STRATFOR's 2011 Second Quarter Forecast
John Mauldin's Outside the Box

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I always look forward the beginning of a new quarter, because it gives me a chance to read STRATFOR's update of their annual forecast, which I shared with you in January. Their quarterly forecast explores developing geopolitical trends in each region of the world.  In recent months and quarters I've noticed a much wider recognition in published discussions of "geopolitical risk" as it relates to investments.  Of course geopolitical risk is nothing new to my long-time readers who've been plugged into STRATFOR for years.

This Q2 forecast is a long read, but it addresses everything from China's battle with inflation, to Russia's economic opportunity, to the stalemate in Libya's civil war. They do a fantastic, and usually spot-on, job of telling you what to look out for.  (And when they aren't spot-on, they're up-front about what they missed and why).

I hope you enjoy the forecast below, and take advantage of STRATFOR's current special offer - a free copy of my book, Endgame, to any of my readers who <<subscribe to their intelligence service here>> at a steeply discounted price. I suggest you check it out.

<<Click here to view their special offer.>>

John Mauldin, Editor
Outside the Box


STRATFOR's 2011 Second Quarter Forecast

In our 2011 annual forecast, we highlighted three predominant issues for the year: complications with Iran surrounding the U.S. withdrawal from Iraq, the struggle of the Chinese leadership to maintain stability amid economic troubles, and a shift in Russian behavior to appear more conciliatory, or to match assertiveness with conciliation. While we see these trends remaining significant and in play, we did not anticipate the unrest that spread across North Africa to the Persian Gulf region.

In the first quarter of 2011, we saw what appeared to be a series of dominoes falling, triggered by social unrest in Tunisia. In some sense, there have been common threads to many of the uprisings: high youth unemployment, rising commodity prices, high levels of crony capitalism, illegitimate succession planning, overdrawn emergency laws, the lack of political and media freedoms and so on. But despite the surface similarities, each has also had its own unique and individual characteristics, and in the Persian Gulf region, a competition between regional powers is playing out.

When the Tunisian leadership began to fall, we were surprised at the speed with which similar unrest spread to Egypt. Once in Egypt, however, it quickly became apparent that what we were seeing was not simply a spontaneous uprising of democracy-minded youth (though there was certainly an element of that), but rather a move by the military to exploit the protests to remove Egyptian President Hosni Mubarak, whose succession plans were causing rifts within the establishment and opening up opportunities for groups like the Muslim Brotherhood.

As we noted in our annual forecast; “While the various elements that make up the state will be busy trying to reach a consensus on how best to navigate the succession issue, several political and militant forces active in Egypt will be trying to take advantage of the historic opportunity the transition presents.” In this quarter, we see the military working to consolidate its control, balance the lingering elements of the pro-democracy movement, and keep the Muslim Brotherhood and other Islamist forces in check. Cairo is watching Israel very carefully in this respect, as Israeli military actions against the Palestinians or against southern Lebanon could force the Egyptian leadership to reassess the peace treaty with Israel, and give the Islamist forces in Egypt a political boost.

In Bahrain, we saw Iran seeking to take advantage of the general regional discontent to challenge Saudi interests. The Saudis intervened militarily, and for now appear to have things locked down in their smaller neighbor. Tehran is looking throughout the region to see which levers it is willing or capable of pulling to keep Saudi Arabia unbalanced while not going so far as to convince the United States it should keep a large force structure in Iraq. Countering Iran is Turkey, which has become more active in the region. The balancing between these two regional powers will be a major element shaping the second quarter and beyond.

We are entering a very dynamic quarter. The Persian Gulf region is the center of gravity, and the center of a rising regional power competition. A war in or with Israel is a major wild card that could destabilize the area further. Amid this, the United States continues to seek ways to disengage while not leaving the region significantly unbalanced. Off to the side is China, more intensely focused on domestic instability and facing rising economic pressures from high oil prices and inflation. Russia, perhaps, is in the best position this quarter, as Europe and Japan look for additional sources of energy, and Moscow can pack away some cash for later days.

