The dollar closed below the 110 yen mark on Monday in the US markets for the first time since May last year. That should normally have led to screaming headlines about carry trade unwinding. Last May, and even in February this year, the sell-off in emerging markets had largely been attributed to hedge funds dumping emerging market assets as the yen strengthened. This time, however, talk of the carry trade has been strangely muted.

Yet, the parallels with May 2006 are unmistakable. At that time, the yen strengthened from 118.65 to the US dollar on 14 April to 110.07 by 16 May. The sell-off in the stock market started on 12 May and lasted well into June. The Sensex fell 29% from its highs, the Jakarta Composite index, 21%, the Kospi, 18.6%, Taiwan’s index, 16% and the Hang Seng 14.6%.

This time, it has taken longer for the yen to strengthen, but its appreciation has been much more. The yen was at 122 to the dollar on 19 June, falling rapidly to 118.2 by 14 August. Since then, it has been a slow but steady slide for the dollar. This month, the yen has strengthened by around 4.5%. However, the fallout in the stock market has been very muted. The Sensex is lower by just 4.6% from its highs, while the Indonesian index is down even less, at around 4%. But these two indices have been much less affected than other markets in the region. The Hang Seng, for instance, is down 13% from its highs, the Kospi 10% and the Taiwan index down 12%. There’s a simple reason for that—Korean and Chinese banks have also been hurt by the subprime crisis, although their exposure is nothing compared with the US and European banks. Banks and insurance companies in Taiwan, too, had an exposure, albeit a limited one, to the subprime sector. In contrast, the exposure of Indian banks has been negligible, while Indonesian banks, too, have no exposure to the Western flu. As a matter of fact, a look at the MSCI indices show sthat India has been the best performing stock market in the last three months, with the MSCI India index giving returns of 36.4% for the three months to 19 November. Three-month returns for the MSCI emerging market index was in comparison a paltry 12.89%. In second place was Brazil, with three-month returns of 31.9%. The MSCI World Index gave a negative return of 0.37%. Perhaps the safe haven stature of emerging markets has outweighed the impact of yen appreciation.

Will the outperformance continue? The safe haven theory looks a little frayed at the edges now, with most Asian markets seeing a sell-off. More ominously, data from EPFR Global show that during the second week of November, global emerging market funds saw high net outflows, while Asia (excluding Japan) funds also saw hefty withdrawals. In the Indian market, it is local punters who are doing all the lifting. And consider Goldman Sachs’ prediction that the cost of the credit crunch will be $2 trillion (Rs78.6 trillion)—that’s a lot of liquidity down the drain. Emerging markets need another dose of liquidity from the US Fed.

Shares of Gitanjali Gems Ltd have yo-yoed between the Rs325 and Rs425 mark ever since the company announced, in early October, fund-raising plans through an issue of global depository receipts (GDRs) and by making a preferential allotment to promoters. Rumours of a second acquisition in the US also influenced the company’s shares. Gitanjali finally announced the acquisition of US-based Rogers Ltd this Monday, which prompted a 4% rise in its share price.

The company’s shares now trade at Rs382, and have nearly doubled from the Rs195 levels in early July. While the company has delivered strong growth in its core diamonds and jewellery business, its valuations have also been helped by large purchases by FIIs such as Morgan Stanley and Goldman Sachs since July.

The fact that Gitanjali Gems received approval from the Centre for establishing another two special economic zones—one at Nagpur and another at Aurangabad, would have also increased investor interest. In a recent research note, Morgan Stanley has put a base value of Rs130 per share on Gitanjali’s Hyderabad gems and jewellery SEZ. Adjusted for this, the company’s core business is valued at just 12.4 times trailing 12-month earnings. Morgan has a bear case value of Rs60 for the Hyderabad SEZ, adjusted for which the core business is valued at 15.9 times trailing earnings. This seems low considering that pre-tax earnings have grown by 57.4% in the first six months of the current fiscal.

Meanwhile, the company’s acquisitions of jewellery retailers in the US is being viewed positively, especially since it’s the largest jewellery market in the world. Samuels Jewellers, which it acquired in December 2006, is the eighth largest jewellery chain in the US. While this increases the company’s export revenues, its manufacturing base in India (news reports suggest that manufacturing would be shifted to the Hyderabad SEZ) would lead to lower sourcing costs for the US operations. While the idea sounds good, concerns remain about the slowdown in the US economy and the appreciation in the rupee. Morgan Stanley also notes that Indian jewellery exporters are likely to face competition from Chinese exports.

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