Is the world going back to the gold standard?

Sep 20, 2011

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In this issue:
» Petrol consumption slow after price decontrol
» Indian real estate engulfed in a liquidity crisis
» Will the 'Buffett rule' really work out?
» World oil consumption to rise 27% by 2035
» ...and more!

Just recently, we had discussed how the ongoing global currency war has been benefitting gold prices. A recent development hints that gold prices could soar much higher.

Against the backdrop of the European sovereign debt crisis and the so-called currency war, European central banks (ECBs) are now shoring up their gold reserves. This is the first time in more than two decades when these central banks have turned net buyers of gold. During the year so far, ECBs have added about 25,000 ounces (equivalent to 0.8 tonnes) of gold to their reserves. Though the quantum of purchase is nothing to write home about, the act itself is very telling. It marks a 180-degree shift in their attitude. Consider for instance the fact that since 1999 ECBs have sold almost 400 tonnes of gold ever year and in exchange purchased the hitherto more fashionable sovereign debt.

As currencies and sovereign debts are losing their value, central banks across the world have been adding gold to their kitty. Emerging economies such as Mexico, Russia, South Korea and Thailand have made significant gold purchases to lower their exposure to the US dollar. If a leading global financial daily is to be believed, central banks would be buying more gold in 2011 than at any time since the collapse of the Bretton Woods system 40 years ago. If you can recall, that was the last time that the US dollar's value was linked to gold.

The yellow metal has already seen its price surging by 25% in 2011 so far. The evidence in favour of the yellow metal is growing stronger with each passing day. Like history repeats itself, gold, too, is once again emerging as "real" money.

Do you think the world will go back to the gold standard anytime in the future? Share your comments with us or post your views on our Facebook page.

 Chart of the day
Price decontrol is a phrase that most oil companies have been pitching for. Last year, the government gave in to an extent and decontrolled its price. But since then, the consumption of the fuel has been coming down. According to Petroleum Planning & Analysis Cell (PPAC), the consumption growth for petrol has dropped down to 5% in April-August period this year. This compared with the 14% growth that it had witnessed till about 2 years ago, seems to suggest that decontrol may really not have worked in the favor of petrol. However, there is another side to this story. While prices of petrol have been decontrolled, the taxes on it are still huge. As a result, when the oil marketing companies increased the price of petrol to offset the impact of higher crude prices, the resultant prices ended up being sky high. As a result, consumers may have cut back on their consumption of the fuel.

Data source: Business Standard
*April-August 2011

It is unusual not to see a Warren Buffett Op-Ed in a newspaper create a flutter in the financial circles. However, this time around, it has sprung even the US Government in action. President Barack Obama has latched onto the Oracle of Omaha's idea to extract more tax revenues out of the US millionaires. It should be recalled that Buffett had argued for a similar tax rate for both millionaires as well as the average US household. And it is this very piece of information that the US is desperate to use in its proposed overhaul of the US tax code. There is one glitch though. The execution of the 'Buffett rule' could prove to be a tough nut to crack. This is because the arithmetic for calculating tax rates for both the rich as well as the middle class is quite complicated. Both the sections have various deductions and benefits that are applied differently even within the same income group. On account of these complexities, making rich people pay more could turn out to be a difficult proposition. Furthermore, doing away with preferential tax rates for capital gains may also not work as there are valid reasons for capital gains to be taxed at a lower rate than income taxes. All in all, while the 'Buffett Rule' aims to improve tax revenues and reduce tax disparity, making the same happen in reality will be a tall order indeed.

Oil is one commodity whose price in the global markets is not likely to see a dip from a long term perspective, especially when the demand continues to remain strong. Indeed, according to the US Energy Information Administration (EIA), world oil demand is expected to climb to 112.2 m barrels per day (bpd) in 2035, which is a 27% increase from 88.2 m bpd in 2011. For starters, most of the oil is used in the transportation sector and in the absence of significant technological advances; the sector will continue to depend on liquid oil for consumption. Of course, any change in regulations or technology may very well lead to a revision in these expectations. Although the US is the largest consumer of oil in the world, significant demand is also very likely from the Asian economies of China and India. To meet this demand, OPEC (Organization of the Petroleum Exporting Countries) is expected to increase spare capacity to maintain their 40% of the world's liquid fuel production over the next 24 years. However, not many producers will be tempted to increase spare capacity which means that the kind of spare capacity that was present in the past is unlikely to be seen again. This means that the global oil markets will be quite tight over the next many years, which in turn will keep the upward pressure on oil prices.

Very few government organisations in India enjoy a reputation of transparency and efficiency. The National Highway Authority of India (NHAI) is certainly not one of them. Currently mired in controversies and reports of poor execution, the entity can go a long way with better governance. The government needs to look no further than some private sector infrastructure players in India to improve the same. The government has now decided to allow professionals from the private sector entities (with net worth of Rs 20 bn or more) to apply for the top job at NHAI. Entities like L&T Infra and GVK Infra have had some very prestigious projects in their kitty. The same have been executed with a good degree of professionalism as well. However, for the men at the helm of these entities to don the hat of a PSU CEO will not be an easy decision. Besides the bureaucracy and red tape, they will also have to do with considerably lower pay scales. While we appreciate the government's decision to bring in talent from the private sector, lack of operating independence and motivation will not serve the purpose we believe.

