Do it yourself

From my elementary understanding of economics and human behavior, I understand that aging demography, deeper & wider penetration of dematerialization & digitalization in human lives, rising awareness about climate change, and deteriorating growth potential of the developed economies, and perhaps China also, definitely do not augur well for the commodities’ demand in the long term (10-15yrs). However, the opinion of experts is overwhelmingly in favor of a bull market in commodities in the short term (2-5yrs).

The key arguments presented by experts in favor of a bull market in commodities could be summarized as follows:

(a)   Energy prices have corrected back to the pre-covid period. European power prices, US gas prices, natural gas prices, coal prices, and crude oil prices are back to more “normal” levels. The latest inventory, consumption, and production forecasts for 2024 and 2025 are indicating further easing in energy prices over the next couple of years. Energy being one of the major costs in the production of commodities, lower energy costs and adequate supply is a bullish argument for commodities.

(b)   Focus on the use of clean energy, particularly for mobility and electricity production, is changing the demand mix for metals. The demand for metals like copper, aluminum, lithium etc. is rising much faster than the supply. The stockpiles are diminishing fast.

(c)   Commodity producers, mostly emerging economies, are getting stronger in global strategic balance. The expansion of BRICS to include more commodity producers in the emerging market alliance is just one instance. These economies are now in a much better position in determining the terms of trade, which are dominated by the financialized developed world in the extant global order.

(d)   The geopolitical conditions are worsening. Presently, two fronts (Palestine and Ukraine) are witnessing open war. The fear is that more fronts could open in the next couple of years as the political stands are hardening and no one is showing signs of backing out. Wars have been traditionally bullish arguments for commodities as demand for war equipment and reconstruction work need more metals and building materials.

(e)   There is not much consensus on this point, but a strong view is that USD as a global currency may have peaked and could potentially see a steady decline over the next many years. The share of global trade invoiced in USD terms and USD reserves of global central bankers have witnessed a consistent decline in recent years. Moreover, the cross-border flow of funds from the US has witnessed a sharp rise in 2023. Unsustainable US public debt has led to a downgrade of the US sovereign rating outlook. Besides, the trade conflict with China has led to a conspicuous shift of technological advantage from the US to China. These trends may consolidate the position of commodity-producing emerging economies enabling them to seek favorable terms of trade.

(f) Bloomberg Commodity Index is presently at the same level it was in November 1995.

I have avoided investment in commodity producers for a few years now. I think more study of trends in the commodities market, and a review of investment strategy is due.

·         They all offer credit cards with attractive cashback offers, discounts, access to airport lounges, flexible limits, and purchase protection.

·         A few years ago, Yes Bank started offering higher rates on saving accounts (with conditions). Many other banks like RBL, AU, Kotak, IDFC First etc. followed suit.

·         There is not much to differentiate between SME, Housing, and personal loan offerings of various banks and NBFCs.

·         Most banks have made retail/consumer business a priority and announced a strategy to increase the portion of retail credit in their overall credit slate.

·         They offer tech-driven solutions, claiming their platform to be the best in class; though there is not much to differentiate in the tech platforms of the top 15 banks, which account for about two-third of the total credit market.

This was not the case three decades ago, when the process of privatization of banks and liberalization of NBFCs started. The new-age banks came out with materially differentiated offerings.

ICICI Bank and IDBI Bank, due to their origins, were specialists in project finance. Kotak Bank, having graduated from a leasing NBFC, was considered a specialist in equipment financing. HDFC Bank was a pioneer in capital market business, corporate salary accounts etc., and housing finance. The large public sector banks were specialists in social and priority sector financing as well as funding of large infrastructure and industrial projects with long gestation and payback periods. Small PSU Banks would focus on consumer finance and personal loans. Foreign banks like CITI, Standard Chartered, HSBC etc. serviced large corporates, mostly with foreign trade linkages, MNCs, and HNIs. Private Banking (and credit card) was mostly a domain of foreign banks with CITI having a majority share. Now all banks offer all services. The share of foreign banks has gradually reduced.

