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The table below summarises the returns of Gold and of S&P BSE SENSEX ('Sensex') since 1979, when the Sensex commenced with a base value of 100.
Past performance may or may not be sustained in the future
As can be seen, long term returns on equities are much higher than returns on gold.
Einstein said "Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn't ... pays it". This has been experienced here. At 17.1% CAGR, Rs 10,000 has become ~290 times in 36 years, while in gold at 10.4% CAGR, it has become ~35 times.
A difference of ~7% in returns over longer term (36 years) has resulted in 8x increase in wealth.
The average inflation over this period has been ~8% (CPI). Thus, gold has given returns that are close to inflation, thereby merely preserving the purchasing power. On the other hand, Sensex has delivered nearly 9% p.a. excess return over inflation. Over long periods this has made a big difference.
The reason for this is simple. Equities over time grow in line with the growth of underlying businesses. As businesses comprise the economy, the nominal growth of the economy (real growth plus inflation) is a good proxy for the average growth in businesses.
The table below gives the nominal growth rates of Indian economy over last 35 years.
The Indian economy has grown at a remarkably constant nominal growth of 15% p.a. No wonder that the Sensex CAGR of 17.1% is close to 15% nominal GDP growth.
Who is Smarter: FII's or Local?
The table below gives the FII ownership of Indian stock markets, annual FII flows and net gold imports. In India, it is interesting to note that in the last 22 years or so that FII have been allowed to invest in stocks in India, the FII's ownership has steadily gone up from nil to 24% today i.e. at roughly 1% p.a. The sellers obviously have been domestic investors.
The dollars received by the locals from sale of their shares have been thus invested in gold. Gold as was pointed out earlier has yielded near inflation (~10%) CAGR vs 17% CAGR for the Sensex.
In effects domestic investors have been exchanging a ~17% CAGR asset for a ~10% CAGR one. This certainly is not a smart thing to do.
The way forward
Outlook for Indian economy and Indian equities is promising. India is one of the best placed among large economies in the world in terms of demographics, demand, growth etc., in my opinion. India is a key beneficiary of lower crude oil prices. The savings from lower oil prices are near 2% of GDP on run rate basis at current oil prices over CY13 average.
Apart from lower oil prices, a strong, growth oriented government bodes well for economic growth and for businesses. Key decisions of new government so far give confidence that lower fiscal deficit is a priority and it should continue to fall. The government has shown with its actions that it will prioritize quality of supply of essential things like electricity etc. over the price of supply as bad supply can prove to be even more expensive; put in place a transparent framework so that India can harness potential of its vast mineral resources; simplify tax structures and improve tax compliance; and follow policies that will aim to lead healthy and sustainable economic growth.
From an equity market perspective, current P/E multiples of equity markets are reasonable - still below long term averages (Chart1). Further, corporate earnings are expected to be better than estimates as corporate margins are significantly below the long term averages and should improve as capacity utilization and business conditions improve (Chart2). There is thus room for multiples to expand as growth improves and as interest rates move lower besides strong earnings growth.
To summarize, the outlook for equities is promising with a 3-5 year view.
Summary
Equities are the real gold. Equities compound near Nominal GDP growth rates whereas Gold compounds near inflation.
So far, Indians have preferred Gold over Equities, which is not a very wise thing to do as explained above. They would be better off by doing just the opposite.
DISCLAIMER: The views expressed by Mr. Prashant Jain, Executive Director & Chief Investment Officer of HDFC Asset Management Company Limited, constitute his views as of February 3, 2015. The views expressed herein are based on internal data, publicly available information and other sources believed to be reliable. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information contained in this document is for general purposes only. The document is given in summary form and does not purport to be complete. The document does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. The information/ data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on our current views and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. HDFC Mutual Fund/AMC is not guaranteeing/offering/communicating any on investments made. Past performance may or may not be sustained in future. Neither HDFC AMC and HDFC Mutual Fund (the Fund) nor any person connected with them, accepts any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.
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