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Middle East

Regional Trend: Iran’s Confrontation with the Arab World

The instability in the Middle East carrying the most strategic weight is centered on the Persian Gulf, where Bahrain has become a proxy battleground between Iran and its Sunni Arab rivals. Iran appears to have used its influence and networks to encourage or exploit rising unrest in Bahrain as part of a covert destabilization campaign in eastern Arabia, relying on a Shiite uprising in Bahrain to attempt to produce a cascade of unrest that would spill into the Shiite-heavy areas of Saudi Arabia’s oil-rich Eastern Province. Saudi Arabia responded by sending military forces into its island neighbor.

Continued crackdowns and delays in political reforms will quietly fuel tensions between the United States and many of the Gulf Cooperation Council (GCC) states as Washington struggles between its need to complete the withdrawal from Iraq and to find a way to counterbalance Iran. The Iranians hope to exploit this dilemma by fomenting enough instability in the region to compel the United States and Saudi Arabia to come to Tehran for a settlement on Iranian terms or to fracture U.S.-Saudi ties, thereby drawing Washington into negotiations to end the unrest and thus obtain the opportunity to withdraw from Iraq. So far, that appears unlikely. Iran has successfully spread alarm throughout the GCC states, but it will face a much more difficult time in sustaining unrest in eastern Arabia in the face of intensifying GCC crackdowns.

Iran probably will have to resort to other arenas to exploit the Arab uprisings. In each of these arenas, Iran also will face considerable constraints. In Iraq, for example, Iran has a number of covert assets at its disposal to raise sectarian tensions, but in doing so, it risks upsetting the U.S. timetable for withdrawal and undermining the security of Iran’s western flank in the long term.

In the Levant, Iran could look to its militant proxy relationships with Hezbollah in Lebanon and Palestinian Islamic Jihad in the Palestinian territories to provoke Israel into a military confrontation on at least one front, and possibly on two. An Israeli military intervention in the Gaza Strip would put pressure on the military-led regime in Egypt as it attempts to constrain domestic Islamist political forces. Syria, which carries influence over the actions of the principal Palestinian militant factions, can be swayed by regional players like Turkey to keep this theater contained, but calm in the Levant is not assured for the second quarter given the broader regional dynamic.

In the Arabian Peninsula, Iran can look to the Yemeni-Saudi borderland, where it can fuel an already-active al-Houthi rebellion with the intent of inciting the Ismaili Muslim communities in Saudi Arabia’s southern provinces in hopes of sparking Shiite unrest in Saudi Arabia’s Eastern Province. This represents a much more roundabout method for trying to threaten the Saudi kingdom, but the current instability in Yemen affords Iran the opportunity to meddle amid the chaos.

Regional Trend: War in Libya, Fears in Egypt

Libya probably will remain in a protracted crisis through the next quarter. Though the Western leaders of the NATO-led military campaign have tied themselves to an unstated mission of regime change, an air campaign alone is unlikely to achieve that goal. Gadhafi’s support base, while under immense pressure, largely appears to be holding on in western Libya. The eastern rebels meanwhile remain an amateurish group that is not going to transform into a competent militant force within three months. The more the rebels attempt to advance westward across hundreds of miles of desert toward Tripoli, the easier Gadhafi’s forces can fall back to populated areas where NATO is increasingly unable to provide close air support for fear of inflicting civilian casualties. The geography and military realities in Libya promote a stalemate, and the historic split between western Tripolitania and eastern Cyrenaica will persist. The elimination of Gadhafi by hostile forces or by someone within his regime cannot be ruled out in this time frame, nor can a potential political accommodation involving one of Gadhafi’s sons or another tribal regime loyalist. Though neither scenario is likely to rapidly resolve the situation, a stalemate could allow some energy production and exports to resume in the east.

