In past few months, the rally in stocks markets, bonds, precious metals and resilience of energy prices despite diminishing demand due to lockdown have been subject matter of intense debate and extensive analysis. It has been strongly argued that prices of financial assets may not be in sync with the economic realities.
Given that the corporate earnings are likely to remain suppressed for an extended period of time; and the government's fiscal discipline has been violated, ideally the stocks and bond prices should have fallen. The data also indicates that the Indian consumers' demand for gold has fallen sharply in past few years. India, one of the largest importers of gold has been importing less gold since 2017. The world gold council expects the Indian gold demand to hit 26yr low in 2020 (see here). Theoretically, this should have checked the prices of bullion too. The demand of petroleum products has also contracted in past 5 months. Nonetheless, prices have risen for stocks, bonds, energy and gold as well.
Obviously, the trend must be intriguing for common people; even though the experts have offered a variety of explanations for these trends. The most common explanation however is that markets are always forward looking and the current prices factor in the future demand, supply, and profitability trends. Unfortunately, there is little evidence to justify this proposition. In past 30years, since I have been a student of Indian financial markets, I have rarely seen the "forecasts" of analysts and economists coming close to the actual outcome.
In that sense, I believe that markets are efficient as they price the assets based on current demand and supply scenario rather than the future forecast. I am discussing this issue today, because the recent strength in Indian Rupee (INR) appears to have surprised many people. Most of the economists and currency analysts had forecasted a weaker INR for 2020. The latest USDINR forecasts for 2020 had ranged between 75-82, before RBI decided that a stronger INR may be better tool to control inflation rather than raising rates or constricting liquidity.
Despite sharp decline in USD vs number of global currencies, RBI had been maintaining INR in 75-76/USD range for past many months. RBI's frequent interventions made INR the worst performing Asian currency in 2020. However given that the scope of RBI's intervention in forex market got limited due to running away inflation, it now seems to have decided to let it move according to the market demand and supply equilibrium. Improved current account, higher yields attracting foreign flows, and government strongly encouraging FDI flows indicate that supply of USD may remain strong in near term leading USDINR further low, may be towards 72/USD levels. It suits the government also, which is struggling with higher energy prices.
In December, while sharing my outlook for 2020, I had estimated "USDINR may average close to INR72.5/USD and move in 70-76 range" (see here). I had reiterated my view in February review of my investment strategy (see here). For now I am maintaining my view on USDINR. Hence, better trade in my view therefore lies in currency rather than stocks, bonds or bullion.
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