August 11, 2020

Stock Market Is Higher, Gold Is Higher, While Economy Is On Ventilator

General Money   || Personal Finance   || Stock Markets  ||  Real Estate ||

It comes with a simple understanding that historically – money choses that path where there is clarity & certainty. When there is fear of business failures, money gets stacked up in gold due to easy liquidity & when there is absolutely higher business confidence – money slowly gets stacked up in stock markets. It’s been historically seen that there has always been an equilibrium between the two based on which we could say – money only chooses the path between gold or stock markets based on underlying sentiments and never both.

Now let’s look at underlying conditions in the markets at present. There is absolute pessimism across the market as every business has fallen short of clear ‘business continuity plan’ (BCP) to counter the challenges posed by Covid. Businesses are sitting on ‘zero’ order book growth while bills receivables are historically high due to stagnation in end customer demand.

Most often, strength in an economy is judged based on how strong is the banking sector. Giving the present conditions, most elite banks globally have paused and adopted a wait & watch approach. Second rung financial sectors like the NBFC’s which cater to borrowing needs of businesses in Small & medium term enterprises are already sitting on loan portfolio that was built at the cost of lower credit ratings of the borrowers. Most businesses in MSME sector which runs on thin line of profit margins are either killed due to business shutdowns or have become targets of potential take overs. Take overs will mostly be from bigger elite companies which runs on higher revolving credit line which they receive from bigger banks.

While all of this is happening – governments of sort after countries are busy printing currency to avoid a harsh crash landing of their economies. Governments have seen it in the past, how Sub prime crisis in the US spiralled down across every business sector during 2008 & most countries have realised that the only way to keep the economy floating is to print more money. When there is surplus money, it can be used to lend to banks & banks in turn will use this to re-capitalise businesses. This is the factor that keeps the stock markets higher, as most companies find different ways of showing this borrowed capital on their balance sheets to stay float in the market.

Gold is one of the most widely discussed metals due to its prominent role in both the investment and consumer world. Even though gold is no longer used as a primary form of currency in developed nations, it continues to have a strong impact on the value of those currencies. Moreover, there is a strong correlation between its value and the strength of currencies trading on foreign exchanges.

Value of gold is also a derivative of bullion contracts traded on the commodity markets. If we were to analyse price of gold in Indian markets by taking inferences from gold futures traded on our commodity market at present – most actively traded contracts for the months of October & December 2020 seemed locked at prices between 51,200 – 52,800. This range is clearly acting as a support zone, so every time prices are swinging to this level there is huge spike in accumulation based buying. There is a general fear psychosis that is at play during this level, which could push all short term traders to liquidate their holdings out of fear of a collapse at this range, while the stronger hands who have accumulated at every dip could look to stay invested for a longer term.

The value of a nation’s currency is strongly tied to the value of its imports and exports. When a country imports more than it exports, the value of its currency will decline. On the other hand, the value of its currency will increase when a country is a net exporter. Thus, a country that exports gold or has access to gold reserves will see an increase in the strength of its currency when gold price increase, since this increases the value of the country’s total exports. Excellant example would be – currencies of Middle East countries, which is benchmarked based on underlying physical gold.

Now this is where the maturity of the government’s come in. Most developed economies strategise this ‘money printing’ theory by making sure there are clear flags or alerts – set at every level of the economy to make sure money doesn’t leak into loose pockets/businesses. And mind you, this is a very thin margin between good economic principles & bad economic principles and string of bad ones will put the entire economy on the ventilator.

 

–    Article by Suman Adithya Rao (SEBI Certified Research Analyst, Management Graduate in Entrepreneurship & Small Business Management)
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