Winter Update

Gold and the Kondratieff cycle

I was recently told on Twitter that I have been bearish for long and it is time to be bullish. Now bullish and bearish are a perspective. Elliott Waves are not a figment of one's imagination. They reflect the herding behaviour of a crowd as reflected in a group of prices like an index. Where Elliotticians go wrong however is they are not able to see extentions in advance. So a 3rd wave may complete 5 wave but can extend to 5+4=9 waves or 5+4+4=13 waves as well. We can get bearish early in the trend.

But what I really want to discuss again is the impact of Inflation on Equities on Long term returns during the Economic winter phase of the market. Yes we are in a winter, one that involves high levels of debt that results in high levels of NPAs that have to be written off as default or inflated into the air. Slow inflation over many years is often the choice of policy makers. This can also be referred to as financial repression where savers are paid lower interest rates than the rate of inflation, or rise in prices. Do this long enough and the Nominal debt to GDP ratio comes down to a manageable level. But as discussed in My Kondratieff winter reports, India has already broudht down the ratio for the Govt debt portion, while the private sector continued to expand its debt through the rood. This was a EM wide phenomena and not India centric. So Corporate debt is now an EM problem near 9 trillion dollar big.

Now the objective is to lower corporate debt by raising product prices. But do it at a pace that it does not hurt the public at large. While difficult this is what we have seen happen to some extent. History also shows that Equities do not outperform during inflationary periods associated with a Winter because eventually higher interest rates will hurt, even as higher prices help drive up equities. In other words the relative performance of Equities v/s inflation is poor.

Now to charts. After the 4 year correction in commoditiy prices did commodity prices really fall. The fall in commodities was a global issue not one ''Made in India''. In other words inflation has persisted in India since 2009 that corporate debt started to explode that the Nifty adjusted for either of INR, CPI, GOLD, is down from the 2008 peak. I covered all the charts in the Economic winter 2.0 report so you can see them there but I will cover just one today to make my point.


The above chart is the Sensex/Gold ratio and it has retraced 50% of the 2008-2009 fall and is falling again. In other words Inflation has outperformed equities and so has Gold. The chart below is the MCX gold chart and in 2008 when Sensex topped it was at 11000. At 30000 now it has almost tripled. The Nifty has not tripled to 18000. In fact unlike what most tell you gold has not been in a bear market in INR terms. Just because Gold declined by almost 50% in USD terms did not mean anything for Indian buyers of Gold. Gold prices never fell below 25000. Not more than a 33% correction from the peak. On the chart below Gold has been consolidating since 2011 and should start the next move higher now.


In fact if you think that Gold crashed after 1980 due to the interst rate hikes and was in a bear market for 20 years, that was not true in INR terms. The following chart of Gold in Rupees per Ounce gives a long term picture of Gold going back to the 70s. Gold in rupee terms doubled in that period.


However this zoomed out chart of the Sensex/Gold shows that the Sensex was rising for most of that period till its peak in 2008. So Equities did beat inflation for this time. It is the subsequent period of high debt and NPAs when history shows that this does not hold true and so far has been the case. You can use any measure instead of Gold like CPI or USDINR to validate this. I believe that this ratio is likely to fall much lower by the time we are done with this winter cycle. Either because of rising Gold prices of falling equity prices till the debt ratios normalise again and a new economic cycle can start.


Yes an ending diagonal in Gold means we have broken out of it into a bull market that should be far from over. But why just Gold?, You have to be Long Inflation. This again is not an India only phenomena but a Global one and I discussed it in the Oct Long Short report as well. The interplay of inflaiton with equities can be triky because interest rates can start to rise and that is probably why you do not beat inflation but inflation can keep equity prices elevated as well. But that is the numerator, the denominator is where the bulls will be.


