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Hold Gold or enter Bonds?
October 11, 2010

Not just Gold but stock markets in India have been truly shining. The recent surge in prices of different asset classes has left investors with mixed feelings of delirium and excitement. In such a scenario, should investors consider a revision in their asset allocation and look at fixed income/bond funds? We speak to Ruchir Parekh, Fund Manager, Fixed Income and AIG World Gold Fund at AIG Investments, to know more.

Author : Dhanashri Rane

Untitled Document

Never before, has the word ‘safety’ held more meaning and carried more weight in the global markets. With slower than expected recovery in the developed countries, low interest rate regime and further talks of quantitative easing in US to promulgate growth, money has rushed into low risk and safe assets. Gold, the traditional safe haven for Indians, has seen a steep rise in the last decade, especially since the liquidity crunch in late 2008 (see Chart 1). The prospects of high growth have driven inflows from foreign institutional investors into emerging markets. Consequently, the stock markets in India have rallied as well. As Gold and stock markets hit new highs each passing day, investors wonder about options to invest in and if they should hedge some of their risks and diversify their portfolio.

To get a better perspective on Gold and bond funds, we interview Mr Ruchir Parekh, Fund Manager, Fixed Income and AIG World Gold Fund at AIG Investments.

Key Points from the interview

  • Further impetus to the US economy - a positive for Gold

  • Do not expect the 10 year G-sec rate to go much above 8% at this point

  • Investors should look at some allocation to interest rate products (i.e., Short Term funds/Income Funds/Gilt Funds) depending on their risk appetite and investment horizon

  • Investors can allocate a portion of their portfolio to Gold as a hedge against financial uncertainty and inflation

iFAST: Gold and Silver prices have hit record levels. Do you think this steep rise in precious metals is sustainable in the medium term? Should investors be booking profits at this level?

Ruchir Parekh (RP): We are favourable towards an allocation to Gold at this point in time. Our thesis stems from the fact that there are still no signs of an end to the financial uncertainty around the globe. In addition, the Federal Reserve has recently hinted at another quantitative easing program to support the US economy. This may result in the US dollar weakening further in the near term, and it may also have the potential of creating significant inflationary pressures over the medium term. We are seeing the impact of the first such program undertaken post the 2008 crisis. Further impetus to the US economy in such manner is going to be a positive for the metal.

Many analysts believe that Gold could reach $1500 in the near term and $ 2000 over a period of time. These estimates have been around for some time now on the back of a very favourable demand‐supply situation for the metal.

iFAST: RBI has followed a hawkish stance in the recent mid-quarter policy review. According to your expectations, how much more would the RBI hike rates for the remaining part of FY2011? What would be the impact on bond markets?

source: Compilations, Bloomberg

RP: Over the last year, RBI policy actions were mainly taken to normalise the monetary policy to reflect a growth economy and manage inflation. The RBI now believes that the actions taken over this period have taken the monetary situation close to normal, and going forward this may be less of a driver. The focus from here onwards may be on current and expected macroeconomic conditions.

We believe that there was nothing new in the recent policy review. Increasing policy rates and further narrowing the overnight Liquidity Adjustment Facility corridor (a tool used by central banker to modulate availability of short-term cash in the system) is in continuation of the July policy in an effort to anchor inflation expectations. Similarly, it continues to be hawkish on the inflation front. While inflation may have peaked, the numbers are expected to remain at elevated levels for a little while and this could be a concern. We feel that the markets are expecting another 50 bps of policy rate hikes in FY2011 at this point.

iFAST: What is the range you expect for 10 year G-sec to trade in FY2011? Do you think investors can consider investing in income and long-term debt funds now?

RP: We feel that many of the negatives are priced in the yield curve at this point. Interest rates are not expected to rally anytime soon, given the large remaining government borrowing and also that credit off-take is expected to pick up in the second half of the year. However, we do not expect the 10 year G-sec rate to go much above 8% at this point.

.iFAST: The Government targets bringing the fiscal deficit down to 4.8 per cent and 4.1 per cent for FY2011-12 and FY2012-13 respectively; how do you see that shaping up? And if it is likely to happen, what will be the impact on long-term debt funds?

RP: We are a little sceptical at this point in terms of how these targets will be achieved given that government spending is an important driver for GDP growth. The fiscal deficit number can simply come down as a result of GDP growth but we will also have to see government spending reduce structurally for these targets to be achieved, which will be positive for long‐term debt funds.

The government divestment program, though difficult to forecast currently, can also help fund the deficit and may be favourable for the bond markets.

iFAST: Where are the opportunities to invest for retail investors in the current scenario?

source: Compilations, Bloomberg

RP: Bond rates are pricing in many of the negatives and are not expected to rise significantly from here onwards; investors should look at some allocation to interest rate products (i.e., Short Term funds/Income Funds/Gilt Funds) depending on their risk appetite and investment horizon.

We are also recommending investors to allocate a portion of their portfolio to Gold as a hedge against financial uncertainty and inflation. The stocks of Gold Mining companies tend to have a beta of 2‐3 times that of Gold and investors can benefit further during a bull phase by investing in a portfolio of such stocks.

Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's scheme information document including statement of additional information. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website.Please read our disclaimer in the website.

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