Where should investors hide in the face of an imminent attack on Iraq?

The economic repercussions of a war with Iraq would send shockwaves right across the globe, but the US and the Gulf are clearly the most vulnerable. With the increasing likelihood of a military strike, investors should reassess their portfolios and take a proactive approach to their management.

Many investors, especially those in the US, have adopted a "wait and see" attitude, hoping that a political solution is found and a war avoided. But markets are already suffering, with the general uncertainty and absence of consumer and business confidence weighing down heavily on stock exchanges the world over.

There are two distinct scenarios that could evolve from the current US-Iraq situation. A short attack aimed at the immediate removal from power of the Saddam regime would be highly beneficial to the financial markets if it succeeds in its aim. But if the attack is prolonged, all major economies would be plunged into turmoil.

Doing business in the region would prove to be very difficult. Lower profits for companies, as a result of lower sales, would impact on the values of these companies on their stock exchanges. A business slowdown is inevitably the immediate result of war, and this would affect business right across the board, and worldwide. The sectors most likely to be affected are tourism, TMT and general trading.

The negative impact of the 1990-91 Gulf War, on the US economy in particular, is to be borne in mind. Oil prices soared, consumer confidence took a terrible blow, and recession hit the US. As is inevitable, a recession in the US affects the rest of the world.

The US is currently fighting devastating economic stagnation, and high oil prices could prove catastrophic. The world's largest economy is also the main buyer of Iraqi oil; a disruption in the Middle East would limit the production and distribution of oil, potentially leading to a burst in oil prices. The US is fully aware of this possibility, and has over the past months begun to accumulate reserves: to date, a four-month stock of oil. That, however, is not enough to escape the danger.

Today, the economic backdrop is uncannily similar to that of August 1990, when Iraq invaded Kuwait. The difference is that this time the Federal Reserve can only use monetary policy to a limited extent in combating economic slowdown. The economic scenario of the US in the 1990s saw the Federal Reserve increase interest rates considerably, in an attempt to cool an overheating economy.

Consumers cut back on their spending, and this had the desired effect on the economy. Today, US interest rates are already very low at 1.75%, and may have to be lowered further by the end of the year.

Managing the downturn in an uncertain war environment is likely to prove difficult, affecting the US and those who invest in its economy. If war breaks out, and it turns out to be prolonged, the US government will have no alternative but to increase its defence spending. This may cause a greater budget deficit, on which interest costs would add up substantially.

The threat of war with Iraq, together with the already weak

equity markets and a general lack of consumer confidence, has pushed government bond yields in the US, UK and even the Euro-zone to near historic lows, showing that there is a clear flight to quality taking place.

Usually, bond yields fall with interest rates, and result in a lowered cost of borrowing money. This boosts economic growth, and eventually leads to higher interest rates and a subsequent rise in bond yields. However, the market is still experiencing an environment of low interest rates, which has not yet boosted economic growth. A war in Iraq would make the situation worse.

War raises concerns for all investors: they worry that their capital will be depleted, which is a justified concern. The possibility of war increases investors' risk aversion towards financial markets, and they tend to move towards domestic markets and away from international investments.

The bond market is a safer option than the equity market. Bonds offer a much higher level of security, and a significantly lower level of volatility than do equities. The potential of capital-guaranteed products cannot be undermined: they offer some international investments without the possibility of capital depletion.

Gold has also become attractive over the last few weeks, with its price edging higher amid talk of war. The last significant gold rally was in 1993, but it has now soared again. There has also been a flight to property, despite the inherent risks, as this is seen as one of the best ways of preserving capital. The risks associated with property-related investments are the lack of liquidity that results, and the potential to burst of bubbles created by sudden demand.

The US and the UK are at present lobbying for support in their cause against Saddam Hussein. Following Iraq's go-ahead, the United Nations will now be entering Iraq on October 15 for weapons inspection. If Iraq refuses to co-operate, this may provoke an attack Tony Blair has made it clear that "inaction is not an option" and an attack seems increasingly likely.

With military conflict building up in the Middle East, a well-diversified portfolio is imperative. The invasion of Iraq could bring about a double-dip recession in the US. Spreading investments in terms of currency exposure and type is the only way to ensure peace of mind in such challenging times.

Sarah Bonello is operations manager at Globe Fund Advisers Ltd, which is licensed to conduct investment services business by the Malta Financial Services Centre.