Gold prices are ruling at 25-year-highs. Indian stock indices are trading at their highest ever values. Usually, bullion rears its head when equity markets do not do well, as savings seek safe haven. So why do we have this unusual combination of high bullion and stock markets?

Stock markets have risen steadily over the past 15 months on the back of sustained growth in the profitability of corporate India and an increasing influx of foreign portfolio investments. Initially, the markets took some time to come off its lows in recognising the structurally superior corporate performance that's being currently witnessed. Therefore, there was a big surge in the index values, which induced scepticism about the sustainability at those higher levels (up from the 5,000 levels of the Sensex to 7,000).

In the meanwhile, India took centre stage in the world reckoning and became a favourite market for global investors. They started allocating more to Indian equities, which resulted in a steady inflow of foreign institutional money. This surge continues and has taken the indices to new heights.

Even though in a recent article I had argued that the equity markets are reflecting fundamentals, the subsequent rise now appears more reflective of the buoyant inflow of foreign portfolio funds than the strong fundamentals of corporate performance alone. Given this rich valuation, I think it is prudent that fund managers hedge some portion of the funds under management against the possibility of a downside in equity prices.

This downside could be possibly caused by a reversal of this flow or even a perceptible slowdown in the rate of inflow.

There are only a few instruments of hedges available, because of the peculiar position in which the debt markets are poised. Both due to the cautionary messages issued by the RBI and the continuing tightening of interest rates by the US Fed, and the lack of clarity that such tightening is over, the interest rate outlook continues to be bearish or uncertain at the least. Therefore, fixed- income securities do not offer any succour for the moment. Indeed, there is a flight of investment from bond funds into the equity portfolio.

Commodity prices are also ruling high on the back of lack of investment in both mining and processing in core materials like oil, metals, and minerals. Real estate prices have also hardened, despite an increase in supply in recent times, in response to the steady pick-up of investments in this asset class. While inflation still can be considered moderate, given the relatively low interest rates right now, the real income from investing in fixed-income securities is unlikely to yield satisfactory returns on cash.

And there is always the fear of inflation rearing its head again, with all commodity prices remaining firm and the converters running out of the productivity improvements.

Globally too the picture is pretty constraining. Frontline stocks around the world are trading near highs and do not offer great upside. Global interest rates are also rising. Increase in US interest rates is also strengthening the dollar against most currencies and therefore triggering a massive portfolio rebalancing. While this is good for the dollar, continued scepticism about the US economy in the medium term is not making funds revert to the US equity wholesale.

Like India, other emerging markets have also done well, both reflecting rising fundamentals and a greater influx of foreign funds. At this stage, emerging market equities as an asset class also look well-priced.

On the supply side of investible surplus, the sustained high oil price has led to new investment pockets re-emerging. This has added to the pool of funds seeking better returns, safer havens and a liquid parking place. While there is a build-up in fresh capacity for manufacturing and infrastructure, it is still largely self-financed or equity-funded, without the impinging on the financial systems.

Therefore, the liquidity continues to be good, in fact getting better, thanks to the higher oil prices creating fresh new investible pockets.

Given the abundant uninvested surplus, and limited upside that various financial asset classes might return and the uncertainty surrounding the dollar, gold appears to be the right parking place for at least part of this liquidity pool. Gold is liquid and free of credit risk. The only downside is price risk.

Given the lack of alternatives to park the burgeoning liquidity surplus, the expectations appear to support continued inflow in gold at least till one of the following events happens: