15 January 2011

FII and Money Flow

We all know Nifty follows what FII does. You don't believe it, then check the 4 year chart below. There is almost a one to one correlation between the FII flow and the Nifty gain. While the DII are mostly on the other side of the trade.

So atleast we can safely say Market Direction is mostly decided by FII flow, though they are not always correct if you look at a long term perspective. So when DII buy while FII sell, they have to bear the brunt of catching the  falling knife (the artifacts they buy are in a consistent value decline), with the hope that one day these same sellers will come and buy from them at a higher price.

The problem with DII "this time" is that they are severely cash starved. Their main source which I expect is the Indian retail investor have been investor in the Euphoric top and since then have been to hell and back. They are not easily going to be seduced this time around.

So I believe the DII will not be of any great support in a falling market if FII goes on a selling spree, which looks like they have started after 7 months of consistently strong buying. And as we know FII money however deep rooted it is, still are destined to be pulled out someday.

The above chart shows that serious FII buying started from June 2010 when Nifty was around 5000. 2 things I find striking here : first that Nifty already had doubled from lows of 2500 when this heavy volume FII buying started and second was the ferocity of this money flow. Second point can be estimated with the fact that since Mar-09 to May-10 a period of 15 months FII bought net 29k crore of equity, while from Jun-10 to Dec-10 a period of 7 months they bought 91k crore of equity! Almost a 6 times furious money flow!!

What could be the reason of such a sudden flow? Had suddenly India become a good long term investment or there was a sudden jump in Indian corporate earnings? I can think of only one reason, the money became free in the west, especially the US, where not only interest rate were at bare minimum, monetary injection started and they had to find new avenues. As a result of which dollar as well as assets denominated in dollars plunged in value. It was much more lucrative to sell free dollars that Institutions were getting in exchange of other currencies and buy assets denominated in those currencies.

Apart from India, many emerging countries which had higher interest rates, looked more attractive to these dollar holders, they bought their debt and equities as a result these countries had extra money as well as assets boomed. Now issue with this is kind of investment is that they do not create anything except for inflation and asset bubbles. Had these money been given to start a new industry growth would have emerged, but thats a risky thing for people looking to make some quick buck, knowing very clearly that once US economy recovers these money will be expected back. As a result all we get is all sorts of inflation and illusion of economy getting stronger which even many renowned economists compare with stock markets!

So to sum up I will again say that the game is to see if there is anymore scope of money to be printed in US, interest rate to be retained at these levels and fooling people to believe that the world has now been saved. As long as that continues, money will keep flowing from west and markets will remain strong, we can keep buying cars and ipads on debt. But remember once the printers stop, it will be a struggle to keep our job, forget about emi of our home and car loans and to add to the wounds we will be paying far more than now for the basic food items and services. So you know what Uncle Sam is gifting you apart from your Job... its Inflation...


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