What higher real interest rates could do to demand for real estate and gold... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

What higher real interest rates could do to demand for real estate and gold... 

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In this issue:
» Sensex: Will the strong run continue?
» Greenspan on why China is hoarding gold
» Modi to US CEOs: Come ASAP before its too late
» A weak week for global markets
» ...and more!

We, at Equitymaster, for long have been talking about the need for individuals to invest a part of their savings in equities; given the asset class' inflation beating ability over longer periods. Especially in a country such as India, which has a history of costs rising at a fast pace.

While inflation levels seem to be cooling down in recent times, the fact of the matter is that until recently, interest on savings bank deposits or for the matter fixed deposits were not enough to fetch positive inflation adjusted returns. In other words, the real interest rates were negative.

And with most investors having burnt their hands in the stock market turmoil of 2008, a recent incident, it seems that retail participation in equities has only diminished since then.

These are the key reasons for financial savings by households to be deteriorating over the past few years. As compared to historical trend of having higher proportion of financial savings as compared to physical savings, the same has reversed substantially in recent times. The change in ratio of financial savings and physical savings in India in FY12 and FY13 is a strong indication of that.

However, even though the inflation trends are becoming more favourable as time is passing by, it seems that the RBI governor is in no hurry to lower interest rates. As pointed out by the Mint recently, he met up with journalists post the Monetary Policy review earlier this week and suggested that it would be important for real interest rates to become positive for influencing households to move money back into financial assets. You may recall that at initial stages post his appointment too, Dr Rajan had pointed out the need to bring down inflation as well as increase the share of financial savings. In fact Dr Rajan's suggestion on increasing the savings rate and investment in financial instruments reaffirm the Megatrend in the making.

The government's focus on financial inclusion could give a big boost to financial savings in the country. And that in turn will allow banks and financial institutions a much wider customer base to lend to. Not only will this benefit households that will becoming part of the banking system and will have access to cheaper credit, but it will also benefit financial institutions in the form of having access to cheaper funds to give out.

What about the appetite of Indian households for gold and real estate then? Well, a recent IMF report stated that India's property prices declined the most amongst 52 countries. And gold prices have been softening. As financial inclusion improves and the banking system offers a healthy inflation adjusted rate of return, we see no reason why household savings should not move from physical assets to financial savings in the medium term. And that will at least curb the speculative investments in real estate and gold.

The financial investments could be in the form of stock market investments as well. Now, whether the timing of retail investors and their return on investments will do well or not is a topic for discussion for another time.

But considering that household investment in physical assets were primarily driven by desire for earning high inflation adjusted returns, if financial savings start offering the same, a possibility of reversal in savings and investment patterns in the future is quite high.

If all goes as expected, the banking sector is likely to benefit from this Megatrend over long periods.

Will positive real returns bring back the demand for financial savings or will physical assets continue to dominate household investments? Let us know your comments or share your views in the Equitymaster Club.

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01:45  Chart of the day
Indian stock markets have had a very good run in 2014. As can be seen in today's chart, the Sensex has closed with a gain of 26% during the first nine months of 2014. This has been the best ever nine month performance since 2009. Though the rally in 2009 was much higher, it was sector specific. This time around the rally is broad based, with mid & small caps having joined the party as well.

Sensex: Will the strong run continue?

Considering the prospect of brighter economic outlook amidst change in leadership at the Centre, most brokerages have come out with aggressive Sensex targets. This is where investors need to be careful. When the overall macro environment is improving brokerages try to capitalize on it. Not only brokerages, you may have even witnessed fund houses announcing various new schemes these days. No doubt that the economic conditions are improving. However, much of the improvement could have been priced in as can be seen in the first nine month performance of 2014. Buying blindly without paying heed to valuations could be a fatal mistake. As such, investors should exercise patience and judgment during such times.

