Is gold a screaming buy right now?

Jul 30, 2015

In this issue:
» China's slowdown takes toll on metal stocks
» IMF warns of corporate India's indebtedness
» ....and more!

Making sensational claims is one of the ways in which the attention of the audience can be captured. And perhaps nothing got more sensational in finance than the 1979 August edition of BusinessWeek. Written in bold on the cover page were the following words 'Death of Equities'.

We are wondering what if a similar bug bit the magazine guys today. What asset class would they like to pronounce dead? No marks for guessing it would indeed be the yellow metal gold.

Indeed, the rate at which the bottom has fallen out of the gold market, even the most diehard gold bugs have been left licking their wounds. And the battle line that was already being drawn has suddenly become more prominent.

Other than its glitter, there's something about gold that's alluring if you ask me. And it is the effect it has on both its supporters as well as critics. It always evokes extreme reactions in people. One can rarely be mildly in favour or out of favour with it.

We know for a fact that value investing legends like Warren Buffett, Charlie Munger and for that matter even Benjamin Graham have rarely shown any inclination towards gold. Actually, their disinterest in the metal just about falls short of abhorrence.

In a way that only he can, Buffett made his hatred towards gold loud and clear when he said the following words.

"Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."

Munger isn't far behind. And trust me, when he wants, he can certainly get quite caustic. Like he did when he said he doesn't have the slightest of interest in gold. And he wondered how people who hoard gold can still call themselves rational. Even if it works, a gold hoarder will remain a jerk as per him. Oops.

Well, let me tell you there are some people who would prefer being called jerks if that's what their support for gold leads to. And count people like Marc Faber, Jim Rogers, James Grant and even Ray Dalio in this camp.

These gentlemen argue to the point that if you don't own gold, you know neither history nor economics. And then there's another gold supporter who wants to pull a fast one on Warren Buffett. Just as Martians would wonder why we value gold as much, they would also wonder of what use is a currency note denominated in dollars either. Except for the fact that the Government forces us to think of it as money.

Therefore, as you can see, both the sides have solid arguments to back their claims. And at the risk of being labelled politically correct, we are of the view that neither of the sides is totally wrong.

Buffett and Munger are right when they say that gold is not an investment. Simply because an investment, as value investors would like to call it, should give some hints as to its intrinsic value. And gold hardly leaves behind such footprints. Try as hard as you can, you will still not be able to find the right price to buy gold, the one where you feel your downside is limited.

In that sense, it is a commodity where you are expecting to buy it at one price and offload it at a higher price. Therefore, if you believe in wealth creation through stocks, gold cannot have a sizeable position in your portfolio.

And we also agree with the other side's point of view that one who knows history and economics knows fully well that gold is perhaps the soundest money around. It therefore is an excellent hedge against what is going in our civilisation right now where there is a virtual race to the bottom about which central bank will devalue its currency the fastest.

Consequently, the risk that people will lose complete faith in currency and a new monetary system has to emerge with gold once again at the center of it, is perhaps getting heightened with each passing day.

It thus makes sense to prepare for such an eventuality and make gold a small 10%-15% part of one's portfolio. However, if we are wrong and if the current system of paper money persists, you can count on stocks to build your wealth over the long term.

In conclusion, we don't see gold as a way to create long term wealth. However, it is an excellent hedge against most Governments' efforts at devaluing paper money. Therefore, if you haven't made gold a small part of your portfolio yet, now is perhaps the good time to do so.

What do you think? Where does gold find a place in your portfolio? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Moving over from gold to other industrial metals, the slowdown in China has had a clobbering effect on metal stocks here in India. Some have almost halved since the start of the year, including many big companies as can be seen in today's chart.

Investors are worried that China and its slowing economy will take down with it metal prices even further. This, coupled with the fact that many companies in the Indian metal sector are already quite leveraged, has fed fear among investors in stocks belonging to this sector. Many analysts, mutual funds and brokerages also seem to be turning quite pessimistic about the prospects of the metal industry.

However, we believe that it is precisely times such as these that give investors opportunities to selectively invest in fundamentally strong companies from the sector. The market, as it always does, is quite likely to paint companies belonging to the industry with the same brush. With 'selectively' being the key word here, if an investor able to take advantage of the beaten down prices by picking up companies with strong balance sheets and a competitive advantage in terms of low costs, such opportunities can bear great fruits over the next few years. Of course, patience will have to be an important ingredient to such returns.

China's troubles hit metal stocks hard

And it's not just metal companies that seem to be having debt troubles. The International Monetary Fund (IMF) has warned that a lot of corporate India may be in a precarious financial position. In fact, this may even worsen in the near term. The three key factors to watch out for are interest rates, earnings and exchange rates. If any of these, or worse still, all of these, were to move in adverse directions, the debt at risk of seeing stress could see a significant jump.

The IMF has pointed out that corporate India in aggregate is running quite low on its interest coverage ratio (it estimates that this number could be below 1.5 times for India). Factors like the slowdown in growth of the economy, fall in corporate profitability and high leverage have come together to bring about this state of affairs. If the pace of reforms doesn't see a pick-up soon enough, it looks like the banking sector could have further trouble with more loans going sour.

The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 225 points. Gains were largely seen in FMCG and realty stocks.

 Today's investing mantra
"The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn't going to do anything for is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time." - Warren Buffett.

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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2 Responses to "Is gold a screaming buy right now?"

krishna Murthy

Jul 31, 2015

I buy gold because it is not old. I prefer gold or stone, I can stare at any time and be content. since the so called educated people whom i met or either looter or loot monger.We rarely see the people of good ethics. Hence if you a piece paper (Equity) on it you can shit and not sit on it.


yogesh agarwal

Jul 30, 2015

After reading the comments of Buffet and Charlie Munger about Gold i was reminded of an interesting analogy about gold given by OSHO : He said that if you throw a piece of gold and a piece of bread to a dog, the dog will go and grab the bread! So much for the intrinsic value of Gold. But as a currency it does have some value in our civilisation and when the paper currencies are destroyed by the central banks, Gold will count as a measure of value.

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