Points to ponder over for investors are (i) When the financial and banking services become commoditized, Is there a case for a sharp valuation differential in banks and NBFCs? and (ii) Is there a strong case for the cyclical and commoditized Indian financial sector to trade at a significant premium to its global peers, especially the ones that are much larger and better capitalized?

Some may argue, these doubts are too premature and should be put to rest for at least another decade. I see some merit in this argument insofar as the valuation of Indian financials relative to the global peers is concerned. The Indian financial system and financial services may continue to grow at a much faster rate as a significant part of the population is still underpenetrated and underserved, and the segment of the population that lives from paycheck to paycheck and relies heavily on rolling credit is growing fast. However, insofar as the valuation differential of the top 15 banks is concerned, the question might need to be examined much earlier.

The air quality of Delhi and surrounding areas deteriorates to the severely poor category, requiring several restrictions, including school shutdowns, mobility restrictions, construction ban, etc. Pollution has become a serious impediment to the health, life, and productivity of the local population. Besides, since this is the peak tourist arrival season for North India, it also negatively impacts the local economy.

Every year, governments and administrations pretend to take serious note of the problem and promise to take effective steps to control the air quality. However, the problem is worsening every year.

In my view, air pollution is a major issue that requires a mission scale effort to handle. Random and ad hoc measures that are usually taken every year have minimal effect on the air quality level. In many cases, like the ban on diesel vehicles and power generators, these prove to be counterproductive. I suggest the following 10 measures that may be taken as part of the long-term sustainable solution for the air pollution problem in the Delhi NCR area.

1.    Develop a 2 km wide ring forest encircling the NCR area. Forest may have dense trees like banyan, need, peepul, and amaltas on govt land and fruit trees like Mango, Jamun, etc. on the farmland falling on the way. Farmers may be provided an adequate subsidy to undertake these fruit plantations on their farmland.

2.    The entire Aravali hill range must be declared a protected land. All illegal mining in the area must be punished severely. Intensive reforestation activity must be taken on the hill range.

3.    All households must take a pledge to not use personal vehicles at least 2 days in a week, unless there is a medical emergency.

4.    All civil work contractors must be required to ensure that no dust is scattered around or flies from their work projects.

5.    All roads must be made pothole free to avoid traffic slowdown.

6.    All encroachments on public roads, including unauthorized parking that slows down the traffic, must be immediately removed with severe penalties for any recurrence.

7.    Govt may allow the removal of crop stubble using MNREGA workers till a viable tech is available to dispose of crop residue from farms to minimize burning of crop residue.

8.    Airports in NCR may be expanded to ensure there is no air traffic jam over NCR skies during peak hours.

9.    Large industries with material emissions may be systematically relocated away from NCR.

10. Empty grounds may be developed as city forests. The horticulture department may identify institutional, commercial & residential areas where threes could be planted and partner with the owners to plant and maintain trees.

On the other side, rural markets are reporting a noticeable slowdown in demand. Most companies catering to the rural sector, like farm chemicals, farm equipment, consumer staples, building materials, etc., have commented in their presentations about the slower rural demand.

The Reserve Bank of India, several commercial banks, and other lenders have highlighted rising stress in personal loans, credit card outstandings, and micro-lending. Two wheelers and entry-level cars are also not quite reporting encouraging numbers. There are reports about common households downtrading in staples, personal care, home care, and textile spending.

These trends are, in fact, not recent. Many reports and commentaries have highlighted the acceleration in the “K” shaped trend in economic growth in the past decade or so, especially after the demonetization. Moreover, these trends are not India-specific either. It is well documented that several emerging economies and some large economies like the US, are also witnessing a sharp rise in income and wealth inequalities.

In my view, whatever the statistics might suggest, what we are doing is definitely not progress. Several businesses doing well; their stock prices rising; and more and more middle-class households trying to capture a small piece of the growth of these businesses is inarguably a good omen for the country. But in no way it can camouflage the broader picture, i.e., the risk of India failing to become a middle-class country as the growth becomes even more unsustainable.

Without elaborating further, this morning I want to share three experiences I had over the last week. These experiences highlight that we may be treading on the wrong path of economic progress; the administrative machinery recognizes the problems but is mostly clueless/incompetent in suggesting a course correction; and the people are fast losing their empathy and sensitivities towards fellow citizens and becoming ominously self-focused.

1.    I was sitting in a friend’s office, interacting with a few field executives in his company. Fifteen minutes into the discussions, a young field executive (39yrs of age) indicated some breathlessness and asked for a glass of water. However, before someone could bring water he fell from his chair and collapsed. He was immediately taken to a near by private hospital, where the doctors on emergency duty refused to examine him, declaring him dead on arrival. This apparently healthy man has two young daughters (8yr and 11yrs old) and a non-working wife. He was earning a salary of fifty thousand, but had almost no savings. His life is also not insured.

This instance is not rare. There have been several such instances of young people dying suddenly. It raises serious questions on the health consciousness of our society – poor life style, preventive care and emergency help; social security of the workers in unorganized and SME sector; insensitiveness and incompetence of the hospital staff, etc.

2.    A friend (56yrs) felt unease in the chest while working in his office in NOIDA. He rushed to a reputed hospital in South Delhi, where he was examined and advised a procedure involving the insertion of two stents in his heart arteries, immediately. The problem was that there was no room available in the hospital. The entire hospital was fully occupied. He was operated, on and, kept in the ICU for three days. On checking I discovered that most of the NCR hospitals are currently operating at near full capacity. Respiratory complications, dengue, and waterborne diseases like typhoid, and heart and kidney diseases are afflicting young and old alike.

So, it is not only diabetes and cancer that is a matter of concern for the Indian population. The heart, lungs, liver, and kidneys - all vital organs are getting weak. Overall immunity and stamina of a common Indian youth may not be optimal. As a country, we may idolize Virat Kohli, but only a handful of us can claim to be striving for a fitness regime like him.

3.    Having traveled to various hospitals in NCR for two days, when the average AQI level was more than 500, I am feeling severe itching in my eyes and my throat is almost choked. Obviously, millions like me are suffering like this. The government has shut down schools, and imposed restrictions on driving vehicles and construction activities. Productivity is taking a massive hit. I am told that conditions in Mumbai are also not much better.

I strongly believe that the statistics we claim to be indicating progress are mostly meaningless. It is not progress. It is simply regression.

In the US, the financial system was on the verge of collapse. Several banks, insurers, and other financial institutions were reporting massive write-downs on their subprime Collateralized Borrowing and Lending Obligations (CBLO). The cost of protecting debt (Credit Default Swaps) was rising sharply. The US administration and Federal Reserve were mostly in denial, at least in their public posturing; even though the Fed had started to cut the benchmark fund rates from September 2007.

Signs of a sovereign debt crisis had started emerging in peripheral Europe. In countries like Portugal, Iceland, Greece, and Spain (popularly called PIGS) treasury default swaps had spiked to indicate imminent default.

The financial markets in the developed world had started correcting sharply. Both equity and bond prices had fallen. The emerging markets were however doing relatively better. The investment strategists at the large global banks were coining terms like BRIC (Brazil, Russia, India, China) and Frontier Markets (including Pakistan, Bangladesh, Bahrain, etc.) to distract investors from the crisis in the developed markets and peripheral Europe. Many of these markets like India and Pakistan had become the best-performing global markets in the October 2007-January 2008 period. Bangladesh and Sri Lanka had also done extremely well.

Despite the financial system in the developed markets collapsing and talks of bail-out gaining currency, a section of the market started forecasting hyperinflation, matched only by the inflation preceding the great depression in the 1930s. The resource-rich Latin America was becoming the hot investment theme. Numerous Latin America and Natural Resource funds were launched to collect billions of dollars in fresh investment worldwide.

