I have been cabbing in Bucharest these days. It was a good opportunity to take some on-ground survey interviews and practise my Romanian. My questions to the cabbies were the following. How’s business? Why is it bad? Who is to blame? Could it be inflation and not the politicians? The answers, surprisingly, concluded with corrupt politicians. Corruption is indeed a problem in the Eastern European belt, but the reality of inflation had finally caught up with day to day life.
Inflation was a reality check for ‘The crazy consumption' and its inflation which will invariably upset any recovery. The question is still about timing. How long will the recovery be? And, how strong will the inflation be? When will the latter influence the former? As we see things, this silent implosion will continue well into 2020. The very fact that it is silent will keep the impact from us till the damage will be head-on. Just like inflation has missed our attention from 2000, while gold has moved up 10 times, we might still miss it even if gold moves 50 times from 2,000 lows ($200 to $10,000 is 50 times). This means the average purchasing power would fall by a factor of 50.
Investors don't understand hedging, risk, diversification, sector rotation, inter-market analysis and long-term cycles. We are so focused on short holding periods that tomorrow does not matter much. We talked about this in hyperbolic discounting. Of course, we also suffer from bounded rationality. Our rationality increases as the available information increases. Because decision-making is hard and will remain hard, we somewhere need to simplify inflation hedging.
Assuming we don't want to be taken for a ride by inflation, how do we diversify and hedge against inflation? Real estate is not a hedge as realty is a financial asset, even if your real estate is at a top location. Inflation kills consumption and hence market confidence. Real estate is traditionally illiquid and hence poor sentiment will directly influence it.
The agro sector could offer a hedge, a farm land, being a farmer, a commodity supplier. We are still speaking about something perishable. How long can you sit on a stock of coriander seeds or wheat grains? There is a limitation to food safety. Above this, agriculture is still climate-dependent. Bad weather can wreak havoc with the agro hedge. Above that, how many of us can really become farmers? We can, of course, identify staple stocks or related equity, but there is both a limitation of instruments and representation of the agro sector in India.
Energy and oil sector could be another hedge alternative. We retain our $373-500 a barrel oil target into the 2015-17 time window. Commodity inflation confirms upside on oil and energy resources. Here too, we can look at energy stocks and invest in equity components that would go up along with oil prices. But, the reality of holding oil in a warehouse also has a limitation. Oil has more life than agro and can be stored.
What are we left with? Metals can be stored, metals offer a more diversified selection and metals have a good representation. The best part is that they are out of interest and subdued and underperformers. We think, it’s time to load up on metals for a few years of allocation. All of copper, zinc, lead, aluminium and nickel are inexpensive. If you think there is going to be a better bottom for metals, you are super timing an asset class that is a screaming buy. After a 40 per cent secular underperformance over the last 12 months on CNX Metals compared to Nifty, metals offer a great entering opportunity. Metals are over-depressed, with most of the 30 components of the Indian metals sector below 50 per cent of the performance ranking among the BSE 500 universe and 25 of the stocks below the 30 percentile. JSW Steel, SAIL, Hindalco, Jindal Steel, Tata Steel and National Aluminium are some of the compelling negative outliers getting ready to do a hedge reverse.
The author is CMT, and Founder, Orpheus CAPITALS, a global alternative research firm