10 year G Sec

Indian Government bond yields dropped again today and are near a double bottom to where they were before the 2013 currency crisis. This is important as it would be a major breach of a previous swing low for yields. Will the Bond yields double bottom near 7.089% or break below the 7% mark? This will truly determine whether we have overcome the interest rate cycle into a deeper deflationary trajectory. This is important from the Kondratieff cycle perspective. Today RBI left rates unchanged as he remains unsure of the trajectory of inflation. At the same time the FED appears to be sticking its neck out on raising interest rates just like they did with tapering 3 years ago. So will the rates start to respond to the rising dollar here? My Long term view on Indian G Sec's is that yields have to complete wave e up to one more new high before the long term rate cycle can conclusively turn down for India. This level is therefore important in changing that view. It would put my view in doubt for sure But if this level holds then it will be 9-10% in bond yields in the coming year. A major interest rate shock maybe on the cards. Stay on watch I do believe that this could be a defining moment. I know that talking of a rate rise at this moment to most people is like impossible and stupid. All the more to watch this level carefully because the last 3 years were all about financing the Indian economy with foreign bond money flows. I do not know if anyone noticed but the RBI actually hinted at dumping its reserves on the market if there was a problem with redemption's of the Foreign currency borrowings that are coming due in the coming months. I do not know of any Central bank that would do that. It is almost like a silent threat.


Gold Sensex Ratio

The Sensex/Gold ratio peaked in 2007 so it can be said that since then Gold has out performed the Sensex except for brief periods of time. And once again over the last year Gold is the winner. And this should now continue till the ratio hits a new low below the given range. This would happen either as gold prices soar or equity prices dip or both. So based on this one indicator the Kondratieff winter is not yet ended and the cycle will complete when this ratio breaks below the lows seen in this chart to a new range below it.


The Good The Bad and The Ugly

The Good The Bad The Ugly - Winter update

With bad debts announced a good earnings quarter Monsoons coming the worst should be behind us and we should be back into bull market territory soon.

That is what Dalal street is telling us. [doesn't Dalal street sound so much better as an acronym for the markets?] However the way to look at numbers is not on a one off basis but on a rate of change basis. This momentum should be applied everywhere. And that means streaming years of data and then watching how it moves over time. A one month or one quarter change does not amount to a trend. Still it makes good headline news. And if the market moves up to justify it, it is soon wisdom or even fact. Until...reality strikes.

But today I would like to start with some good news. The good news is that the winter is sprinting to its End Game. This news article that has been building up over the last week is getting increasing attention and is now for real. Last year I was expecting the debt cycle to continue down but never thought that the RBI would be so bold as to ask the banks to write off everything so fast, though I wished for speed. Now the next pillar for bailouts is being put in place. There two sets of bailouts that we will need over time. First the bailout for the banks and then the bailout for industry. For some simply cutting interest rates can amount to a bailout. However that might amount to moral hazard, and as we are witnessing right now it does not certainly work. RBI is trying hard to cut rates but has not been able to ensure transmission. Right now no economy around the world cares about Moral hazard and everyone has already played the bailout card. The new buzz word though is bail-in. I wonder if they have the guts to pull that one. Coming back to our domestic debt cycle this step does speed up things now that we are thinking about writing off debts. But as I read the article in detail it says more about giving more loans for survival purposes which makes no sense. This will eventually lead to many bad loans being written off and help provided to those that can survive. For those written off the banks will be taking a hit with the government funding them further.


What needs to be understood here is this is not an event but a process and it takes time. Think 12-24 months. In the mean time analysts are reading into what ever green shoots they can find. For the markets however there are two things to consider

1. Domestic Growth

2. Global Growth

Often we speak only about the first and there is a stated ignorance to the second. Commentators state it as a risk and supposedly say ''if something happens globally we do not know, else all is well''.

But first let me address domestic growth. While we did get an uptick in numbers it is no guaranty of the future. Simply go back a year and look at the analyst forecast for FY2016 earnings, they were positive lower double digits at the worst, and we got negative growth, same for FY15. So I think no one has a clue. The primary reason is that economics is a social science and it was defined as such for a reason. Economic activity and trends are a behavioural. And public behaviour often herds and that is why herding behaviour shows up in patterns such as the Elliott Wave Fractal. So once we consider that India is in an economic winter the trend that we should be witnessing is increasingly as the debt problem blows out of proportion lenders and borrowers lose faith. Leanders will raise lending standards to avoid future losses and will make borrowing difficult, and borrowers having been hurt by previous declines in business conditions will not want to get deeper into debt, unless they are already in a debt trap. This leads to a decline in credit activity and a slowdown in the economy. This is what India is witnessing today. Much of our headline GDP numbers are a function of government action, and the new means of measurement that include inflationary indirect taxes. Else bank credit growth would not be languishing at single digits [9.83%].