Coming out of its own political crisis, Egypt sees an opportunity in the Libya affair to project influence over the oil-rich eastern region and position itself as the Arab power broker for Western countries looking to earn a stake in a post-Gadhafi scenario. However, domestic constraints probably will inhibit Egyptian attempts to extend influence beyond its borders as Cairo continues its attempts to resuscitate the Egyptian economy and prepare for elections slated for September. Egypt also has a great deal to worry about in Gaza, where it fears that a flare-up between Palestinian militant factions and Israeli military forces could embolden the Egyptian opposition Muslim Brotherhood and place strains on the Egypt-Israel peace treaty.

Regional Trend: Syria Locking Down

The minority Alawite Syrian regime will resort to more forceful crackdowns in an attempt to quell spreading unrest. There is no guarantee that the regime’s traditional tactics will work, but Syrian President Bashar al Assad’s government appears more capable than many of its embattled neighbors in dealing with the current unrest. The crackdowns in Syria occurring against the backdrop of a stalemated Libyan military campaign will expose the growing contradictions in U.S. public diplomacy in the region, as the United States and Israel face an underlying imperative to maintain the al Assad regime in Syria which, while hostile, is weak and predictable enough to be preferable to an Islamist alternative. Both the GCC states and Iran will attempt to exploit Syria’s internal troubles in trying to sway the al Assad regime to their side in the broader Sunni-Shiite regional rivalry, but Syria will continue managing its foreign relations in a cautious manner, keeping itself open to offers but refusing commitment to any one side.

Regional Trend: Rising Turkey

The waves of unrest lapping at Turkey’s borders are accelerating Turkey’s regional rise. This quarter will be a busy one for Ankara, as the country prepares for June elections expected to see the ruling Justice and Development Party consolidate its political strength. Turkey will be forced to divide its attention between home and abroad as it tries to put out fires in its backyard. The crisis in Libya provides Turkey an opportunity to re-establish a foothold in North Africa, while in the Levant Turkey will be playing a major role in trying to manage the situation in Syria to avoid a spillover of Kurdish unrest into its own borders. Where Turkey is most needed, and where it actually holds significant influence, is in the heart of the Arab world: Iraq. Iran’s destabilization attempts in eastern Arabia and the United States’ overwhelming strategic need to end its military commitment to Iraq will put Turkey in high demand for both Washington and the GCC states as a counterbalance to a resurgent Iran.

Regional Trend: Yemen in Crisis

The gradual erosion of Yemeni President Ali Abdullah Saleh’s regime over the next quarter will plant the seeds for civil conflict. Both sides of the political divide in Yemen agree that Saleh will be making an early political exit, but there are a number of complications surrounding the transition negotiations that will extend the crisis. As tribal loyalties continue to fluctuate among the various political actors and pressures pile on the government, the writ of the Saleh regime will increasingly narrow to the capital of Sanaa, allowing rebellions elsewhere in the country to intensify.

Al-Houthi rebels of the Zaydi sect in the north are expanding their autonomy in Saada province bordering the Saudi kingdom, creating the potential for Saudi military intervention. An ongoing rebellion in the south as well as a resurgence of the Islamist old guard within the security apparatus opposing Saleh will meanwhile provide an opportunity for al Qaeda in the Arabian Peninsula to expand its areas of operation. Saleh’s eventual removal — a goal that has unified Yemen’s disparate opposition groups so far — will exacerbate these conditions, as each party falls back to their respective agendas. Saudi Arabia will be the main authority in Yemen trying to manage this crisis, with its priority being suppressing al-Houthi rebels in the north.

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South Asia

Regional Trend: Intensifying Taliban Actions in Afghanistan and Pakistan

Our annual forecast remains on track for Afghanistan. With the spring thaw, operations by both sides will intensify, but decisive progress on either side is unlikely. The degree to which the Taliban is capable of mounting offensive operations and other intimidation and assassination efforts in this quarter and the next will offer an opportunity to assess the impact of International Security Assistance Force (ISAF) operations. It may also reveal the Taliban’s core strategy for the year ahead, namely, whether it intends to intensify the conflict or hunker down to encourage and wait out the ISAF withdrawal.

The Pakistani counterinsurgency effort has made some progress in the tribal areas, but the Pakistani Taliban have yet to really ramp-up operations. The tempo of operations that the Pakistani Taliban are able to mount and sustain this quarter and next will be telling in terms of the strength of the movement after Islamabad’s efforts to crack down.

