Have you learnt this biggest lesson in Finance?

May 5, 2011

In this issue:
» And now, China grapples with coal shortage
» NREGS is riddled with corruption
» Bank of Mexico latest central bank to stock up on gold
» NHAI to change the way it awards projects
» ...and more!

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Come next month and we could witness the bursting onto the scenes of the world's richest CEO. Never before has the financial market seen so much wealth created for the head of a firm in a single day. The man in question is Mr Ivan Glasenberg, the CEO of a Swiss firm called Glencore International AG. Apparently, Glencore's IPO (Initial Public Offering) is going to go on the floors soon. If estimates hold out correct, Glasenberg's stake in the company would be valued at a staggering US$ 9.6 bn. Let's put things in perspective a bit. Google founders held stocks worth a little more than US$ 3 bn at the company's IPO in 2004. Even Stephen Schwarzman's stake in Blackstone was worth around US$ 9 bn when the private equity giant went public in 2007. Thus, Glasenberg is well on his way of being qualified as the world's richest CEO at the time of an IPO.

Impressive as Mr Glasenberg's wealth be, what is even more impressive is the sector his company Glencore belongs to. No it is not a high flying tech company. Neither is it a private equity venture or a boutique investment banking firm. It is in fact a giant in the world of physical trading; buying, refining, transporting, storing and selling basic commodities like metals and minerals, energy products and agricultural products. In other words, it is in the business of commodities.

The reason this is interesting is because commodities have indeed come a very long way. Just about a decade ago, commodity companies were so called outcasts of the investment community. What were red hot instead were the technology stocks. And look what the situation has come to now. While most high flying tech stocks of that era have been confined to the dustbins of history, commodity companies like Glencore have created extraordinary wealth for its shareholders.

And herein lies the biggest lesson for investors we believe. It has to do with that iron rule of financial markets called as reversion to the mean. Father of value investing, Ben Graham has said it best when he had engraved these words right at the start of his value investing bible Security Analysis. The words read 'Many shall be restored that now are fallen and many shall fall that are now in honor'. Indeed, if you want to create wealth in stocks, do not do what the crowd is doing. Picking beaten down good quality stocks and waiting for the tide to turn is the best approach to have we believe. And Glencore is just another example of this phenomenon.

Do you think reversion to the mean works extremely well in financial markets? Share your views with us or post comments on our facebook page.

 Chart of the day
The fact that India's GDP growth gets negatively affected by higher crude prices is certainly well known. But what about putting a number to the same. Today's chart of the day tries to address this problem. As shown, India is amongst the most sensitive of major countries to rising crude prices. Every US$ 10 per barrel rise in crude prices has the potential of affecting its GDP growth by 0.6%. China too isn't far behind either with the same rise causing its GDP growth to fall by 0.5%. Important to add that these numbers are well above world average.

Source: Businessinsider.com

The fastest growing nations in the world are being held at ransom by a single commodity. One that threatens to shove their future into pitch darkness! And so far there is very little that the nations can do to substitute this scarce resource. Yes, we are referring to coal. The fact that coal shortages have tossed Indian power capacity addition targets way behind schedule is well known. But a leading Chinese daily reports that the parts of dragon nation too are facing severe power outages. And there too the problem is insufficient coal supplies that are not keeping pace with the rise in power demand. While both China and India are looking at sustaining their growth rates, a lot hinges on their ability to conserve energy. In the absence of coal supplies, renewable sources of energy seem to be the only recourse. Nuclear energy has already been a matter of debate given the risks involved. Thus the governments of India and China need to carefully review their energy conservation plans before finalizing the growth targets.

Central banks across emerging markets are banking their reserves on gold. Mexico recently purchased nearly 100 tonnes of yellow bricks. China, Russia, India have also acquired large amounts of the precious metal in recent years. These bankers are desperate to move away from paper currencies and sovereign debt instruments. After 20 years of being net sellers of gold, since last year, these bankers have been lapping it all up. Strong demand helped gold reach record levels of over $1,575 per troy ounce.

GFMS, a precious metals consultancy, predicted that the official sector would make purchases of 240 tonnes in 2011. This is close to the post-Bretton Woods peak of 276 tonnes in 1981. With Mexico's sudden move, crossing this level looks likely. The erstwhile safe heaven, the US dollar on the other has plunged 10% against major currencies since the beginning of the year. It is currently trading near its all-time low. With more countries expected to follow the sell dollar, buy gold strategy, we can expect demand for the metal to remain strong.

Few months ago, Gajendra Haldea, an advisor to the planning commission came out with a paper stating that National Highways Authority of India (NHAI) would go bankrupt in years to come! His contention was that the revenue of NHAI which typically comes from cess collection on petrol on diesel would be insufficient to meet the future claims. It seems that the new surface transport minister C P Joshi has taken a moral or two from the published thesis.

From here on, NHAI is aiming to award maximum number of projects on Build Operate Transfer (BOT) toll basis as opposed to BOT annuity basis. Under a BOT toll model the developer earns revenues in the form of toll collection during the concession period. In case of a BOT annuity model, the toll rights are with the government. But the developer is entitled to receive payments in the form of annuity during the concession period. Awarding projects on annuity basis increases the liability of NHAI as annuity payments are typically assured. We believe the move towards BOT toll model may provide some relief to the worsening fiscal position as the annuity payments on behalf of NHAI are borne by the government itself. However, it would be interesting to see the bidder interest for BOT toll model route adopted by NHAI. As BOT toll model entails volatility in revenues, developers would generally vouch for a higher viability gap funding (VGF). And higher VGF has the potential to destabilize the fiscal roadmap.

High unemployment rate in the US is such a hotly discussed global topic. But how often do we hear about unemployment problems in our own country. If official numbers are to be believed, unemployment rate in India is around a staggering 10%. Remember this is only the official number. Actual unemployment rates may be higher. Even after that, we are yet to account for all the fake employment that happens through various government programmes.

Take the US$ 9 bn (over Rs 400 bn) Mahatma Gandhi National Rural Employment Guarantee Scheme. Senior government officials have admitted that unlike the name, the scheme is riddled with corruption. More than half of the projects that commenced in 2006- including new roads and irrigation systems- remain incomplete. Further, workers are denied their rightful pays and are often forced to pay bribes. Also, they aren't learning any skills that could help them escape the poverty trap. It is not difficult to imagine the state of other such schemes.

Put all this is contrast with the India shining, India emerging harp. What's going on in our economy? Why is the progress so divided? It's high time we address these serious questions.

Meanwhile, Indian stock market indices that traded mostly flat the entire morning slipped into the red all of a sudden and were trading way below the breakeven at the time of writing. BSE-Sensex was lower by around 240 points led by decline in heavyweights such as ICICI Bank and ITC. Other Asian indices closed mixed today and Europe too has opened on a mixed note.

 Today's investing mantra
"In candy, as in stocks, price and value can differ; price is what you give, value is what you get." - Warren Buffett

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1 Responses to "Have you learnt this biggest lesson in Finance?"


May 5, 2011

This is very basic concept every long term investor has to bear in mind that 'LEARN TO SWIM AGAINST CURRENT'.In the year of 1993 February when Infosys IPO came in market,investors were reluctant to apply for.Mr Narayanmoorthy has to pursuade from pillar to post to request for applying for INFY ( Rs.10 + Rs 85 Premium).Rest of the things are known to everybody.The Share has given appreciation of 128 times + several lacks as Dividend ! I dont think any other co.on Indian bourses has done well as INFY ! You have to have long term view & strategy.This IPO had a background of great Harshad Mehta affair.This enough to explain what I mean.

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