current account deficit running at approximately 5% of GDP.