The picture is further bleak as is brought about by this chart from Credit is growing at negative rates for MSMEs and Medium industry. The biggest chunk of growth is going to high end Real estate and personal loans. And I would not take a one month or quarter up tick in numbers to be called a trend. The way to read data is to run a Rate of change analysis to spot a trend. Also understand that behavioural trends do not just change with a knee jerk reaction. They do so slowly. Right now consumption trends are still hot as is seen in personal loan growth but is this the start or end of a trend? A change in trend for the economy requires a change in trend for economic behaviour. Right now the winter trends above will continue to push us to being more conservative and towards saving and not spending. This will eventually hurt the economy more than it will benefit us. The only hope is that the government keeps stepping in with stimulus from time to time to give us a soft landing. That they have done by clearing more projects. The Pay commission boosting incomes. OMOs, and a weak currency. The RBI has also kept down volatility in these factors so we are not faced with runaway inflation. But to conclude for these reasons that the economy has turned up might be premature.


Then given our current high valuations that puts the entire burden for our elevated bullish stock market trends on the global markets and global liquidity. During last year we did face a shock for this reason even as domestic inflows were among the highest ever. With that trend cooling off a bit we remain dependant on global flows. However in the recent months most global agencies have announced reductions in their global growth forecasts. So a slowdown in the global economy is already here. Among the global economies the strongest has been the US economy however that too has recently seen a clear decline across economic data. In fact as I have been posting articles on the Newsletter mailing list, you would have read that for over a year the US economy has been slowing on a rate of change basis. Here is just one chart from Weiss Research, that chose to look at core business orders as they exclude volatile government orders. The declining trend is clearly concerning. Various PMI numbers also dropped recently, including job growth.


So is the stock market elevated in the US markets because everyone is just buying the dip in a bull market, or that they believe that the FED will print again. That is what Wall Street media would have you believe. But here too herding is a trend that needs to be measured and will change with the markets. People buy all the way into a top and sell all they way to the bottom. With extremes on both sides. So the US markets did peak in May 2015 a high that has not been surpassed for over a year. Since then, as seen in the chart from Weiss Research below, investors have been withdrawing from equity funds all along. In fact they paused at the Jan bottom and now in April we are back at -23.8 Billion out of stocks. This coincides with so many recent announcements by billionaire investors that they were raising cash levels or even short US equities. Now you may react to this and say that this is a contrarian signal. If all are selling it must be a buy signal? Remember the selling only started after the market topped last year and not before that. So they were not selling the top. Second 2015 witnessed $569 billion of stock buybacks. US companies borrowed over 200 billion of which 80% went towards buybacks. So this is a bull bear fight into the open. Corporations borrowing cheap FED money to buy stocks and investors watching the economic data roll over and sprinting [not yet running] for the hills. We can try to guess who will win but let me tell you who....The one that technical indicators support. So if your MACD for the Dow goes into a sell listen to it this sell signal might tell you who is winning, and vice versa. After all if liquidity is all that supports markets technical indicators should tell us which way liquidity is moving. There is no doubt that the US and other world economies are slowing down and that even for India is the greatest global headwind that you should not ignore or stay ignorant to.

Winter Chills

Winter Chills continue in economic data and this time it is not Europe or the EM world alone it is everyone. Yes the same old NPA problem is not one that is only for India Or Brazil to foster. The US recently reported the highest delinquencies since 2009. Bank credit turning bad is a global trend. So here a chart for China that was just put out by and it shows how they have done too. Everyone is coming out of the woods with bad loans that are putting the banking sector deep in the red. Yesterday I read that almost 40% of Italian loans are now bad. I do not know how this ends but it is in the data.