This was the time when a renowned commodity guru, Jim Roger forecasted an unprecedented commodity super-cycle. I had an opportunity to meet him in person in the spring of 2008 when he was speaking at the prelaunch event of the Natural Resource Fund by an Indian fund house in Mumbai. In a brief 15-minute interaction, I found his knowledge of economics, global finance, and strategic affairs quite ordinary. He appeared to be a smart trader who would sense opportunity in commodities markets and rotate his positions swiftly.

Nevertheless, all the assumptions of global experts and gurus were demolished in the next 12 months. BRIC and Frontier markets performed the worst. Commodity markets went into a long (almost a decade) bearish phase. Investors who relied on these experts lost money, despite the financial stability returning to most troubled countries. Smarter investors who ignored these experts and invested in Greek and Italian bonds at 60c to a dollar raked in the mullah.

I find that the global markets are in the same position as they were in 2007-2008. Experts in their wisdom are making a variety of forecasts.

For example, numerous experts are forecasting the trajectory of Fed rates in 2024 and 2025; even though there is no empirical evidence of any correlation between Fed decisions and experts’ forecasts.

One renowned global strategist has reportedly forecasted a 25% correction in Indian equities if the incumbent regime loses power in the 2024 general elections. Disregarding the fact that there is no empirical evidence of any correlation between political regime and stock market performance in India.

Similarly, there are forecasts of Bitcoin topping US$1,00,000/per coin; gold outperforming financial assets; and Japanese equities doing better than Europe and the US.

There is an intense debate over the US economy skirting (no recession), slithering (soft landing) or collapsing (hard landing) into a recession. The debate on the end game for mountains of debt developed markets have accumulated over the past 15 years, more particularly in the past three years is also intense.

For a tiny investor like me, the situation is very tough. After reading zillions of pages of research, I discovered almost no one (analysts, economists, strategists, government officials, central bankers, et. al.) has any clue about how the situation is evolving. Everyone seems to be arguing from their biases and experiences; and praying to god that their prophesies come true so that they can tell the world “I told ya so”.

The Fed chairman is no exception to this. As you would hear from him tonight, he has literally no control over prices, growth, geopolitical situation, and markets. Regardless, there is an entire industry that will try to establish a correlation between what the Fed says and what happens in the market thereafter.

I have therefore decided to read research reports only for some useful data points and indications towards future trends. I shall avoid the forecasts, conclusions and recommendations, till I find strong evidence of clarity emerging.

The economic performance of the US has been below par in the past decade. The handling of the pandemic has been highly questionable. Both monetary and fiscal policies have not yielded the stated objectives of price stability (inflation has been persistently high and rates have become growth restrictive) and financial stability (many regional banks have failed, delinquencies are rising and capital adequacy & reserves of banks have deteriorated, particularly in the past couple of years). Fiscal profligacy has benefited the rich much more than the poor.

The efforts to restrict the benefits of advanced technological innovations flowing to China through tariff and non-tariff means have mostly failed. In fact, these efforts have led to a greater focus on China to successfully develop indigenous technology, forge new alliances, and diversify its market and vendors. The Sino-Arab technoscientific alliance is one prominent example.

The exit of the US forces from Afghanistan and the installation of the Taliban government; failure to prevent Russian invasion in Ukraine and protracted (21st months) conflict there; continued ISIS aggression in Syria and alienation of Turkey; virtual failure to reign Iran’s nuclear ambitions; and now escalation of hostilities between Israel and Palestine are only some recent examples of the strategic failures of the US.

To make things worse, the demography of the US started to worsen. In 2022, the US population grew a meager 0.4% and is estimated to shrink in 2023. Whereas the number of homeless and jobless may be rising.

Consistent deterioration in the quality of political leadership; sharp rise in income and wealth inequalities leading to a conspicuous rise in domestic unrest and violence; unmindful fiscal profligacy; the emergence of an alliance of nations having quasi, pseudo, and non-democratic regimes led by key adversaries China, Russia & Iran and including key allies like Saudi Arabia is seriously undermining the US supremacy.

