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Exclusive: Gold to stay strong, top performing funds say

(Reuters) - Gold will stay strong due to a lack of alternative havens for investors operating in a slowing global economy, top performing commodity fund managers told Reuters after taking a defensive approach and going into cash during September's gold sell off.

"We consider the current weakness in gold as temporary and also the slump in commodity prices should come to an end soon," said Kurt Hug, an investment adviser for the Antares Precious Metals Fund.

The fund came third in the Lipper Global commodity sector rankings in the third quarter of 2011 by keeping a high percentage of "strategic liquidity" in Swiss francs in anticipation of "a severe, but short-lived commodity shock."

Fund research and analysis organization Lipper, a Thomson Reuters company, covers more than 108,000 funds. The commodity segment covers funds investing in both commodities futures and natural resources-related equities.

Reuters approached the best performers to ask for details of their winning strategies.

Also staying defensive was Paula Bujia, manager of the $330 million Schroders Gold and Precious Metals Fund, which came fourth. Steering clear of precious metals other than gold, and investing in mid-cap gold miners rather than seniors and juniors, helped her outperform, she said.

The gold price has risen by nearly 17 percent so far this year, having hit a record $1,920.20 an ounce in early September before correcting sharply downwards. It was around $1,655 an ounce on Friday.

Bujia said gold's correction from its peak was still only half of its declines in 2008 and she would wait for more selling of gold, particularly in exchange traded funds (ETF), before she felt able to resume aggressive buying of other precious metals and of mining equities.

"In this environment, it's very difficult to believe that other precious metals could do well," she said. "Until we see more capitulation in gold and more ETF outflows it is not the right time to turn aggressive."

Bujia is sticking with her gold tilt, saying the recent correction has been meaningful, but gold is not yet at a capitulation point. She believes gold may trade sideways for another couple of months, or come off another 10 percent.

Precious metals funds dominated the upper end of the Lipper league table of over 130 funds in the third quarter.

The LGT Dynamic Gold Fund came first, returning 9.36 percent over a quarter which saw the commodity index S&P GSCI fall 11.69 percent.

Peter Sigg, head of investment management for commodities at LGT Capital Management, said the $73 million fund had been invested between 96 percent and 115 percent over the quarter.

"We have been slightly leveraged during the move to (gold at) $1,900 (an ounce) and we were slightly invested in cash during the sell-off in September," he said.

TESTING QUARTER

Reuters' analysis of the Lipper data showed that the third quarter was testing for all commodity managers, with the average actively-managed fund in the Lipper Global commodity sector down 8.34 percent.

S&P said equity market weakness and U.S. dollar strength had culminated in the worst quarter for the S&P GSCI since the fourth quarter of 2008.

Energy prices came under pressure due to fears of slowing demand and even precious metals did not escape, with profit-taking overwhelming the market in September. The S&P Precious Metals index ended September down more than 14 percent.

"Our conclusion of the last month is that gold is not immune in a very negative global commodity and equity market environment, which was similar to the autumn 2008 experience," said LGT's Sigg.

But, like Bujia and Hug, he remains relatively bullish on gold, saying that whilst the recent sell off had washed out the CFTC net long positions held by professional investors, individual investors had only marginally reduced their physically-backed gold ETF holdings.

Bujia also noted that an equity exposure of just 20-25 percent may have protected her from stock market losses, helping her outperform those with higher equity tilts.

There is still a big gap between the performance of gold futures and gold mining stocks, which she said is partly because the miners are unable to decouple from overall equity markets.

"When you have a fear trade, gold can perform well but not the equities," she said.

She believes gold equities offer great value, with record earnings and cash levels and increasing dividends, but these fundamentals will not come good until the stock market calms down.

Bujia remains cautious, focusing on mid-caps such as Randgold Resources, Yamana Gold and Eldorado which she said have good production growth.

Among the more diversified funds, Neuberger Berman's $100 million Enhanced Commodities fund, managed by Gresham Investment Management, also acquitted itself well largely due to a fairly high exposure to precious metals.

Douglas Hepworth, director of research at Gresham, added that a tilt to crude oil over natural gas, and to meats over grains and softs, had helped.

