Market rally: Why you should forget gold and buy equities instead

Dow, S&P 500 and German Dax at record highs, Nikkei up over 60 percent over the last one year and Sensex and Nifty at just off a few percentage points off record highs. US in sluggish economic growth, Eurozone in recession, Japan in deflation and India’s growth at decade lows. China’s growth in danger of flattening out and emerging markets feeling the heat of China’s slowdown in growth. Fiscal austerity everywhere with governments from US to India cutting backs spending. Central banks from the US Fed to the Bank of Japan pumping in cheap liquidity.

The bulls are saying fundamentals are improving while the bears are saying cheap liquidity will vanish. Bulls are buying while bears are waiting to buy gold that has crashed by 26 percent from highs seen in 2011. Are the market bulls over optimistic? Will the bears be right on equities crashing and gold rising?

[caption id=“attachment_822169” align=“alignright” width=“380”] What do you do in this market? Should you buy equities or should you worry about a market crash and buy gold? Reuters[/caption]

What do you do in this market? Should you buy equities or should you worry about a market crash and buy gold?

The answer is you should buy equities. The rally in equity markets this time around has some sound fundamentals attached to it. Yes, central bank liquidity is one of them but the fact is that the system has enough absorption capacity to take in the central bank liquidity without any fears of overheating.

The equity rally has not been broad based and that gives a sign of comfort that markets are being choosy. Markets of China, Brazil and Russia are well below all time highs and have not really participated in the equity rally over the last one year where markets in US, Europe and India are up over 20 percent.

Commodity indices are well below highs with the Reuters CRB Commodity index that tracks a basket of 19 commodities down 30 percent off highs seen in 2007. Oil prices are down 25 percent from record highs.

Equity markets are giving thumbs down to commodities given China’s growth slowdown and are also giving a thumbs down to economies driven by commodities. On the other hand markets are taking up equities in economies that benefit from lower commodity prices. Outlook for commodity prices is down given that US oil imports are falling on higher shale oil production in the country and given that over investment in China has considerably reduced demand for industrial commodities.

Central banks are pumping in money with US Fed buying $85 billion of assets a month and Bank of Japan looking to double its monetary base. ECB is giving liquidity support to banks in the Eurozone. However given the massive amount of deleveraging by governments and banks across the globe, the central bank liquidity is not leading to asset price bubbles. In the periods leading to the credit bubble burst of 2007-08, governments and banks had expanded their balance sheets to unsustainable levels. The credit bubble burst exposed both the governments and banks leverage and now fiscal austerity is the buzz word while banks are bringing down their loan books.

Equity markets are seeing positive impact of liquidity as corporates are benefitting from productivity, technology and restructuring in the face of a global economic slowdown. Once economic activity stabilizes, central banks can cut down their monetary easing without having to worry about growth falling off.

The bears calling for a fresh debacle will be wrong this time around as conditions are nowhere near any kind of bubble territory.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors