Gold Can Turn a Maruti 800 into a BMW. What Can Stocks Do?

In this issue:

» Are shrinking FII inflows a cause for concern?

» Why unlisted real estate companies are in a spot of bother?

» ...and more!

How has gold performed over the years? Apparently, a message doing the rounds on WhatsApp has the answer...

If an investor had 1kg of gold in 1990, he could have exchanged it for a new Maruti 800. Fast forward to 2015, and the same 1kg of gold could get our investor behind the wheel of a gleaming new BMW X1.

Perhaps in a few more years, he could be driving a Jaguar...

What about the Sensex? Can it compete with gold's alchemy?

We have done the math, and the short answer is...you could've been driving a Jaguar since 2015.

While gold has gone up around 10x between 1990 and 2015, the Indian benchmark index has gone up a whopping 26x. Clearly, stocks have a few more tricks up their sleeves.

Not that gold's performance has been bad. While it's underperformed stocks, gold has easily outperformed most other asset classes - fixed income in particular. The case for gold to be a permanent fixture in your long-term portfolio is strong.

Now, it's no secret that we're big fans of value investing legends, Warren Buffett and Benjamin Graham. Investors who follow their value investing principles are almost guaranteed to do well over the long term.

However, value investors aren't known for their gold appreciation. Here's Warren Buffett on the yellow metal:

• Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything

And Benjamin Graham was hugely sceptical of gold's wealth-creation potential: 'The utility, or intrinsic value of gold as a commodity, is now considerably less than in the past. Its monetary status has become extraordinarily ambiguous, and its future is highly uncertain.'

We disagree.

You see, the value investing legends are evaluating gold as an investment asset. And from that vantage point, gold does lose some of its lustre.

But real beauty of gold is that, through the millennia, it has held its value better than any other monetary asset. No fiat currency in history has outlast gold.

And in uncertain times such as these, preservation of purchasing power becomes a priority. The world is awash with debt. A 40+-year experiment with credit-backed money is showing more signs of blowing up with each passing day. If you want to protect yourself from the fallout, we recommend making gold 5-10% of your long-term portfolio.

But don't get us wrong...

We think Indian corporations will be setting new earnings records 10-15 years from now. A bulk of your savings should certainly be in quality blue chips like the ones we recommend in StockSelect.

These companies should account for 60-70% of your total stock exposure. But you also need a shock absorber should the near-term ride get bumpy. As far as we can tell, gold is the best shock absorber in history.

03:45 Chart of the Day

Indian equity markets have given good returns since the lows seen in August 2013. The index itself has returned over 45 percent on an absolute basis in the past few years. Domestic as well as foreign investments flows have been strong since then. However, India's share of FII flows among emerging markets like Brazil, South Korea, Taiwan etc. has seen a steady decline.

The primary reason being foreign investors are apprehensive over stretched valuations in Indian markets compared to some emerging markets which are comparatively still trading cheap. The returns from the benchmark index BSE-Sensex has been lower than in the MSCI Emerging market Asia Index.

Are shrinking FII inflows a cause for concern?

Should the declining foreign inflows raise alarm bells to the general public? It is good to have diverse set of participants in the market. However, one must not think of these foreign inflows as similar to the proverbial 'smart money' reducing exposure to Indian equities.

The proverbial smart money might just be wrong when it comes to India. With the present government pushing for reforms and working towards simplifying tax rates, improving the ease of doing business etc. such initiatives are akin to a strong foundation that would help bolster the Indian economy in the long run. These fundamental factors together will drive the markets forward in the long run and one would be wise to keep a track on these than divert attention to fund flows.

Real estate companies are in a tight spot. For some time now, real estate prices have cooled down in most parts of the country resulting in slower offtake of home units. In addition, rising unsold inventory levels of home units has squeezed the company's cash flows. Some of the cities have a huge unsold inventory level buildup.

With a tepid demand and excess supply glut, things do not look good for the real estate developers. In a double whammy, few aggressive unlisted real estate firms which had borrowed money to expand are now exploring various options to reduce their overall debt or their cost of debt. Mumbai based Lodha developers which reportedly is the country's largest developer in terms of sales, plans to go for an IPO in the next year and a half. The company is also looking to find ways to reduce its cost of debt.

On the other side are companies like Tata Housing Development company that are resorting to raising fresh money through issue of non-convertible debentures in the market. Loans to the commercial real estate sector are on the rise. The real estate prices are still at considerably higher levels than present affordability. The game is set for who will budge, the developers reducing prices or the consumers coughing up more money. As of now, developers seem to have blinked first.

After opening the day on a flattish note, the Indian stock markets fell below the dotted line. At the time of writing the BSE-Sensex was trading lower by about 170 points (down 0.6%), while the NSE Nifty was trading lower by 56 points (down 0.7%). Sectoral indices are trading on a negative note with stocks from the pharma sector witnessing maximum selling pressure.

04:55 Today's Investing Mantra

"Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down - Warren Buffett

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