Post-COVID, investors have seen significant wealth creation, with strong returns across various asset classes. The last 12 months have been especially rewarding, with major indices and commodities posting impressive gains:
| Asset class | Returns |
| Equity: S&P 500 | 25.31% (as of August 31, 2024) |
| Equity: NIFTY | 31.08% (as of August 31, 2024) |
| Gold | 39.77% (source: Goldprice.org) |
| Silver | 40.71% (source: Goldprice.org) |
Key Insights:
Precious metals, particularly Gold and Silver, have outpaced equity markets. This reflects investor behavior that hedges against inflation and uncertainty, especially as interest rates stayed high for much of this period.
With the Federal Reserve’s 50 basis point rate cut on September 18, 2024, and the expected additional 25 basis point cuts in November and December, the investment environment is shifting. Adding to this, the People’s Bank of China has implemented measures such as reducing the reserve ratio and lowering repo and lending rates to boost their slowing economy. The following analysis outlines the potential impact of this low-interest-rate environment on key asset classes.
Impact of Low interest rate on various Asset classes:
Equity:
Equity markets tend to perform well in a lower interest rate environment due to:
- Reduced borrowing costs: Companies with low cost of borrowing can finance operations more cheaply, potentially boosting their earnings and driving stock prices higher.
- Increased liquidity: A loose monetary policy pumps liquidity into the market, often fueling growth in stock markets.
However, a word of caution:
NIFTY’s P/E Ratio of 24.1 appears somewhat elevated. Historically, a P/E ratio below 20 is considered reasonable. For NIFTY to maintain its upward trajectory, corporate earnings need to keep pace with the market valuations. If corporate earnings do not grow in line with market valuations, stock prices may face downward pressure or correction.
Gold:
Gold has traditionally been a go-to asset in times of economic uncertainty and rising inflation. In a falling interest rate environment:
- Opportunity cost of holding gold diminishes: With low returns from bonds and fixed-income assets, investors often turn to gold as a safe haven.
- Currency depreciation: A lower interest rate environment is likely to weakens the U.S. dollar and other global currencies, which typically boosts demand for gold, as gold is priced in dollars.
- Risk of inflation resurgence: With central banks adopting loose monetary policies (low interest rates, increased money supply), inflation may return, further pushing gold prices higher.
Central Bank Gold Demand: Central banks have increased their gold reserves dramatically, with 2022 seeing a 140% rise in purchases to 1,082 tonnes (up from 450 tonnes in 2021). In 2023, demand remained robust at 1,037 tonnes (Metals Focus, World Gold Council). This strong institutional demand provides a significant price floor and future support for gold prices.
Silver:
Silver, like gold, benefits from lower interest rates and serves as an inflation hedge. However, its dual nature as both a precious and industrial metal provides additional tailwinds:
- Industrial demand: Silver is widely used in electronics, solar panels, and manufacturing, so its price is closely linked to global economic recovery. As economies rebound, demand for industrial metals like silver tends to rise.
- Inflation hedge: Like gold, silver acts as a store of value, making it attractive to investors concerned about inflation, especially when interest rates fall.
Summary:
- Equity (NIFTY): Expected to benefit from cheaper borrowing costs and increased liquidity, but high valuations (P/E 24.1) mean earnings growth is essential to sustain current levels. Without that, equities face a correction risk.
- Gold: Poised to continue its strong performance as inflation risks remain, weakened currencies, and continued central bank demand.
- Silver: Likely to outperform due to its dual role as a precious and industrial metal. Its industrial demand will rise in line with economic recovery, while its inflation-hedging properties will maintain investor interest.
Conclusion:
Future performance across these asset classes will largely depend on global monetary policies, inflation trends, interest rate adjustments, and economic growth. Investors should remain cautious, especially in equities where high valuations could lead to corrections. Monitoring central bank actions, inflationary pressures, and shifts in economic policies will be essential to navigating this evolving market environment. Balancing risk and reward will require staying informed and vigilant.
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