The education and skill standards of the average US youth are deteriorating fast, raising the reliance on immigrant workers for jobs requiring high skills. The political rhetoric, even from the likes of Vivek Ramaswamy who himself comes from a family of immigrants, further explains the goal incongruence in the US policy.

In my view, it might be a matter of years, not decades, when the fabled “US Consumer” diminishes. The average American household becomes spendthrift; the social security system collapses and fiscal profligacy is forced to reverse the course. An entire global ecosystem that is based mostly on the indulgent US consumer could potentially come down crashing. Also, while most money managers and businesses in India are talking about the “China+1” opportunity, I have not heard anyone talking about “China is number 1” in new technologies including 7G, 8G, AI, smart chips etc.

As an investor, I would like to build these probabilities into my strategy. I am keen to filter my investments for the US consumer and technology dependence.

I note that the debate is intensifying, widening, and deepening. Moreover, it is becoming more balanced with many conventional money managers, regulators, bankers, and administrators coming in support of digital currencies as an alternative to fiat currencies.

A few days ago, Larry Fink, the Chief Executive Officer of BlackRock, one of the most influential financial firms globally, commented in a TV interview that under the current circumstances “Crypto will play a role as flight to quality”. He was reported to have said, “Bitcoin is a hedge against the devaluation of your currency”. This comment is in total contrast to his comments in 2017 when he had emphatically condemned the idea of cryptocurrencies, saying “Crypto is an index of money laundering”.

Last month, a leading German Bank (Bank) reportedly entered into a partnership with Swiss trading firm Taurus to offer custody services for institutional clients' cryptocurrencies and tokenized assets. In 2018, Deutsche Bank's chief investment strategist Ulrich Stephan criticized crypto for being "too volatile and not regulated enough." Standard Chartered (A leading British Bank) also made a bold forecast predicting that “Bitcoin prices will climb to $100,000 by the end of 2024.”

Earlier this summer, Hong Kong’s Securities and Future Commission proposed guidelines to enable Chinese users to invest in Bitcoin and some other large-cap cryptocurrencies on registered platforms. This is in total contrast to the stance of the mainland Chinese authorities.

In the meantime, several smaller African and Latin American countries, like the Central African Republic, Uganda, Zimbabwe, El Salvadore, Paraguay, Venezuela, etc. have continued to adopt cryptocurrencies in their monetary system, some even declaring bitcoin as legal tender. Last year, even Ukraine created a ministry of digital transformation with an aim to become one of the foremost authorities on crypto. (see here)  Cryptocurrencies are now legal in many countries/regions like the EU, US, Mexico, Brazil, Israel, etc.

There are speculations that the ardent crypto hater Warren Buffet may also be having a slight change of heart in recent months. In an apparent change of traditional policy, Berkshire Hathway has invested as much as US$600 in two fintech firms - PayTM of India and StoneCo of Brazil. This has led to market speculation that the firm may change its long-held stance on digital assets including crypto.

India’s regulatory thought process on crypto has also travelled a long way in the past five years. The Reserve Bank of India started with a blanket ban on the sale or purchase of cryptocurrency for entities regulated by RBI (all scheduled commercial banks and NBFCs) in 2018. The RBI governor “equated crypto trading with gambling”. The ban was declared untenable by the Supreme Court. Presently, the legal position on dealings in crypto in India is ambiguous. It is neither explicitly unlawful nor a regulated asset. However, last week RBI governor reiterated his stance on the cryptocurrency ban, saying there has been no change in the central bank’s position.

No surprise that Bitcoin has weathered all the pessimism and sharply outperformed gold and equities in the past five years. Since October 2018, Bitcoin has gained over 400%, as compared to ~63% for gold (in USD terms) and ~47% for S&P500.

