MUTUAL FUNDS

We Expect Gold Prices to Continue To Climb Given the Current Low Level of US Real Interest Rates <
12-Dec-11   17:37 Hrs IST

Mr. Raju Sharma
Due to weak growth outlook in US, we expect US real interest rates to remain lower for longer, supporting higher gold prices. However, magnitude of outperformance witnessed in CY 2011 may not be repeated in 2012. As regards allocation to Gold is concerned, ideally, one should have an allocation of around 5% of one's portfolio to Gold. We at Capital Market interacted with Mr. Raju Sharma, Head Fixed Income of Indiabulls AMC, to know the outlook on Rupee, Commodities, Gold and Debt Funds in Calendar Year 2011.

Here are the excerpts:

What's your call on Indian rupee? Don't you think if rupee continues to depreciate or even remain at current depreciated levels for long, India's growth story is as good as suspended?

The INR's recent fall in Rupee has been unusual and has caught everyone by surprise. Though some amount of depreciation was anticipated due to a significant real appreciation, the sudden move was unexpected. A combination of factors like rising current account deficit, capital outflows, lack of USD funding especially from European banks, and un-hedged importers and those with USD liabilities coming to hedge and the half hearted intervention by RBI have been key in the move.

Though in the near term, we see the risk of further depreciation with the negative factors mentioned above very much still in play, in the medium term, we see Rupee to become stronger from current levels. While the RBI has been seen selling USD at 52 levels, on the policy front, authorities have taken several steps to increase capital inflows as well. These include increased quotas for foreign institutional investors (FIIs) for investment in corporate debt and GSec, increased deposit rates for non-resident Indians (NRIs), greater freedom for corporates to borrow externally (by allowing higher spreads on external commercial borrowings), and more recently and importantly Government announcing its intention to open FDI in retail. Thus some amount of downside cannot be ruled out, we are bullish from the medium term perspective ( 6-12 months ) from the current levels, as the India will continue to remain a favourite destination for foreign investors due to better growth dynamics compared to other countries.

Overall how will the commodities perform in CY 2012 vis-a-vis CY 2011? Which commodities you are bullish and bearish on for CY 2012 and why?

The European debt crisis remains a significant downside risk in 2012 for the commodities. However, as long as the European debt crisis does not precipitate into a global recession, it is unlikely to severely impact commodity markets. In the present environment, barring base metals, where we see some amount of moderation, we envisage an upside risk to oil, due to tighter physical markets and easing of the tight monetary policy in the Emerging Markets like China which may once again spur consumption demand.

Gold in India has been a great outperformer in CY 2011? What's your view on gold for CY 2012? How much percentage one should allocate into it?

We expect gold prices to continue to climb given the current low level of US real interest rates. Due to weak growth outlook in US, we expect US real interest rates to remain lower for longer, supporting higher gold prices. However, magnitude of outperformance witnessed in CY 2011 may not be repeated in 2012. As regards allocation to Gold is concerned, ideally, one should have an allocation of around 5% of one's portfolio to Gold.

After remaining at high levels for past couple of years, can inflation come down in CY 2012? Will RBI be able to cut interest rate in CY 2012 or the rate will remain stable? What's your view on investment in debt in CY 2012?

We think inflation will be less of an issue in 2012 than in 2011, due to slowdown in domestic demand engineered by tight monetary policy and base effect. No doubt the depreciation of the INR will clearly add to imported inflation. However all other factors, suggesting that inflationary pressures are likely to be limited going forward. Core inflation has already come off and we expect it to continue to fall further as a negative output gap persists through 2012. The food price inflation will also likely come off in 2012 as a result of good monsoon.

We are positive on investment in debt for CY 2012.

Gilt Funds category has been facing net outflows since December 2010, what has been the reason behind it. Do you see any reversal in the trend in CY 2012?

Due to continuous rate tightening by RBI and the huge borrowing by the Government, the bond yields have moved upwards in the last 1 year. Since December 2010, the 10 year yield has moved up by almost 80 basis points resulting in low returns to investors. However, with the inflation looking to come down sharply from current levels and the slowdown in growth as reflected by falling IIP and GDP numbers, we expect the RBI to stop hiking rates. On the other hand, we expect the RBI to cut rates in the 2nd quarter of CY12. This augurs well for long bonds, as the fall in rates will result in higher returns to investors by way of capital gains. In such a favorable interest rate scenario, we expect investors to once again flock back to Gilt Funds.

What kind of debt funds would you be recommending to your investors right now and what are the expected returns from them? Given your expectations of where interest rates are headed next year, would you be advocating short term plans or longer term plans which can take advantage of the double indexation facility?

At the moment we recommend liquid fund plan to the investors since these funds category offer very attractive return with least volatility and risk.

Those with 3-6 months investment horizon, we recommend short term plan, whereas for those with more than 6 months investment horizon, we recommend the income and gilt funds.

What is your outlook on money markets, gilts and medium to long term bonds?

We are extremely positive on the rate market. We expect both the money market yields and the long bond yields to come down going forward. While the current tight liquidity situation and high policy rates haves kept the money market rates at elevated levels, we expect the RBI to continue with its OMO operations and infuse liquidity and even cut CRR, resulting in money market rates softening going forward. Further, there are every indication that inflationary pressures are easing significantly and growth is decelerating, which may prompt the RBI to focus on growth and cut rates in CY 2012.

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