"Macroeconomic factors have been the drivers of the entire commodities asset class for several months, and nothing there looks particularly encouraging," he said.

The worst-placed funds were the BI Basic Long Commodity Fund, which invests in natural resource equities and futures and cannot go short, and the BBGI Commodities fund which invests in a mix of commodity ETFs and commodity equities.

 

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Fitch cuts Italy, Spain ratings; outlook negative

(Reuters) - Fitch Ratings on Friday cut Italy's sovereign credit rating by one notch and Spain's by two, citing a worsening of the euro zone debt crisis and a risk of fiscal slippage in both countries.

The cuts underline the growing vulnerability of the euro zone, which is already struggling to contain the turmoil in the far smaller Greek economy and which would be overwhelmed by a crisis of a similar scale in Italy.

Fitch cut Italy's rating to A+ from AA- and lowered Spain to AA- from AA+.

It kept both countries, respectively the third and fourth largest in the euro zone, on a negative outlook suggesting further downgrades could come in future.

Italy and Spain are embroiled in the region's debt crisis and are reliant on the European Central Bank to buy their government bonds to prevent yields rising to unsustainable levels.

"A credible and comprehensive solution to the (euro zone) crisis is politically and technically complex and will take time to put in place," the ratings agency said in separate statements explaining its downgrades of both countries.

Fitch's rating for Italy is now at the same level as it rates Malta and Slovakia.

After remaining on the fringes of the euro zone crisis until the summer, Italian benchmark 10-year bonds now yield around 5.5 percent, having overtaken Spain's yield of around 5 percent in a sign of markets' increasing unease about Italy.

ECB HELP

Both yields would be higher but for the ECB, which was cited by traders as supporting both countries' bonds in the market again on Friday.

Fitch, the third ratings agency to downgrade Italy in recent weeks following similar moves by Standard & Poor's and Moody's, said market confidence in Italy had been eroded by the government's initially hesitant response to the rise in yields.

The euro fell against the dollar and the yen following the downgrades and U.S. shares fell, but analysts said the move on Italy was largely discounted.

"Fitch's motivations do not differ much from what the other two agencies said. I don't foresee big moves in the markets as a reaction," said BNP Paribas strategist Alessandro Tentori.

ING analyst Paolo Pizzoli said the downgrade should be seen as further pressure on the government to adopt growth enhancing structural reforms which were lacking from a recently approved austerity plan aimed at balancing the budget in 2013.

"There has been a chorus of appeals from the ECB, the EU and the IMF. They have all asked for structural reforms for growth and this (Fitch) is another element in that direction."

Silvio Berlusconi's scandal hit government plans to present a package of measures to help growth later this month but his coalition is so weak and divided that few analysts have any confidence in its ability to adopt the deep reforms required.

Spain's Socialist government has slashed its budget deficit with a series of austerity reforms, although much of the country's debt lies in its autonomous regions which are still implementing cuts.

"LIKE A HERD"

"We respect the decision but we don't agree with it," said a spokesman at Spain's economy ministry.

Italian officials sought to make light of the downgrade. Foreign Minister Franco Frattini said it was fully expected and added dismissively that "markets don't care much about the role of Fitch, Moody's and company."

Fabrizio Saccomanni, deputy governor of the Bank of Italy, said ratings agencies "move like a herd, they all go in the same direction and at the same time." Fitch's move "doesn't change the picture," he added.

Berlusconi flew to Russia on Friday to celebrate Prime Minister Vladimir Putin's birthday, but a statement from his office said Fitch's comments were more positive than the other agencies', and Italy's fiscal efforts were widely appreciated.

Fitch said both Spain and Italy were solvent but pointed to their weakening economic growth prospects and urged Italy, one of the world's most sluggish economies for over a decade, to make "a more radical and sustained economic reform effort."

 

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Merkel, Sarkozy promise new crisis package, offer no details

(Reuters) - The leaders of Germany and France promised Sunday to unveil a new comprehensive package for solving the euro zone's debt crisis by the end of the month, but offered no details and papered over differences on how to shore up European banks.

