The Best Bet for Beating the Inflation Monster?

Dec 17, 2013

In this issue:
» Bitcoin prices in China crash as PBOC doesn't give clearance.
» Holdings in Gold ETFs decline by about a third.
» Fed may unwind bond buying program faster than anticipated.
» MNCs looking to increase their interests in Indian companies.
» ....and more

'Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.' - Ronald Reagan.

John Maynard Keynes said 'By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.'

Inflation is indeed a dangerous phenomenon. Especially when it prevails over longer periods, slowly and gradually eating into one's purchasing power! Therefore, for one to keep their buying power intact, earning returns at least equal to the inflation rate would be essential.

Inflation levels in India have been traditionally high. In recent times, the country's spiraling food inflation combined with the slowdown have adversely impacted the economy.

And it seems that the food inflation problems in India are not likely to disappear anytime soon. This we say because inflation levels are still in their higher teens despite a bumper crop production this year. Severe supply side bottlenecks and leakages in distribution are key factors behind the sharp rise in food prices. These problems need to be resolved at the earliest, and only then will the government be able to battle the high inflation levels.

So, what can an investor do till then? How can he tackle and beat the big bad inflation monster?

The so called 'safe' instruments tend to provide returns a few basis points lower than the actual inflation rate. And over the long term, this difference gets compounded leading to substantial losses in real terms. While gold is an option - despite it having lost its sheen in recent times - over exposure to the yellow metal is not advisable as there are many other factors that come into play for the movement in gold prices.

The answer, we believe lies in stocks. There are a bunch of companies that possess pricing powers in the businesses they operate. In other words, they are able to pass on the rise in input costs to their customers with ease; and that too consistently, year after year.

And what allows them to do so? Their respective moats! Companies with strong brands, strong positions in the industry they operate in, the selling power they possess with their clients /customers, etc. are just some of the factors that help them command a rare kind of pricing power.

When companies possess pricing powers, they generally tend to earn more than their cost of capital and generate excess cash.

This, of course, cannot be the only factor one needs to look at. If pricing power is combined with prudent use of capital, an investor cannot ask for more. While pricing power ensures that the company stays ahead of the inflation curve, prudent use of capital ensures that this translates into real wealth creation for shareholders.

It goes without saying that one needs to consider the valuations when making such purchases. Buy too high and one may not get the inflation beating returns one is looking for over the long term.

Do you think buying companies with pricing powers is a good hedge against inflation? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
India's inflation numbers came in recently. And they were not good as the wholesale price index (WPI) figure came in at a 14-month high of 7.52% led by higher onion and vegetable prices. Retail inflation or consumer inflation figures came in at 11.24% during the month of November 2013.

Which Direction Will Interest Rates Go?

It is however expected that with supply conditions improving, the numbers may ease a bit in the coming months. But it does not take away the point that inflation rates are still above comfortable levels. All eyes will now be on the RBI governor Dr. Raghuram Rajan; as the monetary policy review is due tomorrow. The general consensus is that there would be a hike in interest rates mainly due to the higher inflation. And with interest rates heading upwards, the pressure on the margins and asset quality of banking sector will also intensify.

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The spurt in the price of Bitcoin in recent times seems to have made governments jittery. As per reports, China is already beginning to clamp down on third party payment service providers. Apparently, the People's Bank of China has informed more than 10 third-party payment service providers not to give clearing services to online Bitcoin exchanges. And this seems to have had the desired effect. The bitcoin rates in China are already down 57% from its highs.

Well, the move is erroneous and is more about combating the effect instead of addressing the cause. And it's somewhat similar to what the Indian Government did with respect to gold imports. You see, the focus of most of the Governments across the world has to be to slow down money printing and reduce overall debt levels. Taking ad-hoc measures like restricting Bitcoin transactions and curbing gold imports are not likely to help in the long run. For people will eventually gravitate to asset classes and currencies that do not depreciate the way most fiat currencies are.

US$ 85 bn in monthly bond buying by the US Federal Reserve. This has been the oxygen for an otherwise languid global financial market for the past few months. Chances are that once this bond buying program stops, the financial markets will temporarily sink into a comatose state. But the hopes that such a calamity is sometime away has been boosting market sentiments. It now seems that such false hopes may not be able to keep sentiments upbeat for long.

As we know, the Fed has resolved to not raise rates until unemployment rate falls to at least 6.5% and as long as inflation is contained. The good news is that the fall in unemployment rate to 7% in November from 7.8% in September 2013 is much sharper than projections. However, as per Wall Street Journal, the sharp decline in jobless rate could prompt the Fed to unwind the bond buying program faster than anticipated. Now, the unemployment rate itself comes with a lot of caveats. The fall could well be attributed to the fact that people have stopped looking for jobs. Thus whether the US Fed will react to the improved numbers promptly or not is anybody's guess. However, what remains certain is the fact that investors should factor in the possibility of end of QE sooner or later. As markets get choked of liquidity, asset prices and risk appetites could see a major upheaval. Only those well geared to keep their portfolios intact in such a crisis will emerge triumphant.

Gold and gold backed exchange traded products (ETPs) have not found much favour with investors in 2013. Indeed, as reported on Bloomberg, holdings in the 14 biggest ETPs witnessed a steep decline of 31% since the start of the year. Incidentally, this is the first annual decrease since the funds started trading in 2003. Gold has seen a phenomenal run in the last decade as loose monetary policies of central banks around the world eroded the value of paper currencies and raised fears of inflation. During such times, gold being a solid tangible asset has been looked upon as a store of value and hedge against inflation. Thus, what does the current scenario mean? Interest in the precious metal has waned because inflation has not risen. Plus, there are expectations that the US Fed will put an end to its quantitative easing (QE) program.

We however, think differently. In our view, irrespective of when the Fed decides to end its money printing exercise, fiat currencies will lose value. And if that is the case, gold can be the only asset class to be considered as a store of value. Investors therefore must consider having some gold in their investment portfolio.

Most multinational corporations (MNCs) are currently in an overdrive mode when it comes to increasing their stake in Indian subsidiaries. Recently, GlaxoSmithline Plc announced an open offer to increase its stake in its Indian unit. Earlier we saw Unilever Plc coming out with such an offer. Most of them are planning to capitalize on the higher growth in Indian markets. While most of the Indian units are doing well, there are a couple of other reasons as well for these creeping acquisitions. For one, the Indian rupee has depreciated by roughly 13% this year. This favors MNCs investing in India. Secondly, most of these MNCs are sitting on truck loads of cash. With India being an emerging market with sound prospects, it happens to be a good investment destination for them. As such, there has been a sudden rush of open offers.

This has led to a huge appreciation in stock price of most Indian units as the open offer price is generally higher than the current market price. With this, minority shareholders seem to be rushing to tender their shares and benefit out of it. However, we believe investors should not take the decision in haste only by looking at the open offer prices. If the company has strong fundamentals it may make sense to hold on and reap even greater benefits in the long term. It would be best for investors to do their home work well and then take any decision.

In the meanwhile, Indian stock markets were flat after starting the day on a firm note. At the time of writing, the benchmark BSE Sensex was up by about 5 points. Pharma and FMCG stocks were amongst the top gainers, while banking and realty stocks were amongst the top underperformers today. Most of the Asian stock markets were trading lower led by Hong Kong and China. The European markets opened on a positive note.

 Today's investing mantra
"If you don't feel comfortable owning something for 10 years, then don't own it for 10 minutes." - Warren Buffett

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