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“I think the place to be is in number one precious metals and number two commodity producers. I do not know about India, but in other parts of Asia like Indonesia or Australia, one can find mining stocks that have dividend yields of around 10% and they are not increasing their production and that is why the commodity prices are very high because the supply is not increasing,” says Mark Matthews, Head of Investment Research, Julius Baer.



Reserve Bank of India increased rates, the market came down, Fed increased rates and the markets went up. Why is that?
I think because the Federal Reserve has been communicating its intention to be very aggressive in frontloading the interest rates hikes and reducing the balance sheet. What they delivered yesterday was bang in line with what they have been telling us. Actually slightly less hawkish in the sense that for the first three months, the balance sheet reduction will only be about $35 or $40 billion while they have been previously committing $95 billion.

On the other side of the coin, for RBI, this was an off cycle rate hike which at 40 bps is higher than they usually do and also the reserve requirement ratio – $10-11 billion worth of liquidity was not expected. I guess one was expected and the other one was not and that is the reason why the reaction in the markets is different.

Where do we go from here? What is your understanding or what will do well and what will not do well when central banks are increasing rates? There is a previous template and there is a future template. What do you think will be at work?
Last night’s price action shows us the 10-year treasury yield probably would not go much above 3% because once again, the Fed has been job owning so much over the last few months that the market has already priced in a lot of the moves that it will be doing over the next few months. That being said, I do not think we are in a bull market. We are probably in a very choppy trading range and I would actually think that the chance of it going down is still higher than up because commodity prices are still very high and inflation is a real thing.

So to answer your question, I think the place to be is in number one precious metals and number two commodity producers. I do not know about India, but in other parts of Asia like Indonesia or Australia, one can find mining stocks that have dividend yields of around 10% and they are not increasing their production and that is why the commodity prices are very high because the supply is not increasing. They are just taking the stuff out of the ground and giving you a 10% yield and I think that is the place to be.

But within the equity market construct, are the high consumption, high PE names going to get challenged? Is growth as a story something one needs to move away from and banks and bottom up stories are likely to do well?
I think the jury is still out. Ray Dalio, the famous billionaire hedge fund manager, posted an article worth reading on his Linkedin account on Monday. The article title is something like Popping Bubbles. He has a proprietary bubble indicator and he lists six variables in this thing, that are the kind of classic things you would look at from valuations to sentiment.

He can run this going back to the year 1900 and it is showing that the bubble has been taken out of the market because it was trading at kind of 80% of its all time high back at the end of last year and that has come down to 40%. but he concludes by saying that if you look at past big bursts of bubbles and he uses the 1920s and the late 1990s as examples, and points out that back then, his bubble indicator went down to 20% before it bottomed. We are currently at 40% but his point is that on the way down, one can go even further below where the long term averages or where fair value is typically associated. One can become oversold and undervalued in the process of these massive bubble corrections.

Month to date, India has managed to outperform the fall that one has seen in the US equity markets. For instance, the S&P month to date is down about 8-8.5% whereas the benchmark Nifty 50 has fallen just about 2.5 to 3 odd percent. Is that gap going to squeeze wherein India underperforms and the US equity markets flatten out?
I honestly do not know. On a monthly basis, it is kind of a coin toss but I do know that what is driving the Indian market is the domestic investor and it is very important to gauge their reaction to this surprise rate hike which on balance I view as bearish because not only was it a surprise, but the RBI like most other central banks, does not just do something and that is a one off. We are probably looking at a rate hike cycle in front of us, this is going to last for quite a few months. I would like to gauge the domestic investors’ assessment of that to understand where India is likely to go. Of course, the nice thing for India is that the banks are very big in the index and their net interest margins will be helped by this rate hike. Banks in America are not nearly as big a component of the S&P 500.

When rate hikes start, large banks do well. But since inflation is real and ugly, what can investors do to make their portfolio Teflon coated against inflation?
I just said it. I do not mind repeating it because it is important. One wants to own precious metals and miners of commodities like coal, iron ore, whatever it is.

We are nowhere close to demand destruction when it comes to commodities?
Maybe in certain commodities. They are flexible prices. I mean divide the components of the CPI into flexible and sticky and definitely all of the commodity related stuff – primarily related to energy but also food – classify as flexible price items. their prices can easily come down if they go up enough so that people cannot really afford to buy them anymore.

I used to take a taxi home every day after work here in Singapore because it costs me about $10 or $15, now they want $20 or $25 so I am taking the subway to home instead and so I suppose that in a roundabout way, I am answering your question. Yes, we are seeing some demand destruction. I am witnessing it myself in my daily life.

Now in a commodity boom or a bust which causes inflation, I am using elementary terminology for the benefit of our viewers. Wealth will shift from one region to the other region. In this entire shift of wealth as an investor, apart from buying gold and miners, which are the other frontier markets one should invest in?
Frontiers I do not particularly know but among emerging markets, there is basically South Africa and Malaysia and Indonesia and a lot of countries down in Latin America like Chile and Brazil. But I do not know very much about them.

A counter question which we are discussing is an inflation scare. Markets tend to price in way ahead of the actual event which is that the Fed is tightening today and the Indian central bank has tightened yesterday. But are equity markets already pricing that in because in India, the bond yields at 7.6%. You do not expect the US 10-year paper to go above 3%. Is it too late to buy the poor inflation trade? Is it time to start buying consumers rather than bet on producers?
Your point is well taken that the rate of inflation probably would not stay at this level. In America, it is about 8%. Inflation is not going to continue to be 8% in America for many months and I do not think it is going to go higher than 8% either. But that does not mean that the prices will go down. The prices can stay very high and the companies that produce these things like commodities will have very big margins with the prices at the levels they are at and be able to pay us big dividends.

Thanks

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