German Chancellor Angela Merkel and French President Nicolas Sarkozy said after talks in Berlin their goal was to come up with a sustainable answer for Greece's woes, agree how to recapitalize banks and present a plan for accelerating economic coordination in the euro zone by a G20 summit in Cannes on November 3-4.

"We are very conscious that France and Germany have a particular responsibility for stabilizing the euro," Sarkozy told a joint news conference.

"We need to deliver a response that is sustainable and comprehensive. We have decided to provide this response by the end of the month because Europe must solve its problems by the G20 summit in Cannes."

Sarkozy will host the Cannes summit and is keen to deliver a big success that might bolster his flagging chances of winning re-election in a presidential vote next year.

But even if the two leaders can agree on a way forward, the experience of the past two years has shown that they could struggle to get the other 15 countries in the euro zone on board in a timely fashion.

Pressed by reporters, both leaders refused repeatedly to discuss details of their plan. Sarkozy said he and Merkel were in "total agreement" on the recapitalization of European banks, even though officials in Paris and Berlin have made clear in recent days that the countries are far apart.

The two euro zone heavyweights have come under pressure worldwide to resolve a crisis which is roiling markets.

U.S. President Barack Obama Thursday urged Europe to "act fast," calling the common currency bloc's crisis the largest obstacle to a recovery in the United States. World Bank President Robert Zoellick told German magazine Wirtschaftswoche magazine that there was a "total lack" of vision in Europe and Germany in particular needed to show more leadership.

Following the news conference, the leaders of the euro zone's two biggest economies were due to hold a working dinner at the Chancellery.

BANK IMPLOSION

The implosion of Belgian lender Dexia, the first bank to fall victim to the two-year-old euro zone debt crisis, has added a sense of urgency to the talks.

The prime ministers of France and Belgium and the finance minister of Luxembourg agreed a rescue plan for Dexia Sunday ahead of the meeting in Berlin. [ID:nL5E7L903A]

Other French banks have come under intense pressure because of their exposure to Greece and other weak countries on Europe's southern periphery.

BNP Paribas and Societe Generale denied a report Sunday that they could seek to raise a combined 11 billion euros as part of a broader European recapitalization plan.

Ireland estimated at the weekend that European banks may need more than 100 billion euros ($135 billion) to withstand the debt crisis. The International Monetary Fund (IMF) has said they need double that figure.

Paris wants to tap the euro zone's 440-billion-euro European Financial Stability Facility (EFSF) to shore up its banks, worried that pouring its own money into them could compromise its coveted triple-A credit rating.

Officials in Berlin have made clear that they believe the fund should be used only as a last resort, when euro zone member states don't have the means to support their banks on their own.

Another area of contention is how to use a new, enhanced EFSF to buy sovereign debt -- an issue that would become particularly crucial if Greece failed to secure its next tranche of aid.

Greece is expected to run out of cash as soon as mid-November. Inspectors from the European Commission, the IMF and the European Central Bank -- the so-called "troika" -- are currently assessing whether Athens has fulfilled the criteria for more aid.

"We are working closely with the troika which is currently in Greece and we expect them to present a sustainable solution for Greece that keeps it in the euro zone and also ensures the financial stability of the euro zone," Merkel said.

European Commission head Jose Manuel Barroso told German newspaper Bild at the weekend that a Greek default would have unforeseeable consequences and may cause the crisis to spread.

"This is new territory for us and we are discussing solutions which have not really been tested before," he said.

Merkel said France and Germany were working on steps to boost economic coordination in the euro zone and said their proposals would necessitate changes to the bloc's Lisbon Treaty.

Sarkozy made clear, however, that Europe needed to "take decisions now," rather than announce new long-term plans that would take time to implement. Changing the treaty could take several years.

"Comprehensive, sustainable and rapid responses before the end of the month. That is the result of this Franco-German meeting," he said.

 

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Euro edges up on EU pledge, markets cautious



* Euro up 1/4 cent on Germany, France pledge to recap banks

* Thin trading expected due to Japan holiday

* Key China data due this week



SYDNEY, Oct 10 (Reuters) - The euro inched up in Asia on Monday after leaders of Germany and France promised a new comprehensive plan to recapitalise euro zone banks by the end of the month, though markets remain wary as they have been disappointed many times before.