The Raymond David case brought ongoing tensions between the United States and Pakistan over the U.S.-jihadist war to an all-time high in the past quarter. Though the issue of the CIA contractor killing two Pakistani nationals was resolved via a negotiated settlement, the several weeklong public drama has emboldened Islamabad, which the Pakistanis will build upon to try to shape American behavior. While a major falling out between the two countries is unlikely, the Raymond Davis incident as well as the increasing perception in the region that Washington’s position has been significantly weakened will allow Pakistan to assert itself in terms of the overall U.S. strategy for South Asia, and especially on Afghanistan.

Islamabad will be trying to leverage further gains by Afghan Taliban insurgents to move the United States toward a negotiated settlement and exit strategy that does not create problems for Pakistan. However, there is little sign of meaningful negotiation or political accommodation so far this year. While there have been efforts to reach out behind the scenes, neither side is likely ready to give enough ground for real discussions to begin.

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East Asia

Regional Trend: China’s Inflation Challenge

China’s challenge in this quarter is clip_image008inflation, namely, finding a way to balance inflation’s impact on society without overcompensating. Inflation is expected to peak this quarter, and political leaders have pledged to get tougher on constraining price increases. Yet policy tightening remains cautious, and new threats to growth have emerged in the form of slackening exports, encouraged by the Japanese slowdown, and rising raw materials costs and other uncertainties in global trade and capital flows. The government will try to prevent or delay price increases for consumers, but kinks in supply and demand, including hoarding and price gouging, will occur and trigger reactions from the most affected social or occupational groups and corporations.

Government fears about economic and social instability and political dissent have triggered an unusually intense security crackdown on dissidents, journalists, newspapers and the Internet. April to June is historically the prime time for strikes, protests, and other incidents and contains sensitive anniversaries like Tiananmen. Given inflation pressures, such incidents are likely to occur in the second quarter. Beijing therefore has no inclination to relax its grip, and is more likely to squeeze harder if social unrest seems to spread more widely or become more coordinated.

The government will delicately handle relations in high-level meetings with major partners including the United States, Australia, Russia, Brazil, India and others, with economic deals preventing tensions from exploding. However, Beijing’s growing sensitivity toward dissent and potential foreign influence means its actions may attract more criticism internationally. A high-profile, serious incident in China relating to human rights or mistreatment of foreigners could invite international moves toward punitive measures, though there is no movement in that direction now.

Regional Trend: Japan’s Postwar Low

The earthquake, tsunami and nuclear crisis have brought Japan to its lowest point since World War II. The second quarter will see the full force of the negative impact on Japan’s economy and on the global economy, where the ripples will be limited but measurable. The power shortages affecting the Kanto area will be manageable because of seasonal low demand. But as the weather warms up, the power shortfalls will increase — affecting more industries — and the need to conserve will become more pressing on the public. Japan typically recovers quickly from earthquakes, but recovery will not gain momentum until after this quarter at the earliest.

The political aftermath of the disaster will focus in the short term on budgeting and stimulus for reconstruction. Political parties’ unity in the face of disaster will prove superficial. The ruling party’s perceived success at managing recovery in the devastated northeast and containing the nuclear crisis will determine its standing. But as the levels of radiation that escape from the damaged plant and the effects of contamination on water, agriculture, health and international commerce increase, so too do the chances for an extensive shakeup of political leadership.

Popular anger could lead to outbursts of large protests or social instability that are otherwise rare in Japan, but the ramifications of any such activity will be contained within the current political system.

Regional Trend: Ongoing Tensions on the Korean Peninsula

Korean Peninsula tensions have fallen since the fourth quarter of 2010, but remain relatively high. South Korea and the United States have warned that further provocative behavior from the North, such as a third nuclear test, may occur in the second or third quarter. Seoul and Washington are maintaining a high tempo of military exercises to deter the North. The next episodes in the North Korean leadership succession and indications of an impending return to international negotiations also suggest that the North may stage another surprise incident this quarter as a prelude to a return to talks.

