Sensex Gold Ratio

Posted On Monday, Jan 25, 2010

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Gold began its bull run in 2001, and a noticeable pattern of this run was the consolidation phase post the attainment of a peak. Presently the price of gold seems to be in a correction / consolidation phase post their peak at $1226 levels.

With regards to equities, increased flows and bullish expectations were leading indices higher until we saw some correction in the past two days following global cues.


Although equity indices were moving upwards globally, the fact that the price of gold were at elevated levels suggests that there is still a lot of anxiety in the markets, cautioning about the possibility of ensuing trouble in the financial world. Now, economists wonder, whether this trouble will come in the form of a double dipped recession, a dollar or bond crisis, stagflation, inflation, or deflation.


Back home there have been mixed opinions on where our stock markets are headed. Some experts predict a correction whereas some expect more gains. However, we looked at some past data to gauge what the relative valuations of gold and Indian stock markets have in store for us.

We tried to evaluate the relative relationship between the Indian stock markets and the price of gold. For stocks we chose the Sensex as a barometer, and to establish a historical relationship we calculated a ratio known as "Sensex Gold Ratio".

The equity/gold ratio highlights a commonly used measure of corporate market value (i.e the Sensex) versus a decades-long measure of real asset value (i.e gold).


Chart: Sensex Gold Ratio
Quantum Mutual Fund_Sensex Gold Ratio
Source: Bloomberg * Gold price data in INR used for calculation of ratio is without any applicable levies / taxes / duties.


The current ratio stands at 1.06 vis-à-vis its long term average (since 1979) of 0.70. This long term average considers the data in entirety and helps us evaluate the relative value during different business cycles.

The higher ratio relative to its long term average tells us that either the Sensex is overvalued or that gold is undervalued.

The table below provides an insight on the various scenarios that can evolve if the Sensex Gold ratio retraces back towards its long term average of 0.70.


Table I: Sensex Gold Ratio Scenario Analysis


Scenario`s

Ratio

Sensex

Gold (Rs. / 10 grams)

Current Levels#

1.06

17,051

16,094


If the Sensex Gold Ratio retraces back to its long term average of 0.70


Scenario`s

Ratio

Projected Sensex

Projected Gold

If Sensex remains unchanged

0.7

17,051

24,359

If Sensex further falls by 15% from current levels

0.7

14,493

20,705

If Sensex increases to 21,000

0.7

21,000

30,000

If Gold Remains unchanged

0.7

11,266

16,094


*The Table above is purely illustrative and indicates potential gold prices assuming Sensex / Gold ratio at 0.70. Actual Sensex / Gold ratio may be higher or lower than 0.7.Past performance may or may not be sustained in future. # Data as on 21st January 2009, Gold price data in INR is without any levies / taxes / duties applicable. Source: Bloomberg, www.QuantumAMC.com


India’s growth story has been buzzing with high expectations. In such a case, it looks unlikely that index levels would fall significantly unless we have another major catastrophe in the global economy. Therefore, going by the long term historical average, gold prices seem to be poised for an upward trajectory.

If history gives us an opportunity to peek into the future, we could well say that gold has tremendous potential to do well.

This correction in gold prices seems to be an ideal opportunity to increase allocation to gold. Make the most of this opportunity and Invest in gold before it heads higher.



Disclaimer:
The views mentioned in this article are general recommendations and their relevance would differ from individual to individual. It is hence advised that portfolio allocations are made in consultation with your financial planner.
The views expressed in this article are of Quantum Asset Management Company Pvt. Ltd., and is in no way a definite prediction on trends of Gold. The views are based on past trends in the bullion markets, which may or may not be sustained in the future. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.

Above article is authored by Quantum.

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