The euro eked out a gain of around a quarter of a cent to $1.3390 , from $1.3375 on Friday when it had come under pressure following ratings downgrades of Italy and Spain.

Hourly resistance is found at $1.3423 and a break above should ease the downward pressure, according to a trader. Against the yen, the euro eased to 102.84 yen , off a one-week peak of 103.85 on Friday.

The meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy offered no details, but drew a pledge to do what is necessary to shore up banks, settle the Greek crisis and help growth in Europe, giving a gentle boost to risk sentiment. .

Markets, however, are cautious as EU leaders have promised to resolve the debt crisis before and that could keep the common currency within Friday's range of $1.3360-$1.3525. Trading is expected to be thin with Japan off while the U.S. celebrates Columbus Day.

France, Belgium and Luxembourg agreed a rescue plan for Dexia, while other French banks have come under intense pressure because of their exposure to Greece and other weak European countries. BNP Paribas and Societe Generale denied they would seek to raise a combined 11 billion euros as part of a broader European recapitalisation plan.

Adding to pain, the next aid tranche for Greece is far from being a done deal with the IMF indicating the nation is at a crossroads and will need to implement "much stricter structural reforms" than seen so far.

Athens could run out of cash as soon as mid-November without the new 8 billion euro aid installment, increasing the risk of a default that would drag the region deeper into a debt crisis already shaking financial markets worldwide.

The dollar index was steady at 78.718, having fallen to a 9-day trough of 78.061 on Friday, despite better-than-expected U.S. payrolls. The dollar, at 76.71 against the yen, remained stuck in the 77.29-76.09 range of the past month.

This week's focus will be on key China data with trade and CPI due Thursday and Friday. Strong trade numbers and a lower CPI would be the best combination to ease concerns of a hard landing and boost risk sentiment.

 

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Euro rises after Germany, France promise crisis plan

(Reuters) - The euro jumped to its highest in over a week against the yen and the dollar on Monday after Germany and France pledged to deliver a plan soon to protect banks and the euro region from its sovereign debt crisis.

The single currency was on track for its best daily rise against the greenback since July 2010, helped by buying to exit short positions and on unexpectedly strong industrial output data from France and Italy.

After their weekend meeting, German Chancellor Angela Merkel and French President Nicolas Sarkozy promised to present a plan before a G20 summit in early November to shore up euro zone banks, settle the Greek debt crisis and help growth in Europe.

"Certainly Merkel and Sarkozy pledging a plan to support European banks by November helped. So we're seeing risk coming back on and that's helping the euro and this rally could go on given the extent of short positioning in the market," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York.

The euro climbed 2 percent to $1.3648, above a nine-month low of $1.3145 set last week on trading platform EBS, as investors closed out their short positions initiated earlier.

It was also up 2 percent on the day versus the yen after touching 100.74 yen a week ago, which was the lowest since May 2001, according to Reuters data.

Investors had piled into the U.S. and Japanese currencies in a safe-haven move on fears over the euro zone debt crisis.

The euro's rebound could fade if no comprehensive plan emerges in coming weeks, with the risk of renewed bickering between euro zone policymakers seen as a threat to a decision.

"But at the end of the day Greece still has problems," Chandler said.

Officials of the European Union, International Monetary Fund and the European Central Bank met with Greece's finance minister on Monday to complete talks on 8 billion euros worth of aid so Athens could avert a default in November.

Stronger-than-expected French and Italian output in August reduced fears of sharp economic pullbacks in euro zone's second- and third-biggest economies. That helped propel the euro higher on the day.

Trading volume was muted due to holidays in Canada and United States.

SLOVAKIA VOTE

The pledge from Merkel and Sarkozy, albeit short on details, boosted the euro and other currencies perceived as risky.

Improved sentiment led to a selling of the U.S. dollar against the Swiss franc and the Canadian and Australian dollars.

Traders will now focus on voting in Slovakia and Malta to ratify changes to the European Financial Stability Facility, a 440 billion euro bailout fund. They are the remaining euro zone countries still to approve the changes. Any delay on passing the legislation could affect sentiment toward the euro.

Adding to traders' concerns for the euro, the next aid tranche for Greece is far from a done deal. The IMF said Greece is at a crossroads and would need to implement "much stricter structural reforms" than seen so far.

"Short positions against the euro have been stopped out, which is why the euro has bounced," said Adam Myers, senior currency strategist at Credit Agricole.

The euro slipped against the Swiss franc after touching a 4-1/2 month high at 1.24358 francs on EBS. It had risen on lingering speculation Swiss authorities could raise the floor on euro/Swiss franc from 1.20 francs currently.

The dollar was little changed against the yen at 76.65 yen while it fell 2.6 percent against the Swiss franc at 0.9028 francs.

The dollar index declined 1.6 percent against a basket of currencies at 77.47.

 

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Euro holds huge gains on EU optimism

(Reuters) - The euro held huge gains in Asia on Tuesday after hopes for a new EU debt plan sparked a correction in a deeply bearish market, though sentiment remains fragile as European leaders have disappointed many times before.

The euro rose three cents to a peak of $1.3698 on Monday, its biggest daily gain versus the U.S. dollar in 15 months. It last traded at $1.3627. It also flew to 104.99 yen, the highest in three weeks, showing a rise of 1.65 percent, before steadying at 104.46.

The rally followed an Franco-German pledge on Sunday that they would do what is necessary to shore up banks, settle the Greek crisis and help growth in Europe.

Commodities, stocks and high yielding currencies joined the "risk on" wave with copper close to 13 percent higher in just one week. The Australian dollar enjoyed the biggest one-day rally in over a year, surging 2.3 percent after briefly touching parity at $1.0016. It was last at $0.9980.

The revival in risk flushed out long positions in the U.S. dollar across the board, including the Swissy. It collapsed 2.5 percent to 0.9032 francs. The dollar index fell sharply to near three-week lows at 77.561, down 1.48 percent.

Major resistance for the euro is found at $1.3680-90, the 38.2 percent Fibonacci retracement of the $1.4550/$1.3145 move and the September 28 trend high. A clear break above $1.3700 targets $1.3845.

Dealers were surprised by the scale of the reaction given EU leaders have disappointed many times before.

"Unfortunately, Europe has a history of delivering far too little far too late," said Robert Rennie, chief currency strategist at Westpac.

"Europe doesn't have the political will, the cohesion and the sense of what needs to be done."

He said the rally was temporary and would be looking to sell the euro into strength which means in the $1.365-$1.385 range.

Investors were looking for an excuse to price out bad news that have been gripping markets since September. While there is little doubt the problems in Europe will resurface at some stage, recent economic data was better than feared, countering the danger of a global recession.

Traders will focus on voting in Slovakia on Tuesday, the only country among the bloc's 17 members that has yet to ratify changes to the euro zone's 440-billion-euro bailout fund. Any delay on passing the legislation could affect sentiment toward the euro. Malta gave its backing earlier on the day.

The dollar remained stuck at 76.65 yen, within the tight 77.29-76.09 range of the past month.

UK industrial production and minutes of the FOMC meeting will be released later on Tuesday.

This week's focus will be on key China data with trade and CPI due Thursday and Friday. Strong trade numbers and a lower CPI would be the best combination to ease concerns of a hard landing and boost risk sentiment.

 

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Wall Street holds steady, ready for earnings

(Reuters) - U.S. stocks took a breather on Tuesday after the best five days for the S&P 500 in more than two years as investors look to earnings for a reason to extend the market's rebound.

Stocks wavered between gains and losses throughout the session. Markets have been reacting to news from the euro zone where officials are trying to contain a debt crisis that threatens large European banks and global financial stability.

The focus now will shift to earnings season, which begins with Alcoa Inc's (AA.N) report after the close of trading. U.S. economic indicators have shown signs of slow growth and investors are waiting to see how this has affected company profits.

"Earnings are always important but even more so here after several quarters of solid earnings across many industry sectors. I think investors are going to want to see that continuing or solidifying itself. Otherwise you could see further selloffs," said Michael Cuggino, president and portfolio manager of Permanent Portfolio Funds in San Francisco.

Materials stocks fell throughout the third quarter on worries about global growth slowing. Alcoa gained 2 percent to $10.30 in regular trading but is down 35 percent since the beginning of the third quarter.

