Vijay Kumar Gaba: Equity vs Bonds

Thursday, May 25, 2023

Dr. Copper flashes red card

Three-month future price of copper at COMEX has corrected almost 27% ~US$3.61/lbs from US$4.95/lbs at the end of February 2022.

Moreover, the discount between spot prices three months future at LME widened to the largest since 2006, indicating poor outlook for copper demand in the near term.

Copper prices have fallen over 10% in the past one month alone on disappointing growth data from China. The hopes of a sharp recovery in Chinese growth in near term are fading as more downgrades are indicating. Goldman Sachs reportedly revised its average copper price forecast for 2023 by over 11% to US$8698/t from US$9750/t earlier. Though the optimism over Chinese growth and consequent firmness in copper prices is not lost completely. For example, Bank of America is still maintaining its US$10,000/t copper price forecast for 2023 end in the hope of large demand ramp up as China accelerates spending on its power grid. Nonetheless, the general mood is drifting towards accelerated slowdown in demand.

Since copper is used in infrastructure (power, shipping, buildings etc.) machinery and discretionary consumption (housing, vehicles, appliances etc.) its demand is widely accepted as a lead indicator of the direction of the economy. For its ability to provide a correct prognosis of the health of the economy, the bright metal is popularly known as Dr. Copper.

So, if the latest prognosis of global economy by Dr. Copper is correct—

· We shall see an accelerated slow-down in global economic activity with little support from China, in the next few months. This shall reflect in poor export demand for India also.

· The inflationary forces may weaken as tighter money constricts demand further; eventually leading to the next round of monetary easing by the end of 2023 or early 2024. RBI’s growth forecast for FY24 may also get moderated resulting in change in the present “withdrawal of accommodation” monetary stance.

· Deflation, rather than inflation, could again emerge as the major concern of global policy makers by the end of 2023. Japanese markets that have majorly outperformed the developed peers on easing deflationary pressure could again face pressures.

· Notwithstanding the Debt Ceiling tantrums and political rhetoric, for global investors bonds may emerge as preferred asset class in near term over equities.

· Overall, a foundation for a decent equity rally in India over 2024-25 could be laid in the next 6months.

(Inputs from Copper price slides as global demand drops sharply published in the Financial Times)

Wednesday, March 24, 2021

…till then happy trading

The first monetary policy statement of FY22, scheduled to be made on 7 April 2021, is awaited more for the signals and body language, rather than any monetary policy action.

It is almost a consensus that RBI, like any other major central banker, may not be in a position to cut rates from the present levels. On the other hand, RBI governor has made it clear that “...there is no way the economy can withstand higher interest rates in its current state. It is recovering but certainly not out of the woods yet”. The governor has gone way out of his way to assure the bond market and committed “orderly evolution of yield curve” in public interest.

The bond market has calmed down a bit after aggressive assertions made by RBI governor, but the traders have not retraced their steps. The benchmark 10yr yields are now stable close to 6.2%, much higher than the 5.8% to 5.9% sought by RBI.

Next couple of policy statements would therefore be watched to assess (i) how deep is the RBI’s commitment to keep the yield curve orderly and liquidity ample; and (ii) when RBI would be ready to hike rates.

The equity markets usually do not have a strong correlation with the bond market. However, a negative correlation emerges in months preceding the turning of rate cycle. The current tentativeness and loss of momentum in equity market is indicating that equity traders are also anticipating a turn in rate cycle sometime in 2021. A rate hike or a clear indication about the policy path by RBI could therefore be a positive support for the equity market.

Internationally also financial markets are focused on tapering of bond buying programs of major central bankers and eventual hike in policy rates. As per current estimates, FED tapering may begin sometime in 2022 and rate may not be hiked at least until mid-2023. Notwithstanding the expectations, the markets are definitely indecisive.

In my view, we shall have an extended period of indecision and sideways movement in equity markets before the monetary policy makes its next move. Till then happy trading.