04 - NOVEMBER - 2016 

Dear Members,

Is the Nifty in a bull market? That is a matter of perspective. If you invest in value stocks with a bottom up approach that is one thing. But if you are a Macro investor buying diversified funds or your objective is to beat Inflation then the perspective below is important. We cover the key commodities that are making the Gold inflation trade and related stocks in our updates. I believe in the Long inflation trade. 

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Two must watch videos to start your IC experience

Elliott Wave Basics

Position Sizing Video 

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.

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