The North is deeply engaged with back-channel discussions with the United States, and despite a potentially provocative act by the North, movement back toward the negotiating track is the overall trend for the quarter.

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Former Soviet Union

Regional Trend: Russia’s Dual Foreign Policy

In terms of Russia’s dual foreign policy, Moscow is comfortable in its current position going into the second quarter. The United States has become involved in a third war, this one in Libya, which is further distracting U.S. attention away from Eurasia and toward the Middle East. The Europeans have differences over the Libyan intervention and are dealing with financial and economic turmoil and governmental shifts. Meanwhile, energy prices are rising and key countries like Italy and Japan are looking to Russia to make up for the loss of energy supplies from Libya and the Fukushima nuclear crisis, respectively.

All of these energy developments provide Moscow with opportunities, not the least of which is to fill state coffers. The last time Russia received such an infusion of cash during a time of peaking energy prices, Moscow made a serious show of force in the Russia-Georgia war in August 2008. This time, Russia is putting the cash in the bank and investing in large domestic projects in order to improve the country’s long-term internal strength.

There will be two lines of focus for Russia in the second quarter — Europe and the former Soviet states. With Europe, Russia’s maneuvers will start to take shape via its relationship with the United States. Russian President Dmitri Medvedev and U.S. President Barack Obama will have their first meeting of the year in May. Russia is focusing the talks on the issue of ballistic missile defense — something the United States is less inclined to address at present. Russia, then, will use the issue to shape perception of both the United States and Russia in Europe. The Western Europeans would like to keep out of the discussion, but Moscow will seek to draw them in as Russia tries to exploit and expand differences between the United States and its Western European allies, as well as between Washington and the Central Europeans. Russia, however, will continue to pursue its dual-track diplomacy, and will not push Washington too far away. For Moscow, it is important to balance its assertiveness with a dose of cooperation.

One potential problem that could emerge for Moscow is in the Caucasus. Tensions have been heating up between Armenia and Azerbaijan as preparations are made to reopen a rebuilt airport in the breakaway territory of Nagorno-Karabakh in May. Armenian President Serzh Sarkisian has announced he would be on the first flight from Yerevan to the rebel region’s capital, and this has set the stage for a standoff as Azerbaijan has threatened to shoot down flights that violate its airspace. If a conflict breaks out, it will draw in Russia, as well as Turkey and possibly the United States, though it is more likely this will play out politically rather than militarily.

Regional Trend: Kremlin Infighting

Kremlin infighting increased at the end of the first quarter and will continue into the second. A new evolution is emerging: pushing out old siloviki businessmen (who also happen to be politicians) and replacing them with more Western-minded businessmen (who appear more competent). Moreover, announcements of serious cuts in government jobs will start in a matter of months. A backlash is brewing among those being pushed out, something that Prime Minister Vladimir Putin and President Medvedev are already struggling to keep a handle on in the lead-up to elections at the end of 2011 and in 2012.

Regional Trend: Powder Keg in Central Asia

Central Asia will continue to simmer in the second quarter, especially with low-level instability persisting in Kyrgyzstan and Tajikistan. However, the Kazakh elections in the beginning of April, in which incumbent President Nursultan Nazarbayev secured a comfortable re-election, have sharpened the focus on the real issue in the country — Nazarbayev’s succession crisis. STRATFOR is hearing rumblings that large reshuffles will happen right after the elections, and aside from the movement made in the political sphere, instability can be played out in other critical areas as well, such as energy and finance. This is what really scares global powers with stakes in the country, which will be watching Kazakhstan closely.

