Should 'macro economics' be your friend?

Jun 4, 2013

In this issue:
» Returns from gold vs. real estate over past decade
» Should Greenspan be made to pay for his misdeeds?
» Roubini on why gold could go to US$ 1,000/ounce
» Spain's radical measures to curb unemployment
» ...and more!

In the 2013 Berkshire Hathaway Annual Meeting, Charlie Munger called the game of life - 'the game of everlasting learning'! Truly humble words from a man whose achievements match those of value investing legend Warren Buffett. This was in acknowledgment of the fact that Berkshire's success has been built on learning from past errors. Munger has in the past revealed how Berkshire never believed in the power of brands until it invested in See's Candy. Similarly many of its investing beliefs have undergone radical changes based on new learning.

Paying heed to macro economic trends is one of them. Very often in the past, both Buffett and Munger have expressed their disdain about wasting time reading macro economic projections. Not much has changed in this view. Except for the fact that looking for macro economic trends is no longer a sin word. As Munger recently said "Sometimes the macro-economic tide is working for us - and sometimes against - and we just endure whatever direction it's flowing cheerfully. So we are not people who think we know all the answers about predicting macro-economic fluctuations."

Looking at broad economic trends is therefore not tangential to the principles of value investing. On the contrary, if done correctly the same can help find better and more solid bargains. Allow us to elaborate. By reading macro economic trends we do not mean predicting next quarter's inflation number. Or guessing the chances of rate cut by the central bank in the next Monetary Policy review. Instead looking at how the economic scenario may pan out for different sectors is indeed worthwhile. A sustained trend of lower GDP growth can have a meaningful impact on companies dependent on consumption growth. Similarly a trend of upward revision in interest rates can have an impact on both corporate profitability as well as asset quality of banks.

Ignoring macro economics completely is therefore a mistake that even long term value investors may not want to commit. While it does not make sense to defer investment in a solid and cheap stock due to short term economic concerns, the opposite may hold good. That is if solid and well managed capital goods and infrastructure companies in India are going through pain, the 'economy factor' may be playing a part. In such a case if investors find that companies are trading at a fraction of their true value, the near term economic concern may be a buying opportunity.

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 Chart of the day
If you have been investing in gold and realty over the past decade, triple digit returns are no surprises to you. The two asset classes have offered returns of 585% and 400% (approximately, may differ for various regions) respectively during this time frame. Now as is the case with any other asset class, investment in gold and realty too should be made keeping fundamentals in mind. While for gold, the risk of hyperinflation and currency devaluation remains, realty may be a riskier bet. Particularly for investors who want to speculate on short term movement in realty prices; that too with leverage.

Source: Mint

What is at the root of all the problems that is plaguing the global economy? The answer, we believe, is an extremely twisted structure of incentives. Ideally, good work should be rewarded and bad work should be punished. This is the basis of the carrot and stick approach to motivation and reinforcing desirable behaviour. But is this approach really being followed? Is irresponsible behaviour being penalised? The answer seems to be a big 'No'!

The world has been throwing brickbats at the current US Fed Chairman Ben Bernanke for his reckless monetary policies post the 2008 global financial crisis. And these brickbats are certainly well deserved. But shouldn't former central bankers also be held responsible? We came across an interesting article in Market Watch that raises exactly this question.

Alan Greenspan headed the US Fed from 1987 to 2006. That's nearly two decades! The gentleman retired from his position just at the height of the subprime mortgage bubble. How could he miss a massive US$ 8 trillion housing bubble? Or consider Jean-Claude Trichet, the President of the European Central Bank from 2003 to 2011. Shouldn't these central bankers be made answerable for the massive disasters that were born largely during their regimes? Or should they be allowed to happily retire and enjoy their pensions? The answer is quite obvious. But unfortunately, the opposite prevails in a world that does not punish wrong behaviour.

There are several theories floating around the prices of gold. Some suggest that the prices should go up. Some suggest the opposite. Noted economist Nouriel Roubini has joined the opposition's camp. He suggests that the price gold should correct further and could even dip down to US$ 1,000 per ounce. He has given some reasons for this. The foremost is that the risks that we saw at the peak of the crisis have abated to some extent. At the same time quantitative easing programs have failed to make a mark particularly with regards to inflation rates. Given gold's preference as an investment for capital gains, investors look at these two indicators before investing in the metal. In addition to this is the fact that some central banks are selling gold. And the final reason for expected decline is that gold was overhyped.

Unfortunately we do not agree with Mr Roubini on his take on gold. Yes there are reasons as to why prices could decline in the short term; however the reasons are exactly that - short term. The global economy is still volatile. Developed countries have not found a workable long term solution for their problems. They are simply using short term fixes. In India too things are not all hunky dory. Economic growth has slowed down. Investors have turned cautious. And during such times of uncertainty and volatility, remaining invested in gold makes sense. This is why we suggest that investors hold at least 5% of their total portfolios in gold. Think of it as an insurance policy when the tide turns.

Saddled with massive debt, Europe has been struggling to come out of a slump. But economic recovery is hardly taking place. In the meantime, unemployment in some of the European countries such as Spain, Greece and Italy has only soared. Take Spain for instance. Youth unemployment in the country has risen to a record 57.2%. And this has compelled the country to come out with a radical solution. Indeed, the Bank of Spain has recommend that the country suspend the minimum wage mechanism altogether. It believes that this will enable Spain to tackle its problems of unemployment. The relevance of minimum wages has been going on as a debate for quite some time now and is a thorny issue. Those in favour argue that it puts more money into the hands of the families enabling them to better their standard of living. Those against it opine that minimum wages only cause employers to find ways to circumvent it. This is because employers will prefer not hiring those people whose productivity is lower than the wage being offered. This probably explains why the youth unemployment in Spain has soared. Young workers find it difficult to secure and hold on to jobs and employers probably think it better not to hire them. Whether doing away with these wages will solve the problem remains to be seen. But given that so far no other measures have worked, it seems like a solution worth carrying out.

Indians are easily the world's most voracious buyers of gold so as prices fall, demand should rise, right? Conversely, as prices rise, demand should fall, right? Wrong. Experience of the past few years suggests that Indians buy gold with an apparent disregard for price. Imports of gold and silver have grown by 30% in volume in the five years up to 2012. They now rank in value second only to petroleum and amount to about US$ 50 bn annually. Gold and silver imports during April, 2013 jumped by 138% YoY. For the month of May the country imported 162 tonnes. That is a headache for policy makers because gold imports have a big impact on India's current account deficit. As a result the government is planning to introduce more steps to curb gold imports. This may include banning sale of gold by banks. They may also review export import policy on gold. Last month, the RBI had imposed curbs on import of the yellow metal by banks. Besides, it has also put restrictions on banks and NBFCs for providing loans against gold coins as well as units of gold ETFs. We do not think curbing gold imports is the most ideal solution to the current account deficit problem. The government should instead focus on making India's exports more competitive.

Banks in an economy have been the epicenters and also the first casualties of most of the financial crises. Hence, it is important to be right in assessing the risks associated with the banks. Perhaps it is with this purpose in mind that rating agency Moody's has put rating of subordinate debt of 11 Indian banks on watch. The decision is not triggered by anything fishy going on in banks. But it is just a case of Moody updating its rating methodology. So what is different in the new approach? Well, unlike in the past, the agency will assume that the Government will not bail out subordinate debt holders in case of a crisis. It is the increasing uncertainty about Government's response in cases of banking crises due to which Moody's has adopted a more guarded stance. As per the agency, the evidence that the Government will support subordinate debt holders in case of a crisis is waning. As such, a stricter way to assess the rating of such debt is warranted.

Buying interest in select pharma, auto and engineering stocks have led the key indices in Indian equity markets to stay marginally above the dotted line today. The BSE Sensex was trading higher by around 48 points at the time of writing. Other major Asian equity markets closed higher while markets in Europe have also opened in the positive.

 Today's investing mantra
"Some people are more teachable than others. This is also true of dogs, however, so take it as you wish. The executive level should be a tough meritocracy. It shouldn't be easy. I look for people I can trust. Hiring people you can't trust is like starting off by dropping a spider in your bosom." - Charlie Munger

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    3 Responses to "Should 'macro economics' be your friend?"

    girish shah

    Jun 5, 2013

    who are buying this much amount of gold? more than 50 to 60 % of the popul. is below poverty middle class is fighting inflation so who is buying the 1,62,000 kilos of gold multiply it by around rs 26 lakhs per kilo --the simple answer is the most corrupt and the maximum tax evaders



    Jun 5, 2013

    The fact is that value investors like Mr. Buffet and Mr. Munger have also changed their views from time to time. I don't know why EM goes out of the way to justify every change of view by these two gentlemen on every occation. Another fact is that Mr. Buffets way of investing is not the best strategy for developing markets like India where there are many extraneous factors which Mr. Buffet would have never ever thought of! So merely apeing Mr. Buffet is not going to work in Indian markets.


    Nadir Godrej

    Jun 4, 2013

    The article criticizes Ben Bernanke but he has done a great job. He is criticised for easing too much but if anything he has done too little. His critics have been accusing him of building inflationary pressures but none of them have admiitted that their fears were wrong. Please don't keep blaming him for doing a good job.

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