Gulf stocks to help investors remain on top

For the past 25 years, Southeast Asian stocks dominated the dreams - and the winnings - of emerging-market investors. Today, those economies are looking more like those of the developed world.

So where should players look for the next ground-floor opportunity? Follow the money, of course. The next quarter century belongs to the Middle East.

The Gulf states restrict foreign stock ownership. So far, it has been a game primarily for hedge funds and private equity. But the Middle East is opening up to homegrown investors as well as international capital.

Last September, T. Rowe Price launched the Africa and Middle East Fund - the first chance for average US investors to take a shot at markets they never heard of before but, eventually, will make a splash.

Your targets are the economies of the six Gulf Cooperation Council states. The GCC just negotiated a free-trade agreement with Singapore, their first with a country outside the Middle East. Last December, they announced plans for a GCC common market.

If you think of the Gulf states as mostly camels, oil, sand and war, Google "Dubai image" or "Abu Dhabi image" and goggle at what you see. Skyscrapers, stunning hotels and resorts, marinas, golf courses, high-end malls and, yes, bars.

Politically, they are poster children for moderate Islam in the Middle East, with religious but cosmopolitan cultures. Jihad looks like yesterday in countries embracing commercial modernity.

Seller's market

The main event is oil and natural gas - commodities in tight global supply and whose price the GCC can influence.

It's "perhaps the most compelling seller's market in the history of capitalism, providing a relatively uninterrupted transfer of wealth to suppliers of oil", says Jay Sellick, managing director of 13D Research Inc, a global research firm based in Boca Raton, Florida.

Developed countries will have to import ever more gas and oil from the Middle East, even during economic slowdowns, because they are producing less of it themselves. Developing countries need more, too, as their standards of living rise.

"We believe the GCC equity market could be in the early stages of a huge bull market, not unlike other bull markets that were driven by changing secular dynamics not fully appreciated by investors," Sellick says.

Oil is far from the only story. The GCC is investing hundreds of billions of dollars to diversify their economies, create jobs for their young people and prepare for the day when they run short of oil and their customers develop alternative sources of energy.

They are raising world-class hotels, promoting tourism, creating financial and tax-free trading hubs, relaxing restrictions on businesses and foreign ownership, developing industries such as petrochemicals that need low-cost energy and backing centres for high technology.

"A year ago, international investors just flew in for a day," says Fahmi Alghussein, executive director at Morgan Stanley in Dubai. "Today, they're setting up shop in the region and putting asset managers on the ground."

Equity indexes

At the moment, the GCC countries aren't included in the emerging-market equity indexes that managers use for their global asset allocation. If that changed, "it would be colossal", says Brad Durham, managing director EPFR Global in Boston, which tracks fund flows.

In January 2006, MSCI Barra launched separate GCC indexes for the six countries - a move that will probably generate some US-listed, GCC exchange-traded funds.

The new T. Rowe Price fund holds 60 per cent of its assets in the Gulf, which is even benefiting from the conflicts in Iraq, Iran and Lebanon. "Money flows to the GCC," says London- based Joseph Rohm, vice president of T. Rowe Price International. "They're the stable economies and safe haven in the region."

Clearly, markets like these aren't for sissies. The GCC stocks bubbled in 2005, crashed in 2006, and haven't yet climbed back to their former peaks.

Hot money rushed in at the close of 2007, when GCC stocks (not counting Saudi Arabia) leaped almost 40 per cent. So far this year, they are up two per cent. Easy money can rush out again.

The current building frenzy is a worry, too, as the countries compete for the financial and tourist trade.

They risk creating a glut and a collapse, says Richard Thompson, London-based editor of the Middle East Economic Digest. It will be a rough ride. But over time, following the money pays.