Monday, June 23, 2008

Capitulation? Not yet!!!

The Indian Government, two weeks ago increased the price of petrol by Rs.5/- per litre, diesel by Rs.3/- per litre and the price of domestic LPG by Rs.50/- per cylinder. This was bound to set inflation on fire, which it did as was shown by the inflation figures zooming past 11% for the week ended 7th June 2008. Not to say, that this price hike was not needed. In fact, it was very badly needed and much earlier than when it was finally announced.

Back in 1974, India was a very poor country and when the price of crude virtually doubled overnight, India could afford no subsidies to its citizens and they had to bear the brunt of the price increase. The same happened in the US in 1979 when they abolished all subsidies and the full price of crude was passed down to the consumers, which eventually led to the demand going down. Today, India is a much richer country but none the wiser. It can afford all these subsidies which is why the price passed down to consumers is only about $60 a barrel as against the $135 a barrel ruling in international markets. This heavy subsidy artificially keeps the demand high and hence the prices. The moment the full price is passed down to consumers, the demand will go down which should bring the prices down. So, in effect, by subsidizing crude prices we are artificially keeping the demand high and hence the prices are not coming down. So, while it is increasing the subsidy burden on our government, all that money is actually going to the OPEC countries. This is very well explained by Mr. Swaminathan S Anklesaria Aiyar in a column titled Swaminomics on the Times of India. This article also got me thinking on what am I doing in India? I should instead have been in Venezuela where petrol costs only Rs.2/- a litre. Paradise. Absolute paradise.

The Nifty continued its southward journey today, but did find support between the 4230 and 4240 levels on two occasions during the day. This was very much in line with our expectations in
yesterday’s post where we had expected 4234 as one of the levels where the Nifty could find support. One of the supports was also placed at 4157. So, could the Nifty go down to that level or is 4234 the final low? The answer is, we don’t know. The markets would have to capitulate first to indicate that a reversal is possible. Capitulation happens when most of the investors lose their confidence in the markets and close their positions. Capitulation results in a panic like situation where the prices shave off quite a lot and quite fast. What happened in late January 2008 was a capitulation like situation when the markets lost about 30% from its highs in just 10 trading days. A similar situation is happening now when the markets have lost almost 10% in the last 4 trading sessions. But I don’t think a capitulation has happened yet.

With the inflation going past 11% and the repo rate being only 8%, all our investments in fixed deposits are now earning negative returns. This imbalance in the bank rates and the inflation cannot be maintained for long. The RBI shall have to intervene and increase the rates by at least a 100 basis points (could be in 2-3 steps rather than in one go) and such measures would have to be taken much before the scheduled credit policy meeting due on July 29, 2008. The market has already started discounting rate hikes into the prices but a strong reaction, albeit short, will be expected when the rates are actually hiked. Probably that will be the day of capitulation.

The 17 MPs (Members of Parliament) of BSP (Bahujan Samaj Party) have already withdrawn support from the UPA (United Progressive Alliance) Government on fears of the Government’s increasing proximity to the JD (Janata Dal) and the SP (Samajwadi Party). The Government is taking all steps possible to go through with the nuclear deal without forcing the Left Front to take drastic action. I wonder if they would be able to pull it off. The Prime Minister, Mr. Manmohan Singh, is already looking for reasons to resign. While the present government falling can only benefit the country, I doubt the market will take it that positively. Probably that will be the day of capitulation.

Nobody knows when that day of capitulation will come or how far down will the markets go or how much pain is still left. But one thing is for sure, the day the capitulation comes, we shall know. Such days are usually accompanied with huge and steep declines and extreme panic. The panic will build a lot of fear in everybody’s minds. But believe me, only the courageous few who decide to buy on such a day will end up as winners. Others shall see the opportunity come and then see it go. It is important to set aside your emotions of panic and fear on such a day and be as greedy as you can. As Warren Buffett says, "Be greedy when others are fearful and be fearful when others are greedy".

I leave you today with two charts, the top being the daily chart of the Nifty while the one at the bottom being the weekly chart. Both are giving contradictory views and my views are pasted on the charts itself. The market may follow one of the views. It is also possible that it follows one view for a short period of time (2-3 days to a week) and then follow the other view. What it finally decides to do, only time will tell.

Nifty Daily Chart - Bears Take Control
Nifty Weekly Chart - Will Support be Found Here?

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