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Europe

Regional Trend: Closing the Circle on the Eurozone Periphery

The eurozone’s sovereign debt crisis continues, but with social unrest and natural disaster in other parts of the world, the focus of the markets has shifted away from Europe, providing the continent with a temporary respite. As STRATFOR stated in its Annual Forecast, the EFSF, Europe’s bailout mechanism, is more than capable of accommodating the Portuguese bailout — and even bailouts for Belgium and Spain, if need be. Rising energy prices due to geopolitical instability in the Middle East could, however, hinder the recovery of private consumption. Private consumption is not as important for Europe as it is for the United States, but Mediterranean countries tend to rely on it for a greater proportion of their gross domestic product (GDP) than northern European countries. They also tend to be less efficient at using energy and oil tends to make up a higher proportion of their overall energy profiles. The last thing the Spanish economy needs is additional headwinds, as it is expected to grow only 0.8 percent in 2011. A serious revision of the 2011 Spanish GDP closely following the Portuguese bailout could refocus the markets on Madrid’s — and therefore the wider eurozone’s — sovereign debt problems.

The aspect of Europe’s economy most concerning to STRATFOR is the status of the eurozone’s financial system, specifically the health of its banks. As the sovereign debt crisis recedes, the banks are returning to the forefront. For many countries, these issues are two sides of the same coin (as in the cases of Ireland and Spain) and for others there is a danger that banks have troubled sovereign bond holdings. The ECB is expected to unveil new support mechanisms in the second quarter, particularly for restructuring banks in Ireland, and it will likely expand the mechanism to the rest of the eurozone’s restructuring banks, probably by the end of the quarter. However, many European banking systems are integrated into local politics — German Landesbanken being one example — and there could be resistance to restructuring.

Regional Trend: Austerity Measures and Political Costs

Getting to the point where it could manage the sovereign debt crisis took a great deal of work for Europe. Bailing out Greece and Ireland, setting up the EFSF and pushing through tough austerity measures across the continent was, and continues to be, politically expensive. The non-traditional, anti-establishment parties are gaining popularity. This annual trend should continue across the continent and is not only confined to the eurozone. Instability in the Balkans is growing as well, with Croatia and Bosnia-Herzegovina, both EU candidates, facing a particularly unstable quarter.

Furthermore, German Chancellor Angela Merkel has lost a number of state elections and will likely face more negative election results throughout 2011, resulting in a severe loss of political capital. This will not play an immediate role on pushing through changes to EFSF’s capacity or the ability of bailout mechanisms to purchase government bonds directly, but rather will reduce her ability to go against her conservative base in the event that a new crisis emerges. If the upcoming German Federal Constitutional Court decision on the constitutionality of the bailout mechanisms rules against the mechanisms, this would certainly precipitate a crisis, and remains the event to watch in the second quarter. Such a ruling would reopen the fundamental question of whether Berlin stands behind the eurozone — supposedly answered in the affirmative with the Greek and Irish bailouts.

Regional Trend: The Devolution of Cold War Institutions

Another trend to observe in the second quarter is the long-term devolution of two Cold War institutions: NATO and the European Union. The Libyan intervention plays into this process very well, since it has strained member state relations in both organizations. But Libya is a symptom, not a trigger, of a process long under way. Three trends in particular are evident in the Libyan situation:

  • Germany’s focus is being drawn away from NATO and transatlantic links and toward Central and Eastern Europe, a traditional sphere of influence referred to as Mitteleuropa, and Russia.
  • Central Europeans have for some time expressed their displeasure with NATO being used for operations outside the European theater. As a result, Central Europe will have little support in the second quarter in pushing back Russia on its periphery and will be forced to stand with the status quo — an uneasy acquiescence to Russia’s gains in its former Soviet sphere of influence.

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Sub-Saharan Africa

Regional Trend: Fallout from North Africa

We will be watching in the second quarter for unrest from the revolutions occurring in North Africa spreading into sub-Saharan Africa. A number of governments in the region have faced low-level protests, including Senegal, Angola, Gabon, Sudan, Burkina Faso and Mauritania, but so far no protests in sub-Saharan Africa have emerged on a scale that has significantly threatened a government. We cannot say that any specific government will be vulnerable this quarter, but even so, these governments and aspiring opponents will be calculating throughout the quarter how to best advance their interests.