Alan Greenspan, responsible for lighting the fire under quite a few asset bubbles, has come to the rescue of an asset class one would not normally associate with him. The yellow metal gold of course. Yes you heard that right. He has indeed come out in support of gold in a leading Op-Ed he has penned for a magazine. He is of the view that China is hoarding gold in large quantities and this is likely to push gold prices higher, infact much higher. And why is China doing this? Greenspan is of the view that China is keen to steal the US' thunder and take its place as the world's largest holder of monetary gold. Well, we doubt if that's the real reason. As per us, China seems to be well aware that dollar is fast losing its value what with relentless dollar printing by the US central bank. And consequently it needs to diversify into what is perhaps the only currency that has held its value since time immemorial. It thus makes immense sense for us too to follow China's lead and have a small portion of one's total investments in gold we believe.

PM Modi seems to be leaving no stone unturned to whet the appetite amongst American CEOs to invest in India. Even for those who are not buying into his promise of 'acche din' anytime soon, PM Modi exhorted them to act fast. Referring to the Gujarat Investor Summit of 2009, he reasoned why any delay in investment decision could lead to a long queue of investors ahead. As far ease of business, regressive tax laws etc are concerned, the government's policies will be tackling them soon. More importantly, he tried to convince the business leaders that his government is not interested in 'being in business'. As a result it has planned mammoth disinvestments of US$ 10 billion. Instead it would facilitate businesses, through the 'Make in India' initiative. Proper infrastructure, friendly neighbours and availability of quality human resources are the other promises that PM Modi made to the corporate leaders. Well, according to us, the call for action is indeed pertinent given India's requirement for FDI. However, given India's track record, it is unlikely that global business will rush in without the government taking some steps to solve their problems. Therefore PM Modi's investor queues may remain imaginary unless and until his government acts really fast.

The global markets were down for second consecutive week on disappointing economic signals. Barring China all the global markets witnessed selling pressure. In the midst of growth concerns, positive economic data cheered the Wall Street on Friday. Despite this rally, the protests in Hong Kong and outbreak of Ebola in US weighed down the US and global markets for the week gone by. The trading volumes were also low as markets in India, China and South Korea were closed on the last trading days of the week.

The Chinese central bank eased the lending rules in order to increase the home mortgage loans in order to boost the housing sector. The China market closed the week up by 0.7%.

Along with global indices, the Indian indices too closed marginally lower this week. The BSE-Sensex was down by 0.2%. The Reserve bank of India has kept the key rates unchanged in its bi-monthly policy review. In order to tame the inflation, the RBI decided to keep the repo and CRR rates same. The move by the central bank was much anticipated. However Indian markets witnessed sharp fall trimming down the gains after the announcement.

Performance during the week ended Oct 3rd, 2014
Data Source: Yahoo Finance, Kitco

04:55  Weekend investing mantra
"Never adopt permanently any type of asset or any selection method. Try to stay flexible, open-minded, and sceptical." - John Templeton
Today being a Saturday, there is no Premium edition being published. But you can always read our most recent issue here...
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Equitymaster requests your view! Post a comment on "What higher real interest rates could do to demand for real estate and gold...". Click here!

3 Responses to "What higher real interest rates could do to demand for real estate and gold..."

awadh bihari giri

Oct 5, 2014

your mails are too lengthy in the main text , and are overburdened with little information on stocks to pick (and why) and the recommendations are rare.

You mails are also repeatative and not-a-crisp , precise and compulsive read.

suggest you reformat your letters to 1000 words ,with annexures for details.



Oct 4, 2014

In a long term perspective physical assets will always dominate financial investment.


V Swaminathan

Oct 4, 2014

Yes, but only if SEBI removes myriad requirements making life difficult for small individual investors .. otherwise they would rather buy gold or real estate where they are not constantly bombarded with a new requirement every now and then

Equitymaster requests your view! Post a comment on "What higher real interest rates could do to demand for real estate and gold...". Click here!


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