Central banks may be forced to sell gold; India at risk: Chris Wood

According to reports, official gold reserves in India totaled 653 tonnes at the end of March 2020, while those in Saudi totaled 323 tonnes.

There is a growing risk of liquidation of gold in India caused by a lockdown-triggered collapse in economic growth, wrote Christopher Wood, global head of equity strategy at Jefferies in his weekly note to investors, GREED & fear.

The potential for forced selling in gold, Wood believes, could come from central banks given the dramatic fiscal deterioration being suffered by many countries. India, he said, is at risk given its substantial gold holdings.

“Another potential seller is Saudi Arabia where fiscal pressures caused a draconian threefold increase in the value-added tax (VAT) rate to 15 per cent and the suspension of cost of living allowances,” Wood said.

Given this backdrop, he feels gold prices may not break the $1800-1900 level in a hurry. “Still what investors should remember is that when gold finally takes out the 2011 high of $1921/ounce, it will be the proverbial ‘blue sky’,” Wood wrote.

According to reports, official gold reserves in India totaled 653 tonnes at the end of March 2020, while those in Saudi totaled 323 tonnes.

Bearish on banking stocks

The growing pressure on banks to offer and even extend the moratorium on payment of installments seems to have Wood bearish on the sector, especially in the Indian context. In his Asia Pacific ex-Japan portfolio, Wood has exited his holding in Kotak Bank and replaced it with Maruti Suzuki.

“This issuance of forbearance pressure on banks is not just an issue for India but one for bank stocks globally. It is why bank stocks would not be GREED & fear’s favourite way to add to cyclical exposure for those who buy GREED & fear’s base case that the health crisis will prove to be a three to four-month cycle and that life will return to normal much sooner than currently assumed by the chattering classes,” he wrote.

Defensives versus high beta. What should your stock strategy be?

While JP Morgan believes 'cash is king' given the uncertainty that lies ahead, selective buying from a long-term perspective can be done in defensive plays.

With the frontline indices – the S&P BSE Sensex and the Nifty 50 – crashing over 35 per cent from their peak levels given the rampant spread of coronavirus (Covid-19) pandemic across the globe, most analysts remain cautious on the road ahead for the markets. Going ahead, they believe the markets will track developments related to the progress of the health scare and how effectively can the governments combat it.

That said, they do believe long-term investors with risk appetite and those who can digest volatility can start nibbling at stocks given the attractive valuations.

So, what should your stock strategy be? Is it better to allocate more towards defensives or look at high beta names that can deliver handsome returns once the markets recover?

While JP Morgan believes ‘cash is king’ given the uncertainty that lies ahead, selective buying from a long-term perspective can be done in defensive plays. Before investing, investors must evaluate companies carefully and put money in stocks of only those companies with strong balance-sheet and earnings visibility despite the Covid-19 health scare, they suggest.

“The backdrop of a sell-off across asset classes led by COVID-19 fears means our strategy is set with the primary objective of capital preservation with cash in hand until volatility recedes. We would be selective buyers within Indian equities, albeit with a defensive bias. Our preferred sectors are consumer staples, healthcare, large retail private sector banks and utilities,” wrote Rajiv Batra, Kevyn H Kadakia and Sahil Dhingra of JP Morgan in a recent report.

Eye on equity-linked debentures as volatility spikes in Indian markets

FY20 had seen increasing issuances on higher demand from issuers.

Instruments whose pay-outs depend on equity market levels are likely to be closely watched amid the carnage in global and local markets.

The Indian market saw its steepest fall in five years even as fears of coronavirus spreading continued amid a crash in crude oil prices. A price war roiled global oil markets as Saudi Arabia and Russia sparred over oil production. Saudi Arabia steeply cut oil prices and crude prices fell around 30 per cent. The S&P BSE Sensex was down 1,942 points (5.2 per cent) closing at 35,635.

Higher cost of issuing such debentures amidst such volatility is likely to weigh on issuances.

Ashish Shanker, associate director and head of investments for Motilal Oswal Wealth Management said that equity-linked debentures will become more expensive for issuers now. Higher volatility increases the price of issuing such debentures since they typically hedge their risk using derivatives. The cost of such hedging goes up when volatility increases, making it less attractive for most issuers since they tend to prefer taking derivative positions to manage their risk.

"Most people will hedge," he said.

The India VIX, a volatility index which is also known as the market’s fear gauge, surged by over a fifth on Monday.

Equity-linked debentures involve a payout which depends on market levels. This is usually achieved by investing a portion of the capital in call options. They give the investor the right but not the obligation to buy into securities at a pre-defined price.

The issuer usually writes long-dated options for the investor depending on the maturity of the instruments. The interest on the debt portion covers the invested principal over the period of the instrument. The value of the call option provides an upside boost to returns.