After the market closed, Alcoa said third-quarter profit jumped from a year ago, but earnings and revenue slipped from the second quarter as economic growth slowed from the first half of this year.

A delay in a key vote by Slovakia on expanding the euro zone rescue fund has also kept investors cautious.

With 16 of 17 euro zone states having ratified a pact to boost the size and powers of the European Financial Stability Facility bailout fund, all eyes turned to Slovakia. The country's finance minister said the country was expected to approve the changes this week.

Any more delays in coming up with a plan intended to head off crisis could give the market an excuse to sell. Stocks have reached the top of a recent range, hitting resistance around 1,195 on the S&P 500. Another area of resistance is seen at 1,215 on the S&P 500, said Larry Peruzzi, senior equity trader at Cabrera Capital Markets Inc in Boston.

"The bounce we've had is kind of getting us close to resistance levels ... we're looking to see if it can break through," he said.

Apple (AAPL.O), which gained 3 percent to $400.29, lifted the Nasdaq and S&P 500.

The Dow Jones industrial average markets/index?symbol=us%21dji">.DJI was down 16.88 points, or 0.15 percent, at 11,416.30. The Standard & Poor's 500 Index .SPX was up 0.65 point, or 0.05 percent, at 1,195.54. The Nasdaq Composite Index .IXIC was up 16.98 points, or 0.66 percent, at 2,583.03.

After the close, Alcoa, the largest U.S. aluminum company, dipped slightly $10.03 after it posted results.

In the past week, analysts have lowered their consensus earnings estimates for Alcoa, citing a precipitous drop in metals prices in recent months sparked by global economic concerns.

About 6.90 billion shares were traded on the New York Stock Exchange, NYSE Amex and Nasdaq for the day, well below the year's daily average so far of 8.03 billion.

Advancing stocks outnumbered declining ones on the NYSE by a ratio of roughly 16 to 13, while on the Nasdaq, advancers beat decliners by about 3 to 2.

 

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Italian debt sold, China hits equities


(Reuters) - Italy's sale of 6.2 billion euros in bonds on Thursday eased investors' immediate concerns about its funding in the euro zone debt crisis, but stock markets were hit by weaker Chinese trade data.

European shares fell 0.9 percent after recent gains and Wall Street looked set to open lower following data showing China's trade surplus narrowed for a second straight month in September, with both imports and exports lower than expected.

It reflected global economic weakness, which along with the euro zone debt crisis has kept investors avoiding aggressive risk taking over the past months.

In Europe, there appeared some traction to the idea that policymakers were working on a cogent plan to solve the debt crisis, or at least reduce its threat.

Jose Manuel Barroso, president of the European Commission, outlined a broad plan on Wednesday to tackle the euro zone's two-year debt crisis, fuelling optimism.

"Maybe the political decisions are finally coming through," said Justin Urquhart Stewart, director at Seven Investment Management.

The sale of Italian bonds went relatively smoothly, although a lot of the buying may have been prompted by cheaper prices ahead of the sale.

Traders said the European Central Bank began buying Italian bonds focused around the 10-year sector shortly after the release of auction results.

Earlier 10-year yields rose to 5.87 percent, their highest since the central bank began purchasing Italian debt in August as part of an effort to cap the country's rising cost of borrowing. The 10-year yield was last at 5.80 percent, 6 basis points higher on the day.

STOCKS MIXED

On stock markets, the FTSEurofirst 300 finance/markets/index?symbol=gb%21FTPP">.FTEU3 fell but was still heading for its third straight week of gains, something it has not achieved since March/April.

World stocks as measured by MSCI .MIWD00000PUS were down a bit.

Earlier, Japan's Nikkei .N225 rose nearly 1 percent, catching up with U.S. and European gains from Wednesday.

The euro fell broadly, pulling back from a one-month high versus the dollar after the European Central Bank warned about the impact on the currency and the region's banks of involving bondholders in euro zone bailouts.

The euro hit a session low of $1.3711 after an article in the ECB's monthly report said forcing private bondholders to accept losses on euro zone sovereign debt could damage the euro's reputation, prompting traders to take profits on a rally which has been built on investors backing off bets for further euro weakness rather than betting on future gains.

