Equity market recently got encouraged by the Chinese announcement to make its currency more flexible against the dollar by letting it appreciate. This kicked off a rally in metal prices on the London Metal Exchange. Back home, share prices of Indian metal companies also soared. Also, equity markets are becoming more susceptible to commodity markets in India?especially, metal prices?more than ever. There has been three discernible bull runs in the Indian equity markets since 1980. One, between 1980 and 1985. Then, 1988-1994 and finally, during 2002-07. Of course, 1999 and 2009 was more a case of a single-year bounceback than a sustained bull rally. Barring those periods, during the period 2002-07, the equity markets danced to the tune of metal prices more than ever.
During these years, Sensex was up approximately 1.7 times that of returns of JP Morgan All-Metals index. When these returns were analysed on a calendar year basis, the Sensex returns moved in sync with the metal index. More the returns of the metal index, the higher was that of Sensex. And when metal index crashed 33% in 2008, the Sensex fell even further by 52%. Metal prices rebounded 58% in 2009, and the market was up 91%. In short, equity market exhibited a high ‘beta’ to that of the metal index.
Earlier, it wasn’t the case. Take, for instance, 1993, 1996 or 1997 when equity and metal indices moved actually in the opposite direction. While it moved in the same direction in some other years, the scale of difference was startling, sans any discerneble pattern. For instance, in 1994, when metal prices were up 49%, the Sensex was up only 12.5%. But in 1992, when metal prices were up 1.2%, the sensitive index moved sharply by 29%.
The Sensex?s greater dependence on earnings of commodity-based companies (oil, metal) is to blame for the increased susceptibility of the Street to metal prices. In FY05, around 46% of Sensex profits was contributed by commodity companies. Ever since, while it has fallen consistently, it is still expected to be higher at around 38% of Sensex earnings for FY11.
Oil prices, in contrast, have no discernible truck with the Sensex. An extraordinary rise in oil prices?and that too, for a longer time?can spook markets. If not, they at least mute the Sensex returns. For instance, in 2000, when prices as measured by Brent crude were up 165% year-on-year, Sensex was down 21%.
In 2008, when the Lehman crisis rocked the global markets, all of them?metals, equities and energy (oil)?were down. But gold was the only one that stood out. On a long-term basis, though, equities stack up much better than any other asset class. From January 1992 to date, while the Sensex was up 807%, gold was up 508%, Roger International Commodity index 507% and JP Morgan All Metals 361%.
Interestingly, gold will be the only investment in the last ten years which would have gained (in terms of prices) in every single calendar year. Unless 2010 plays a party-pooper, it?s unlikely that the trend will reverse.
With gold prices (in terms of dollars) already up 12.5% and the busy festive season ahead in the second half of the year, gold prices will remain higher.