RIYADH, 30 June 2005 — Saudi Arabian shares may be heading for a fall just as the world’s biggest oil exporter reaps the rewards of record crude prices, a Gulf-based analyst warned in a report hotly disputed by some Saudi economists.

Saudi shares have soared more than five-fold since January 2003, fueled mainly by a surge in oil prices which hit a record $61 a barrel this week and have driven Saudi corporate profits ever higher. But the report issued by the Bahrain office of Japanese brokerage Nomura, titled “The Great Arabian Bubble: Red Alert”, warns that share prices have lost touch with reality and could be heading for a “sharp and painful” correction.

Alternatively, the Arab world’s biggest bourse may be set for a gradual but prolonged decline despite a buoyant economy and rising profits, just as Chinese stocks have fallen since 2001 throughout China’s economic expansion, Nomura said.

The official share index closed 13,694 points yesterday, translating into a gain of two-thirds so far this year. Total market capitalization is significantly larger than Saudi Arabia’s total GDP.

Comparing Saudi share price gains with the seemingly inexorable rise of US technology shares up to their March 2000 peak, Nomura said investors were ignoring fundamentals to justify the sky-high prices “on the basis of some new paradigm”. An unweighted list of the 30 largest Saudi stocks produced an average price/earnings (PE) ratio of 50 times 2004 profits, and an “outrageous” price-to-book ratio of 9.2, the report said.

If share prices remain unchanged it would take around 10 years of 10 percent annual profit growth for the PE ratio to “correct toward historically sustainable levels”. But bankers and economists in Saudi Arabia have taken issue with the Nomura report, saying anticipated profits this year suggest Saudi share prices are not so outlandish, and that strong domestic demand can sustain the market rally.

“As long you have a tsunami of demand and limited shares, where do you think the share prices will go?” said Khan Zahid, chief economist at Riyad Bank.

“PEs make sense when you have a market which is driven by fundamentals... But as long as you have the liquidity, and very limited channels of investment, it’s going to keep going”.

Share ownership in Saudi Arabia is limited to Saudi nationals and citizens of its Gulf Arab neighbors, though foreigners can invest in Saudi stock mutual funds.

Stocks and real estate are the two main, if not only, channels for Saudi investors to plough their cash into.

Since the Sept. 11 attacks against the United States, which tipped US-Saudi relations into crisis, many Saudis have been wary of investing there. Political factors were reinforced by economics as Gulf markets soared, unlike most major bourses. “Saudi investment will not be going to the dollar economy as long as the war on terror goes on,” Zahid said.

Some economists disagree, saying wealthier Saudis will shift money abroad as soon as financial returns justify it, and said Nomura’s warning should be heeded. But financial consultant Bishr Bakheet said the report was flawed because it used last year’s financial results to calculate valuations six months later in a market witnessing double and even triple digit profit growth.

Using forecast results for 2005 he said petrochemical giant SABIC and Saudi Telecoms Company, which together account for 38 percent of market capitalization, have PE ratios of a more modest 23 and 24. That calculation was based on “conservative” profit growth predictions of 54 and 24 percent, compared to 112 and 9 percent the two firms achieved last year, Bakheet said.

While many of the smaller speculative Saudi stocks remain “way over-valued”, the market as a whole still offers opportunities to investors, he added. “The majority of the market...still has more of an upside potential...given that oil prices keep hitting new highs,” Bakheet said.