Market Review Part I


Dear Investor

There was a long break in between. I wrote last on 6th March.

In my last latter, I said, technically Dollar may rally further and can consolidate around 85-87.[ Link: ].

Dollar did breach 81 after jostling there for prolonged period. Since than, it is in narrow range.
In last 2 days, it has closed below 81 but I would wait for Dollar to close below 79.53 (first support)
and further below 78.3 ( Strong second support) to initiate any short dollar or contra dollar trades.

Gold is moving along support line. If dollar strengthens with sharp up leg, there is a possibility of corrective action in Gold. In such case, Gold may pull back up to 1060 for further consolidation and may up to 1000 for very very brief period before leg up. This does not negate the bullish scenario of Gold. It is part of natural up and down price cycle of securities.

Hold your long term gold. Nothing has changed. Fed is still printing massive money and will continue to do so and same is the case for European nations and for England.

Why all central banks will continue to flood the market with cheap money?
The obvious reasons are
1. Real Economies are still mired into recession
2. Jobless rates are still hovering around 10%
3. Debt to GDP ratios are exploding higher than 100% and for some countries like Japan,
it is more than 200%
4. Banks are flooded with cheap money but instead lending to consumers, banks are busy in writing off bad debts. Confidence of Banks is low in recovery and same is reflected in their action.
5. Consumers confidence in recovery is equally low. Consumers have shut their wallets for abysmally high consumption. They are learning to leave within the means and have started saving more.

Now. let me take you to GDP numbers to showcase the real effect. Hereunder, we are considering real GDP numbers not the nominal GDP numbers to analyze true picture.
For that, first understand difference between Nominal and Real GDP.

Gross domestic product is defined as the market value of all final goods and services produced in a geographical region, usually a country.

Nominal GDP equals to volume of goods and services multiplied by price.
Nominal GDP= Volume x Price

Nominal GDP does not show true picture when there are sharp rises in price or say in periods of high inflation.

Real GDP measures only volume for current year and takes the price of base year so that year on year real rise in goods and services can be known.

Real GDP growth rate of major nations in calender year 2009(est..).

Country Real GDP %
US -2.4
Euro Zone -4.0
Germany -5.0
France -2.1
England -4.3
Russia -7.90
Japan -5.70
India +6.50
China +8.70
World – 1.0

I believe, now picture gets clear. Across developed nations, there is a negative growth from -2.4% in US to -4.0% in Europe to as high as -7.90 in Russia.

Here is a reason to worry.

If picture is still not clear. Let us look at the size of GDP of developed nations.

Rank Country GDP
World 57.53 trillion
European Union 16.00 trillion
1 US 14.27 trillion
2 Japan 5.04 trillion
3 China 4.75 trillion
4 Germany 3.23 trillion
5 France 2.63 trillion
6 England 2.19 trillion
7 Italy 2.09 trillion
8 Brazil 1.48 trillion
9 Spain 1.43 trillion
10 Canada 1.31 trillion
11 Russia 1.25 trillion
12 India 1.24 trillion

Out of total 57.53 trn world GDP, developed nations GDP( European Union, US, Japan and England) contribute 35.7 trn dollars and in % terms, developed nations accounts for 65% of world GDP.

When 65% GDP contributor countries of world are deep into debt, experiencing negative growth rate, unemployment rate is in double digits, real recovery is far far from near.

Then , why markets are going up?
Because of massive stimulus packages declared in 2008, massive money printing, massive current account and budget deficits and interest rates at nearly ZERO percent.

These massive money is finding way into stock market, commodity market and even in bullion market.
With help of this massive money, two great institutions Goldman Sachs and JP Morgan, posted highest ever profit in calender year, last year. Same is the story for large European institutions.

None of this organization posted profit through lending last year. It was blessed by their trading activities. Never in history they could profit so much through their natural business activity of lending.

But, then Why Prices are rising of everything be it commodity, be it energy… I mean everything, when developed economies are in recession????
Because of massive printing, massive deficits, massive money infusion through various stimulus packages and massive debts, currency is loosing value.

Price rises because
Supply is short or
Demand is high or and third element which rarely people think about is
Currency devaluation ( Currency loosing value ).

Example: IF you had lent Rs 100 to someone without interest for 9 years in year 2000. He pays back Rs. 100 in April 2010. Are you really getting back Rs. 100? Heck no. Probably, you are getting back just Rs. 50 or may be Rs. 30 only. How?

With Rs. 100 in year 2000, you could buy around 10 liter milk(Rs.10 per liter). Come 2010, same Rs. 100 buys 3.8 liter milk. So, in purchasing power terms you lost 60% value of currency in last 9 years. Or say, you got just Rs. 40 back from Rs. 100 lent in year 2000.

So, What next? Will economies come back to pre crisis level? Will markets take out their pre crisis highs?

About Economies

Consumption of European and US consumers was a big driver for the growth of world economy. Rest of the world were producing to feed these fat consumers.

Consumers were over purchasing because of the easy access to credit.

Now, neither easy credit is available nor consumers are willing to shop at pre crisis level. They have learnt lessons very hard way.

Hence, it looks extremely difficult, whatsoever action may be taken, for developed economies to return to pre crisis level any time soon. It may take years more if not decades.

Kenneth Rogoff, former chief economist at IMF, and Reinhart writes in his recent book “This Time is Different”

“…highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked…”Reinhart and Rogoff analyzed 800 years of economic history, including 250 financial crises in 66 countries. They looked for patterns, similarities and differences. Put simply: this time is not different. Their prediction is simple: Pain.

About Markets

I like the quote of Citi’s former CEO Charles O. Prince, he said before crisis — In terms of liquidity “As long as the music is playing, you’ve got to get up and dance, when music stops things would be difficult. We are still dancing.”

In Part II, I will write about effects of currency devluation.

Investment Academy | Baroda | 098255 28815
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