Low crude and gold price can’t sustain Indian stock market rise

“Too much of anything” is bad. As such it applies to very high and very low prices of oil and commodities and also to inflation. Contrary to the belief that lower oil prices would be good for countries like India and China which import bulk of their energy requirement, history suggests otherwise for the stock market as shown by the charts below.

I have put two charts below which show 1) the price movement of oil and gold and 2) BSE (Bombay stock exchange) SENSEX movement with gold price.

1st chart shows near perfect correlation coefficient of almost 1 between oil and gold price movement and 2nd chart shows high correlation coefficient of 0.75 and RSQ (r2 or square of correlation coefficient) of 0.56. Basically this means that movement of SENSEX can be explained by the price movement of gold and crude oil as they are highly correlated.

Chart 1: Price chart of gold vs crude oil for 10 years

Chart 2: Gold price vs SENSEX (STOCK INDEX)

Source: BSE, ECB, USA Gold, Niraj Shah Research

Let me explain in detail. I have taken monthly average price of gold, crude oil and SENSEX for last 10 years. For calculating correlation coefficient and RSQ, I have divided 10 years into 3 time periods of Jan2004-March 2008, Apr2008-Apr2013 and May2013 till date. The correlation coefficient and RSQ between Gold & SENSEX for the first 2 periods is strong and positive at 0.93 & 0.87, 0.66 & 0.44 respectively but from May2013 onwards it has become negative which is an anomaly and can’t continue for long. So either, oil and gold prices should increase to justify SENSEX rise which looking at the current global economic situation does not look possible or its time for SENSEX correction. I am of the view that SENSEX should correct by 30% from its peak level of 28560.

I continue to hold the view that oil and gold prices will go back to its medium term average of US$ 92-95/bbl and US$ 1,400/oz respectively over next 2 years but it will remain soft for 2015 due to many factors including strong US$, lower demand, higher production, geo political issues and so on. As such, Indian stock market and currency is also expected to remain weak and underperform along with other emerging countries’ markets and currency.