Regional Trend: Nigerian Elections

Nigeria will hold national elections in the second quarter, an event that could trigger considerable violence as incumbent and aspiring politicians maneuver to win office and the significant perks that accompany it. The election timetable is staggered, with parliamentary elections currently scheduled for April 9, a presidential vote April 16, and gubernatorial and local government elections April 26. A new president will be inaugurated by the end of May. Although localized protests and violence can be expected, there is a strong chance that militant activity in the oil-producing Niger Delta region will be restrained. A combination of political, financial and security measures will be used to manage Niger Delta militancy.

Reforms to the oil and natural gas sector in the form of the Petroleum Industry Bill (PIB) will be discussed before the dissolution of parliament leading up to the presidential inauguration. While the bill is unlikely to pass during this period, the speed at which the new parliament pursues its passage will indicate the level of consensus for reform that exists within the government. The PIB would restructure state participation in the sector, increasing government revenues and introducing a legal framework for the country’s natural gas operations.

Regional Trend: Southern Sudanese Independence

Sudan’s ruling National Congress Party and the Sudanese People’s Liberation Movement party will use the entire quarter to negotiate terms of Southern Sudanese independence, expected to be declared July 9. Negotiations will not likely be concluded this quarter, however, as the issues — particularly oil revenue sharing — involve deeply entrenched interests. Still, ad hoc working committee-level agreements on how to deal with oil likely will serve in place of the more difficult formalized relations. While there likely will be flare-ups along the border in Abyei and places like Malakal, a return to full-scale war is not expected.

Regional Trend: Consolidating Gains Against Somalia’s al Shabaab

African Union peacekeepers deployed in Somalia together with other pro-Somali government forces and militias will use the second quarter to try to consolidate gains against al Shabaab, a hard-line Islamist militia operating in Somalia. Efforts will focus on Mogadishu; fewer resources will be devoted to counterinsurgency operations in southern and central parts of the country. Political negotiations over the end of the Transitional Federal Government mandate in the third quarter will accelerate as Somali politicians and donor stakeholders try to cut a deal over what political groupings in Mogadishu can best isolate al Shabaab.

Regional Trend: Ongoing Tensions in Ivory Coast

Ivory Coast is likely to remain tense this quarter as President Alassane Ouattara works to entrench his government in Abidjan following former President Laurent Gbagbo’s removal from power April 11. Ouattara and his government, led by Prime Minister and Defense Minister Guillaume Soro, will need the full quarter and then some to promote reconciliation in the country and to try to prevent residents in Abidjan loyal to Gbagbo from carrying out guerrilla attacks, including assassination attempts on Ouattara and Soro.

Both activities will be necessary to protect the Ouattara government from reprisal attacks by gunmen armed by the former Gbagbo regime. Ouattara will take the lead on political reconciliation while Soro will assume the task of disarming pro-Gbagbo loyalists. International economic sanctions applied against the Gbagbo regime will be dropped shortly after Ouattara consolidates his hold on power, and revenues that will flow again from cocoa and other commodity exports will be used to buy good will among southern Ivorians, civil servants and security personnel to reduce their hostility toward the new government.

Regional Trend: Labor Unrest in South Africa

In South Africa, the second quarter is the period when the potential for labor unrest over annual wage negotiations emerges, though any strike action usually occurs in the third quarter. Last year, the country experienced widespread strikes by civil servants and private sector employees in the wake of the 2010 World Cup.

Pretoria will be keen to avoid a repeat performance in the sectors where negotiations are taking place, but will unlikely be able to meet wage demands due to its need to control inflation. Any significant concessions to labor will come as a result of the ruling African National Congress prioritizing its need to placate the ruling alliance’s union members at the expense of the country’s economic priorities. South Africa will also hold local government elections May 18, and while no major changes in voting trends are expected, the government will want to make sure that major labor disputes do not affect voter preferences.