The euro had rallied earlier in the week, climbing to $1.3834 on Wednesday after German Chancellor Angela Merkel and French President Nicolas Sarkozy late last week said they would announce a plan to solve the euro zone debt crisis by the end of the month.

 

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Global week ahead: Bright spots amidst the gloom

(Reuters) - An improvement in manufacturing, employment and retail sales data in the United States, and mounting signs that Europe will agree on a rescue plan large enough to contain the Greek debt crisis, have lifted some of the gloom overhanging the global economy.

But the gains are highly tentative and policy mistakes in Brussels this week could easily upend the outlook.

Over the past three months, political gridlock in Washington over the U.S. budget deficit and infighting in European capitals resulted in the biggest falls in the prices of risk assets since the collapse of Lehman Brothers in late 2008.

Global stock prices have since stabilized, and in Europe even posted gains over the past week, easing fears that the developed world would drive the global economy off a cliff.

"Despite the dark policy backdrop, not all is bad," said Joachim Fels, head of global economics at Morgan Stanley.

Energy and commodity prices also have fallen sharply, boosting spending power, particularly in the United States where crude oil has tumbled 14 percent since July.

The relaunch of unusual liquidity measures by the Federal Reserve, European Central Bank, and Bank of England has alleviated strains in bank funding and calmed markets, buying politicians some extra time to sort out their fiscal woes.

"Things are looking a little bit brighter out there, but there are still enormous out-sized risks," said Nigel Gault, U.S. chief economist for IHS Global Insight.

Prime among them is Europe. If European Union leaders fail at their summit next weekend to deliver a comprehensive plan to resolve its sovereign debt crisis and recapitalize its banks, market volatility will return with a vengence, analysts warn.

Even the extraordinary steps that central banks have taken to prevent the crisis worsening have brought large risks.

Global liquidity, as measured by foreign exchange reserves and central bank balance sheets, has soared to $18.3 trillion, equal to 30 percent of global GDP, from $10.4 trillion three years ago, Bank of America/Merril Lynch has estimated. This massive monetary policy easing has stirred inflationary fears.

There is only one solution. "Better policy decisions on both sides of the Atlantic are needed to get us out of this fix," said Fels.

Otherwise the negative feedback loop will resume, where bad policy decisions intensify risk aversion and worsen the sovereign debt crisis by destabilizing financial markets, undermining bank solvency, and upending world economic growth.

U.S. AND CHINA

In the United States, there are few signals that lawmakers have the appetite for a medium-term resolution to the budget deficit before November 2012 elections.

The U.S. Senate this week rejected President Barack Obama's $447 billion jobs package after disagreement over how to fund the minor stimulus measure, with two Democrats facing tough re-election joining Republicans.

Senators next week may agree to vote on some piecemeal jobs measures such as extending jobless benefits and cutting payroll taxes.

Joel Prakken, economist at Macroeconomic Advisers in St. Louis, calculates that extending unemployment benefits for the long-term jobless would add 0.25 percent to real GDP growth in 2012, and support 200,000 jobs. Continuing the payroll tax holiday for employees would add 0.50 percent to GDP over the year and raise employment by 600,000, he said.

"It is modest at best," Prakken said.

But combined with recent improvements in auto sales, retail sales in August and September, and better manufacturing and employment reports, the U.S. economy looks on more solid footing than a few months ago, he said.

That would be good news for China, which relies heavily on its exports to the United States and where economic growth is clearly slowing. The question is by how much.

Figures on Tuesday are expected to show China's third-quarter GDP up 9.2 percent from a year earlier, according to a Reuters poll of economists. That would be down only modestly from the second quarter, when China recorded 9.5 percent growth.

A less closely watched indicator, urban investment, may provide a better signal. Last week's disappointing trade figures underscored China's vulnerability to a global slowdown. Domestic growth has cushioned the blow so far, and investment is a big reason why.

The data on Tuesday is expected to show urban investment up 24.8 percent from a year earlier, only slightly below the second quarter's 25 percent rise. If external demand weakens dramatically, economists think China will compensate by ramping up investment, which accounts for the bulk of its GDP.