The Indian real estate sector is in a deep liquidity crisis. Absorption rates are on a decline due to increasing property prices. Further, rising interest rates and commodity prices have also dented the overall demand scenario. Huge inventory build-up amidst a general confidence crisis prevailing in the sector has impacted the cash flow situation of many developers. Even banks are not willing to lend a helping hand to these developers because of high risk attached to real estate lending. Liquidity infusion from the Private Equity (PE) funds has also dried up.

While reducing the prices would re-ignite buying interest, it can impact the margin profile of the developers considering that commodity prices and labour costs have increased in the recent past. However, we believe this is the most feasible option with the developers now. There is no ray of hope as far as external liquidity support from banks or other lending institutions is concerned. While a few of them are raising capital by exiting non-core businesses, we believe it would just provide a temporary relief. In an environment where cost of capital is high and general buying confidence at all time low, only price bait can garner buying interest and help developers tide the current liquidity crisis.

In the meanwhile, the Indian stock markets were trading in the green today. At the time of writing, the benchmark BSE Sensex was up by 144 points (0.9%). All sectoral indices were in the positive, except capital goods and PSU stocks. Asian stock markets were showing mixed performance with South Korea (up 0.9%) and China (up 0.4%) leading the pack of gainers. Indonesia (down 1.9%), however, was the top loser followed by Japan (down 1.6%), Hong Kong (down 0.3%) and Malaysia (down 0.2%).

 Today's investing mantra
"Making an investment decision is like formulating a scientific hypothesis and submitting it to a practical test. The main difference is that the hypothesis that underlies an investment decision is intended to make money and not to establish a universally valid generalization." - George Soros

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10 Responses to "Is the world going back to the gold standard?"

Mushtaq Badlani

Sep 21, 2011

Comparing the growth of petrol demand without taking in account the Growth of Diesel demand is misleading as for last 2 years there is considerable shift to Diesel fuelled vehicles (Cars) and they now account for almost 50% of the new cars sold in some categories.



Sep 21, 2011

I have no doubt about "Gold becoming real money". The forces acting against this are delaying and causing more harm to their own economies and others. It is better for the world to realise their mistake and revert back to gold.
I give a max of 20 years for the world to go back to Gold standards. This would certainly bring in the necessary discipline among every economy.


Adi Daruwalla

Sep 21, 2011

NHAI and other private road building companies, spread in the east, west, north and south of India, would do well to refer to the new rubberized road technology developed by IIT Chennai. What normally happens is we develop something in this nation, it is not accepted it gets exported to the US UK and other regions, they benefit from it for 20 years and then it gets imported back to India. Why dont we use something good developed by our engineers for the betterment of India staright away. Why is there a nexus between business men and decision makers??? Can a study be done for the new offering by IIT Chennai and is feasability and viability.Why does a small nation like Switzerland have expressways, certain straight stretches where even an air force aircraft can land? Why dont we have similar quality of roads in India? If there is a will and you dont swallow the bribe pill then it can be done.



Sep 20, 2011

I Like the phrase " useless metal " used by Chandrasekaran



Sep 20, 2011

Hello Sir,
Gold can only be a Edging investment to make up inflation , that too as long as people are getting attracted towards this useless metal , but it won`t be as convenient as paper money. Gold also a cheating trick of rich. So in the long run when centuries pass probably we may understand this illusory Money exchange trick, even now if there is a political will,there are more avenues to avoid currency failure, but all the big political swallows are against to their protection.


Douglas Montgomery

Sep 20, 2011

The gold standard doesn't solve as many problems as it creates. It's useful economically to inflate and debase currencies. But gold remains a measure of real value. "Gold is money. Everything else is credit."-- J.P. Morgan



Sep 20, 2011

There is plenty reasons to believe that its in a bubble state. Time and again, the big guys fool the small guys, all the time they say its different and then th esmall investor burns their fingers. Please do not encourage your followers with false advice of buying gold. I assure you that it will fall like nine pins in next 1-2 years when all the this dust will settle down about the euro and dollars. Go back just a little while when bill clinton took the administration where he increased the taxes and everything was back normal. Mr Obama is doing the same thing and by next year, things will strat showing the result and he will win the next term also.



Sep 20, 2011

Eq.Master Team,

In all humility fortified with ignorance in abundance, I venture to observe as under:

The father of the nation said thus :" A man wihthout a religion is like a Boat without an oar in the seas.""

Similarly without the backing of a solid asset like any precious metals to back the currency,any currency whatsoever would also be akin to the Man without a religion ??

I hasten to conclude !!


Chandrakant Sakharwade

Sep 20, 2011

Better to return to Gold Std. That way, countries won't have freedom to print arbitrary amount of currency and the resulting consequences (that we are witnessing).


Kaushik Shah

Sep 20, 2011

You mention about the rise of gold.

However, yesterday in Hindu's business paper carried an
article that gold is not as liquid as one would like to
believe. If I can my coin to bank it will not buy as they
are not allowed to. If I take it to my jeweler then he
too does not want to purchase the gold from me. And is
willing to exchange gold for jewelry only if I have
purchased the gold from him.

So if gold is so illiquid an asset, why buy physical gold?

As a result I find something amiss in this whole gold
logic for average man like me.


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