An FII error you can profit from?

Dec 16, 2010

In this issue:
» India may fall out of FII radar in near term
» What is current gold to silver ratio saying?
» Employees in India may see a strong rise in salaries
» China continues to load up on US treasuries
» ...and more!!

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BSE-Sensex, India's benchmark index has lost more than 3% in the past one month. It should be noted that Dow Jones, the US benchmark is virtually up by a similar margin during the same period.

India down and US up. Certainly, an interesting turn of events. And it could be not without reason. You see, since the post crisis lows of March 2009, the Sensex has handily outperformed the US Dow. Not that this was entirely unexpected. Not only did Sensex lose more during the crisis but the fact that its economy was growing at a much faster rate than the US also tilted scales in the favour of the Sensex.

But things are different now. Sensex has had a very strong bull run. Infact, we believe that at current levels, it could be running ahead of its fundamentals. The US on the other hand seems to be heading towards some sort of an economic recovery. Furthermore, with its benchmark index also underperforming, there is a greater probability of money moving out of Indian equities and entering US markets.

This has been further corroborated by the BofA-Merril Lynch survey for the month of December. As per the survey, 16% of investors are now bullish on US equities compared with just 1% in November. Furthermore, bearish position on India has increased sharply over the past one month.

Now, here's something that the survey will not tell you. The US recovery, as per us, may not last long term. This is because it has entirely been built on stimulus and bail out money. The moment this life support system is removed, there is a great risk that the patient called as US economy may die again. India on the other hand seems on a much better ground. Thus, do not wince if FIIs pull out of India in the short term. For it will be a fantastic opportunity to buy into the long term India growth story.

 Chart of the day
Recent correction notwithstanding, silver has been on a tear in 2010. While gold has also given good returns, silver has handily beaten its precious metal counterpart. However, will the trend repeat itself in 2011? Maybe not if the data for the past 20 years is any indication. Today's chart of the day plots the average gold/silver ratio. As the chart shows, the two decade long average stands at around 67. In other words, same quantity of gold is 67 times more expensive than silver. As of now though, the ratio stands in the region of 50. In other words, if the ratio were to go back to long term average of 67, gold will have to rise at a faster rate than silver. However, investors take the data seriously at their own peril. A lot more detailed study is perhaps required before one considers playing the two precious metals. What can be said with certainty though is the fact that with paper currency losing value day by day, both of these metals are likely to outperform cash in the long term.

Source: Bloomberg (2010 data till Dec 9)

Indians are having a lot to cheer about these days. The economy has been growing along at a strong pace, stock markets have risen considerably and there is a general feeling of goodwill all around. And this is only expected to get better next year. For according to Ma Foi Randstand, a huge staffing company, average pay increase in 2011 is set to rise by an impressive 20% in India. This is much higher than the 8-12% rise that was seen in 2010.

Of course, one is not seeing the kind of pay hikes in the heydays before the crisis erupted. But India's strong recovery from the global slowdown has certainly enthused employers across industries. And the demand for people is across the value chain from skilled to unskilled workers. This is indeed good news for the Indian economy. That said, from a long term perspective, given that India's population has been on the rise, it will be interesting to see how easy it will be for its young workforce to be gainfully employed.

China's holdings of US treasuries are increasing at a steady pace. The dragon nation recently increased its holdings of US sovereign debt by 2.6%, to a massive US$ 907 bn. Japan is a close second. Britain is however, a distant third. Overall, foreign holdings of treasuries increased by 1.1% to US$ 4.3 trillion. Why is US debt so popular even though the country is running a trillion dollar deficit, you may ask? And with major tax cuts expected, the deficit is only set to increase. This year's deficit is expected to top the previous record of US$ 1.4 trillion.

Well, the answer lies in the fact that two-thirds of the foreign holdings of US debt are held by governments and central banks. With a closely connected global economy, having the US return to its former glory is imperative for the growth of all other nations. Especially, the export oriented economies. Cutting the legs of the giant doesn't make any sense. Providing crutches to support its weak legs is a much better idea we guess.