Some of the noteworthy events weathered by the market include - hawkish commentary from central bankers (including the RBI and the US Fed); downgrade of global growth estimates; poor growth guidance by IT services companies; a truly ominous escalation of hostilities between Israel and Palestine; erratic monsoon season and consequently elevated food inflation & cloudy outlook for the rural demand leading to a sharp rise in global crude oil prices; opinion polls indicating some setback for the ruling BJP in the forthcoming state assembly elections; etc.

The bond yields in developed countries have risen to levels not seen in the past two decades. The US benchmark (10yr G sec) bond yields are presently close to 5% - a rise of over 700% in the past three years. Similarly, The Japanese and German benchmark (10yr G sec) bond yields have also seen a similar rise in the past three years. Conventional wisdom indicates that such sharp spurts in the bond yields invariably lead to the unwinding of leveraged positions of global investors, mostly resulting in a sharp correction in emerging market asset prices, especially risk assets like equity.

Notably, the emerging markets in general have underperformed the developed markets in the past year. However, the Indian equities appear to have performed mostly in line with the developed markets.

Besides, the broader markets in India have actually done exceedingly well in the past three years; with Smallcap and midcap indices sharply outperforming the benchmark indices. This trend has continued in recent weeks.

In fact, some global brokerages like Morgan Stanely and CLSA have upgraded Indian equities to “overweight” recommendation in their suggested portfolios. It is expected that these upgrades might stem, or even reverse, the net selling position of the foreign portfolio investors in the Indian equities.

In the given situation, a common investor in India may be faced with the following doubts:

(a)   The financial conditions in many of the developed markets, especially the US, are deteriorating fast. If we evaluate the present conditions in the US markets, a sharp correction in asset prices (equity, bonds, and real estate) looks imminent. Chinese and European markets also look jittery. Under these circumstances, would Indian equities continue to do better or these also fall in line with the global peer?

It is pertinent to note that in 2H2007, the Indian economy and markets were also in a position of relative strength and had sharply outperformed. However, in 2008-09 we not only collapsed but also underperformed our global peers.

(b)   The return on alternative assets like fixed coupon-bearing securities, precious metals, and cryptocurrencies now looks promising on a risk-adjusted basis. Would this lead to diminished flows in equities?

(c)   Historically, positive real rates have resulted in the accelerated unwinding of the leveraged USD and JPY positions (popularly known as carry trade) globally. Would we see indiscriminate selling in India along with other high-yield (mostly emerging) markets, like all previous instances of such unwinding?

(d)   Notwithstanding the improving breadth of earnings growth, it appears that the reported earnings may not match the market estimates of 18-24% earnings growth for FY24-26. Would this result in some PE contraction (price-led easing or through time elapse) of the Indian equities?

(e)   If the Indian equities prices do fall, how much fall could be expected, and how long will this correction last?

My views on these issues, as of this morning are as follows. Please note that the situation is evolving very fast. It is more probable that my views will keep changing to suit the conditions as they evolve.

1.    The Indian equities may correct 10% to 15% and not collapse (25% or more). 2023 is different from 2008 since the leverage at the corporate level and financial market level is significantly lower now as compared to 2008 and rates in India may peak at a much lower level as compared to 2008 (repo rate 9%).

However, the breadth of the fall could be severe. Many more stocks could see a fall of over 25% than the number of stocks falling less than 10%. It is therefore prudent to focus on the quality of the portfolio rather than gain potential.

2.    On a 12-month horizon fixed coupon bearing securities could offer matching risk-adjusted returns to equities. However, beyond 12-months equities will continue to outperform alternative assets.

3.    Unwinding of carry trade appears to be already in progress. In September and October, we have seen close to US$3bn net selling in the Indian equities. This may continue and even accelerate, causing deeper daily moves in the market.

4.    I believe that a 10% correction in Nifty50 followed by a one-year time correction would make valuations reasonable.

5.    In my view, in the worst case Nifty could possibly correct to 16880 level. However, the most likely scenario would be a fall to the 17895-18170 range followed by a consolidation phase of 6-8 months. Thus, a fall below 17895 would be an attractive buying opportunity, in my view.