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Latin America

Regional Trend: Venezuela’s Delicate Stability

Venezuela continues to struggle with challenging economic conditions, but this is not likely to be the quarter when things come crashing down. Although Venezuela is not currently experiencing the drought that plagued its hydroelectric system last year, the general decline of the electricity sector after decades of neglect is causing periodic blackouts and disruptions throughout the country, which will likely worsen over the course of the second quarter. However, thanks to high oil prices — which currently hover around $100 per barrel for the Venezuelan oil basket — the government of Venezuelan President Hugo Chavez has enough extra cash on hand to ensure regime stability through the quarter. Domestic economic challenges will keep most of this cash at home, leaving Caracas with little additional money to spread around the region. Given these challenges, we should expect to see continued Chinese interest in Venezuela as China seeks additional investment opportunities and Venezuela looks to form economic and political ties with any country besides the United States.

Regional Trend: Elections in Peru

Peru will select a new president in the second quarter. The first-round election held April 10 was won by leftist candidate Ollanta Humala, who will face either Keiko Fujimori, the daughter of former President Alberto Fujimori, or Pedro Pablo Kuczynski in a June 5 runoff (the results are not yet finalized). Although Humala has forcefully distanced himself from the extreme leftism of Venezuelan President Chavez in favor of the more business-friendly leftism of former Brazilian President Luiz Inacio Lula da Silva, it is not clear at this point how much of his (relatively recent) moderated rhetoric is purely for effect, and how much will translate into policy. If elected, Humala will be constrained by the lack of a majority in the legislature, so any radical policy shifts would be difficult.

Regional Trend: Brazil Charts a Course

This quarter will be the one to watch for the evolving foreign and domestic policies of Brazilian President Dilma Rousseff. Particularly important this quarter will be any movement Brazil makes toward formulating a strategic policy regarding China, Brazil’s most important trading partner with which Brazil has an increasingly tense relationship as a result of rising Chinese exports competing with Brazilian domestic manufacturers. Some limited movement toward tougher trade rules on a number of Chinese goods can be expected as Brazil seeks to protect domestic industry from international competition. However, Brazil has no interest in alienating China, so major strategic shifts are unlikely this quarter. Brazil’s foreign policy overall will take a backseat this quarter under the Rousseff administration as she focuses on economic management. A pending decision on which fighter jet Brazil will purchase will continue to be an issue in the second quarter, with France and the United States both lobbying for the contract. With the U.S. president’s visit to Brazil out of the way and Rousseff settling on her overall policy strategy, we could possibly see movement in the second quarter on the long-delayed decision.

Regional Trend: Political Alliances in Mexico

In Mexico, negotiations continue between the Revolutionary Democratic Party (PRD) and the National Action Party (PAN) over the possibility of an alliance in Mexico state for the July 3 gubernatorial election. It is unlikely either party could beat the Institutional Revolutionary Party (PRI) on its own, so an alliance would be beneficial, but the parties would need to agree on a candidate and a platform, which is no small feat. The PRD and the PAN will have to settle their differences before the end of the quarter if the coalition candidate is to have time to campaign against the as-yet-undeclared PRI candidate. As unlikely as it is, if the PRD and the PAN can come to an agreement in Mexico state, it could set them up for further cooperation ahead of the 2012 presidential election, for which the PRI appears to be well-positioned.

Regional Trend: Persistent Cartel Violence

In the cartel war, Tamaulipas and Nuevo Leon states continue to be hotly contested territory between the Gulf cartel and Los Zetas, with the latter group most firmly entrenched in Monterrey and Nuevo Laredo. Mexican military and law enforcement have made inroads in the Zeta leadership structure, successfully capturing or killing eight mid- and upper-level leaders (including one of the original core group) in Nuevo Leon, Tamaulipas, Oaxaca and Quintana Roo states. Chihuahua, Guerrero, Sonora and Durango states all are seeing an increase in violence as the Sinaloa Federation expands into the regional cartels’ conflicts. The military is fighting an uphill battle, with cartel leaders being replaced as quickly as they are captured.


Disclaimer

John Mauldin is president of Millennium Wave Advisors, LLC, a registered investment advisor. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Opinions expressed in these reports may change without prior notice. John Mauldin and/or the staffs at Millennium Wave Advisors, LLC and InvestorsInsight Publishing, Inc. (InvestorsInsight) may or may not have investments in any funds, programs or companies cited above.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

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Posted 04-14-2011 1:06 PM by John Mauldin
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