The US has done its bit to make gold the most sought after commodity in recent times. By running its currency printing mills overtime, the US has ensured that fiat currencies lose value. Hence demand for gold as a safeguard against depreciating currencies has assumed historic proportions. Not to mention the speculative demand. Gold ETFs, in particular, have gained popularity amongst investors.

However, the role of Indians in the steep run up in gold prices cannot be undermined. For despite not producing any, the country is the largest consumer of gold. The World Gold Council has predicted that India will import a record 800 tonnes of gold by the end of 2010. However, the biggest consumers of the commodity are not interested anymore. Consumers in rural India account for 70% of the country's gold consumption. Key reason for the same is lack of banking and investment opportunities in the hinterlands. But Indian banks are now keen on financial inclusion. So are consumer durables makers vying for a share of the rural pie. Given these options, demand for the yellow metal may see a dip.

Meanwhile, news that the RBI will not tinker with interest rates seemed to have a positive rub off on stocks today as the benchmark index came off the day's lows and was trading higher by around 170 points at the time of writing. IT and banking stocks were seen generating the maximum buying interest. On the other hand, Asia closed mixed today whereas Europe has opened on a positive note.

 Today's investing mantra
"The stock market is filled with individuals who know the price of everything, but the value of nothing." - Philip Fisher

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6 Responses to "An FII error you can profit from?"

Ankur Kathuria

Dec 19, 2010

Well, the export oriented economies are not subscribing to US treasuries because they have any intention to support US with crutches. Instead what is actually happening is that US Dollar is finding its way into export oriented / emerging economies because of higher yields. As a result the currencies of energing markets are getting stronger. So to stop the export currencies from getting stronger, thier local governments buy the US Dollars from the markets. This US dollar is then used by Governments to subscribe to US treasuries.

It is kind of vicious circle now.

Export oriented economies cannot really help US with the crutches. Unless US tries to help itself. The US consumer will have to make sure that debt fuelled spending should be brought down to actually bring the deficit down.


Jignesh Thakkar

Dec 17, 2010

In first paragraph of the article you mentioned about indian market running ahead of looking at the sensex valuation but dont you think sensex is just about 30 stocks & indian markets are made up of number of good fundamentaly strong companies which may attracts eves of investors & not just sensex companies???



Dec 17, 2010

I wonder how long will the USD remain reserve currency of the world? Given it's conservative stance on stimulus, whether Euro has got better chance in the long term to emerge as alternate reserve currency, once the sovereign debt crisis is tamed in the medium term (say, 12-18 months)? Right now, both US and Euro area are 20% of the size of the world economy while Japan and China are only 7-8%, hence Euro seems better placed once it comes out of debt crisis. Even if China continues to grow at higher rates, the closed nature of it's economy will prevent yuan from becoming an alternative. The USD's dominance as reserve currency seems very much likely to get diluted over long term.


Praveen Bhargava

Dec 16, 2010

Foreign Institutional Investors(FII)money in Indian Equity market is just like a kid of 5-10 years old and has not made India as a permanent home for the capital with them. Any how FII money is a venture capital and will settle at any place around the world as the situation arise. In the recent past it was India and/or China and for now it may be USA.
FII money has no permanent future in India or any other place in the world.This FII money will stay long only at that place where the prospects to grow fast and give handsome return is more than the other places of the world.
Side by side it is also true that India is a growing Economy and attract all the FII money as well as other sources of wealth around the world to grow and stay in India for a healthy return of the investments.
The present time is really a good opportunity for Indian Investors to put money in selected counters to get handsome returns in near future when the attraction of FII will through more money in Indian Stock Market.


Sunil Doshi

Dec 16, 2010

Your Article states "As of now though, the ratio stands in the region of 50. ";whereas the Graph depicit ratio more near62/63 ! Which figure is more correct ??



Dec 16, 2010

I really liked the article on china's accumulation of US debt and also the note on the reasons for the hike in gold prices.
Thanks to the entire team of Equitymaster for providing such useful articles daily.

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