The Sensex to Gold ratio says...

In this issue:
» Can gold prices provide valuation cues for Sensex?
» China's baby steps towards stimulus withdrawal
» Metals to witness a strong 2010
» RBI sees uneven patterns in growth
» ...and more!!

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00:00

Chart of the day

If you believe in the law of averages then today's chart of the day has some good news for you. It plots the Sensex/Gold price per 10 gms ratio going back as much as 10 years and throws up some startling information. While the ratio has been quite volatile, the average of all the data points turns out to be 1.

In other words, whenever the Sensex has risen at a much faster pace than gold prices, its fall has also been equally precipitious. And the reason behind this volatility may not be hard to find. Stock market indices are more amenable to manipulation than gold prices because even money printing or an increase in money supply can give the impression that economy is growing. But as the recent crisis has shown, it could all turn out to be phony, making stock market indices come down as sharply as they went up. Gold supply on the other hand cannot be manipulated and hence, tends to show far more stability in its price. Thus, if the Sensex to gold price ratio is way more than one, it could be a signal that the Sensex is overvalued.

Alternatively, if it is way below one, it could mean that Sensex is undervalued. The ratio stands at around 1.03 currently, indicating that the Sensex may be trading pretty close to its fair value! However, we wouldn't advise investors to take this chart as gospel truth. At best, it could just be another useful tool in their valuation tool kit.

Source: Trend database

01:02

Yesterday, China raised the minimum reserve requirement for its banks by 0.5%. The move is an attempt to stop inflation in its tracks and prevent formation of big asset bubbles.

India too is expected to follow suit. The RBI has been concerned with rising food prices and its impact on overall inflation for quite some time now. It is also mindful of the abundant liquidity in the system, thanks in part to its own relaxation of reserve requirements early last year and in part due to surging capital inflows into India. The fact that the Indian industrial output grew at its fastest pace in more than two years in the month of November 2009 also allays any fear with respect to economic slowdown. Thus, the stage seems to be perfectly set for the country's central bank to at least hike reserve requirement if not interest rates in the soon to be held monetary review exercise.

01:34

Coming back to the baby steps being taken by China to withdraw stimulus, we wonder whether such measures would help both the nations achieve desired results unless the developed nations, most of all the US follows suit. And such a possibility looks remote indeed. US unemployment is still nowhere close to comfortable levels and this is the single most important factor that would force the US Fed to continue with its loose monetary policy. Thus, cheap money emanating from the US will continue to look for higher yields and risky asset classes like Indian and Chinese equities.

This scenario also presents a dilemma for Indian investors. It is quite possible that continued surge in capital inflows could take stock markets even higher. But investors fall for this buoyancy at their own peril. It should be noted that that risk reward equation from a one to two year perspective is not that favorable at the current juncture and hence, please take the fundamentals of the underlying company and its valuations into proper account while investing. For if the capital flows start looking the other way, one does not want to be caught on the wrong foot!

02:23

Commodities is an interesting space. And crude oil even more so. Reduce supply by a couple of million barrels per day and prices could skyrocket. And it works the other way as well. Increase supply by the same amount and prices could well cool down considerably. Now, imagine a region having Saudi Arabia like reserves being brought into play over the next few years. We are talking about oil ravaged Iraq. As per CNN Money, Iraq's oil industry is on the verge of a major reconstruction and could start pumping as much as 11 million barrels per day, a number that is just behind Saudi Arabia and Russia, within the next few years.

Forget 11 million barrels, even if it manages to achieve a steady supply of a mere 20% of that amount, it can have a major impact on crude oil prices. However, it looks unlikely that OPEC would let Iraq spoil the oil market. Furthermore, depressing prices more than required would also hurt Iraq's own interests. At best, what we can hope for is reduced volatility in oil prices.

03:00

Now this might seem like an indirect hint from the RBI on its interest rate stance. The bank's deputy governor Subir Gokarn said yesterday that India's economic recovery still seems uneven. As reported in DNA Money, Gokarn said, "...there is still an imbalance in the pattern of growth. I am not saying that recovery is not happening but it does suggest that recovery is 'uneven' and that is really a consideration that will dominate our thinking."

Gokarn however believes that there seems to be some stability emerging on the food price inflation front. However he has also cautioned that a widespread recovery will see inflation spilling over to a wider canvass of goods. Interestingly, this makes for a case of raising interest rates going forward.

In short, the RBI itself seems confused on its interest rate stance. As such, we can do little but wait and watch.

03:30

The RBI like its peers in the West seems to be repenting its extended loose monetary stance. Indian banks that were so far known to be conservative have shown signs of greed since the last couple of quarters. With cheap money sitting on their books, banks have shown the tendency to accumulate assets at throw-away interest rates. The leading PSU bank that led the trend is now most vocal about possible slippages. However, its smaller peers are trying their best to the make the most of the easy liquidity scenario.

The RBI has particularly resented a recent trend amongst banks to offer mortgage and auto loans at 'teaser rates'. These are nothing but temporary low rates on long term assets to attract ignorant borrowers. The RBI fears that in most cases the borrowers are ignorant of the impending hike in interest rates. It also believes that banks are not doing the necessary check to ensure borrowers' servicing ability when rates go up. With such callousness, high NPAs are inevitable. However, banks have defended themselves on grounds that they have put forth the necessary disclosures. The growth in banking sector's loans has been tepid at 12% YoY in 9mFY10. However, we believe that banks need to stick to certain degree of conservatism and keep the lessons of the global financial crisis on their minds.

04:15

Metals are set for a strong showing in 2010 after a dismal 2009. In that year, all metals except gold fell as compared to 2008. As a result, the Raw Materials Group (RMG), a respected Swedish Research Organization is of the opinion that metal prices have bottomed out and will now witness an upswing in 2010. The two main factors which will bolster metal prices are the strong physical demand from China and Asia combined with speculative driving forces from financial players.

While there will be efforts to increase capacity to temper demand, the same is not likely to keep pace with the surge in demand. The reason: Financing problems in the wake of the global credit crisis. And so, till such time the trend for metal prices increasingly points upwards. While this will be a positive for metals companies, companies who are the end users of these metals will be the ones to bear the brunt of higher prices and consequent impact on margins.

04:48

Meanwhile, after staying in the negative during most of the first half, markets staged a comeback and the Sensex was trading marginally in the positive at the time of writing. The recovery was once again being led by the IT bellwethers. Other Asian indices however closed the day in the red. Europe on the other hand, is witnessing a mixed trend currently.

04:55

Today's investing mantra

"The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share." - Warren Buffett