Should You or Buffett Re-Think Views on Gold?

Nov 6, 2015

In this issue:
» Discom relief for power sector
» Megatrend signal as per Ratan Tata
» Update on the markets
» ....and more!

Warren Buffett's dismissal of gold as an investible asset is legendary. In his 2011 letter to shareholders of Berkshire, he elaborated on why he finds gold an unproductive asset.

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melted together, it would form a cube of about 68 feet per side. Picture it fitting comfortably within a baseball infield. At $1,750 per ounce its value would be about $9.6 trillion. Call this cube pile A.

    Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 ExxonMobil's (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with US$ 9.6 trillion selecting pile A over pile B?

While writing this letter Buffett probably never factored in Indians' love for gold or our determination to make it productive. At least on paper.

The government of India has set out on this seemingly unrealistic task. Worried about Indians hoarding black money in the form of gold, the government has offered schemes to monetise the yellow metal.

The Sovereign Gold Bond scheme is expected to offer the same benefits as physical gold. But apart from being used as collateral for loans, these could also be traded on stock exchanges. They will carry sovereign guarantee both on the capital invested and the interest.

The Gold Deposit scheme, on the other hand, aims to attract the 22,000 tons of gold, worth a trillion dollars, lying in lockers. With an interest rate of up to 2.5% the scheme will probably be the first to offer returns on gold.

Should these entice you enough to treat gold as a safe and remunerative asset class? Or should Buffett consider the possibility of gold turning productive? Especially if it starts fetching regular positive returns while commodities and stocks languish.

Well, we will take the liberty to speak for him. Despite the increase in the liquidity of gold as an asset class, such monetisation schemes do not change the fundamentals of gold. Because of its very limited usage, gold, unlike commodities and other products and services, cannot have an insatiable demand. The chances of consistent, long-term positive returns are therefore negligible.

No doubt central banks may buy more gold if currencies collapse. No doubt gold will be back in demand if inflation soars in the developed economies. Also no doubt the yellow metal can be the best hedge against crises. But none of this brings gold at par with productive assets.

Unlike solid stocks, which Buffett may want to hold forever, gold may not be perpetually remunerative. We doubt Buffett will change his views.

As far as you are concerned, monetizing some of the excess gold in your portfolio may not be a bad idea. But buying excessive gold in the hope of earning positive returns is a lost proposition.

The government's gold schemes are subject to its fiscal needs. They are therefore unlikely to last forever. Similarly the virtues and drawbacks of gold remain. So there is no reason for you to buy or hold any more gold than what you need to hedge your portfolio against calamities.

Will you increase your exposure to Gold with the government's new Gold Monetization schemes? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
Just few days back, we wrote about the poor health of the State Electricity Board (SEBs) in India. Due to legacy issues like failure to pass on tariff hikes, power theft, infrastructure issues, over capacity and others have been prime reasons for the current state of the SEBs. These SEBs are caught in a vicious circle of high debt and operational losses. The rising debt burden of these power companies has taken a toll on the banks as well.

Hence to bring a turnaround in these companies, the Ministry of Power has announced a new scheme - Ujwal DISCOM Assurance Yojna or UDAY. The scheme will support financial turnaround and revival of power distribution companies (discoms). Power distribution is one of the weakest links in this sector. Hence the step taken is quite a decisive one.

As per the proposal, the government will allow power distribution companies (discoms) in select states to convert their debt into state bonds. Further, the part of debt not taken over the DISCOMs shall be converted by banks into bonds with a cap on the interest rates. Over and above, states shall take over the future losses of discoms in a graded manner, as shown in the chart.

The rescue package for discoms certainly bodes well for health of SEBs. The government expects, to bring down the losses of most of these discoms to zero by fiscal year 2018. However discoms of states such as Rajasthan, Tamil Nadu and UP will take another year to turnaround. This step by the government will not only help in improving the power demand scenario in the country, but also help in the recovery of the bad loans of the banks. Having said that, we would like to see steps the government takes to make the scheme successful.

Financial turnaround of Power Distribution Cos. around the corner?

Being someone who guided a whole host of Tata group companies through several economic cycles, one can bank on Ratan Tata's views on where he sees the next big growth trend coming from. Recently Mr Tata has been in the news for his investments in various start-ups and e-commerce companies. The industry veteran has done investments in host of new ventures like Snapdeal, cab aggregator Ola, smartphone maker Xiaomi and online furniture seller Urban Ladder. The most recent one being virtual currency company Abra. In an interview to a financial daily, Mr Tata cited healthcare technologies as the next frontier for investments, according to him.

Medical breakthroughs or innovations for treating rare disease will be an important signal for Megatrend going forward. The impact of niche medical discoveries will help in reaping the benefits of exporting value added products to countries across the globe. However, the inventions in the healthcare space require lots of investments into R&D. Plus the probability of failure is far higher than success. Hence very few companies will be able to make a breakthrough on this front.

After opening firm, Indian stocks have lost their early gains and hovering around the dotted line. Sensex is trading higher by around 6 points at the time of writing. Sectoral indices are trading mixed. Stocks from software and oil and gas space are in demand while, those from healthcare and metal sectors are facing maximum selling pressures.

 Today's investing mantra
"I call investing the greatest business in the world ... because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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4 Responses to "Should You or Buffett Re-Think Views on Gold?"


Nov 14, 2015

The sovereign gold bond scheme (bond)is compared to ETF in gold. Bond offers returns of 2% plus in lieu of minimum 5 year lock in.The entry point to the scheme as of now is Nov 2015!
Timing may turn out to be bad,due to possible increase in rate by FED.
Investor is thus denied appropriate time of entry.Say,here is no scope for SIP to even out effect of one time investment
Essentially bond is a call on rate of gold on Nov 2015.


Prof Anil K kothari

Nov 10, 2015

Though the gold bond schemes appear to be attractive but a price of 2684 per gram is on higher side. If govt reduces import duty by say 5 % than the actual price would be around 2425 to 2450 per gram. Than these bonds will be quoting at discounts. Gold monetisation scheme is an excellent scheme as Indian temples have app 3000 tonnes of gold on conservative analysis. This can increase the income of temples which can be used for social purpose. For e.g if Tirupati temple put say 100 tonnes gold in this scheme. it can earn upto 625 crore. Imagine if the entire gold og 1600 tonnes is monetized. If this ruppee can be used for social purpose or may be invested into infra bond how much philip the economy can get which is beyond imagination. Further the saving on foreign exchange can be icing on cake.


krishna Murthy

Nov 7, 2015

I have sufficient gold items for my greed purposes rather than hedge. No more interest in accumulating it. Here afterwards I only buy gold bond rather gold coin.



Nov 6, 2015

The article is good and the views expressed about gold as investment are also logical. But can you please stop invoking Buffett everytime in every paragraph of every article on equitymaster. You are overdoing it and I am not so sure that your investment advice is of the caliber of Buffett for you to invoke him so often (I have been subscribed to some of your services so I know).

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