Do away with these myths about Gold!

Dec 23, 2011

In this issue:
» Good time to buy mid and small cap stocks?
» Power tariffs may have to rise 50% to erase deficits
» Government now takes the share pledging route
» India on its way to energy security?
» and more!
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 Chart of the day
It is gold that glitters! No please don't mistake this reference to the yellow metal's appearance. We are strictly sticking to comments on investment related themes. And the reference is to the performance of gold as an asset class over the different time frames during the past 5 years. A comparison of the price performance of gold (denominated in rupees) with that of other assets, particularly stocks, shows that barring the latest month gold has been the uncontested outperformer. But thanks to the history of gold prices moving up consistently in the past, investors have often been advocates of several myths about the precious metal. Many of which are important to shelve.

The first one being that gold prices never correct! Gold prices have undoubtedly moved up in the past over periods of longer time frame. But speculation on gold prices in the hope of short term gains may lead to disappointment. Like any other asset class, gold prices are not just impacted by the demand supply dynamics but also several other macro economic variables. Hence the likelihood of short term correction cannot be ruled out. The same has been evident in the past month when gold underperformed stocks in India.

The second myth is that in the event of severe economic downturn the demand for gold from major importing nations like India may taper. This may lead to the demand supply mismatch narrowing down and prices correcting. However, three important statistics prove otherwise. As per World Gold Council estimates, official gold holders (governments and central banks) that retain about 18% of above-ground physical gold are currently adding to their physical stocks. Real interest rates being negative across majority of developed and emerging economies, the demand for gold will sustain. And most importantly, the future growth rate of global paper currencies will continue to exceed gold production by a wide margin.

The third myth is that one should have as much allocation to gold as to other asset classes. How much ever economists may favour it, the anticipation of return to gold standard are overdone. Hence gold is far from being used as a medium of exchange in the foreseeable future. Also, gold has always been a monetary commodity and like paper currencies, has very little practical or industrial utility. It is of no better use to the owner than as a store of value or as collateral for borrowing. Hence, too much exposure to the commodity may do more damage to your portfolio returns. Instead a small but meaningful allocation will ensure that your returns remain insulated against inflation and economic shocks., Yahoo Finance

Do you think gold will outperform stocks in 2012? Let us know your comments or post them on our Facebook page / Google+ page.

When the going gets tough, the tough get going. Lot of us keep this phrase near us to draw inspiration from. When it comes to stocks, guess who is in need of this phrase the most? The Mid and Small caps of course. In a year when even the large caps have found it difficult to hold their ground, the carnage in stocks of lower capitalisation was all but expected. And the script has unfolded in exactly the same manner. Firstpost reports that mid and small cap indices have lost anywhere between 30% and 40% of their market valuations in the current year. Given that the dark clouds of economic uncertainty are not going to clear up in the near future, more pain could be in store for these companies in the upcoming year as well. However, it would be a mistake to paint all of these firms with the same brush. Even within this universe, there exist stocks that possess strong competitive advantages and the ability to generate strong cash flows. Thus, you better start scuba diving in the ocean of mid and small caps. You never know, you could unearth some real gems.

All will agree that there is a huge power deficit in the country. As a result, huge plans were laid out to ramp up our country's power generation capacity by 50 gigawatts (GW) in the 11th plan (2007-12). We're just three months away from March 2012 and we have only achieved 29 GW so far. Again we have plans to add 56 GW by 2015? Given our country's past record, it seems doubtful whether we will be able to achieve that. But what's really wrong? Why is supply not coming in? To that, we have to first answer if there is an equivalent demand. Remember, a deficit does not mean demand. In economics, 'demand' not only means desire to buy something but desire combined with ability and willingness to pay. The variable that matches 'demand' and 'supply' is 'price'. By price, we are referring to the power tariffs. There are ample indications that the power tariffs may have to be hiked by almost close to 50% for demand and supply to match.

Let us give you some numbers. As on 31 March, 2011, accumulated losses of power distribution companies (discoms) amounted to a staggering Rs 2.1 trillion. Do you have any clue how big that amount is? It can fund the NREGA scheme for 6 good years. Or for that matter the Food Security Bill for 2 years. The root problem is that discoms are selling power at a rate that is not viable. That is also not allowing power generation companies to pass on rising raw material prices. And this in turn, is causing a lot of power projects to become unviable. So get ready to pay more for power.

India's widening fiscal deficit and the government's inability to bring it down has put it on the edge. While its ambitious divestment programme saw a strong response last year, the scenario has been very different this year what with uncertainty and volatility in the stock markets dampening the appetite for share sales. Meanwhile, the government needs cash to bridge the deficit gap. So the latest move that it has contemplated in this regard is to borrow as much as Rs 500 bn (approx. US$ 9.5 bn) using land and shares as collateral. The idea is to set a fund manager that will pledge stocks that the government holds in non-state companies such as ITC, Axis Bank and Larsen & Toubro (L&T). This fund will then use the proceeds to buy the government's stakes in state-run firms. It must be noted that the government had set a disinvestment target of Rs 400 bn for FY12, of which only 3% has been raised so far. With inflation staying stubbornly high, corruption ruling the roost, and reforms being put on the back burner, the state of poor affairs with respect to its finances has only piled up the pressure on the government. Whether such a move to raise funds eases off some pressure remains to be seen.

In the year 2010, a big event that marked the history of Indian telecoms was the 3G auction. Companies paid through their noses to get a pie of the 3G spectrum and license. But due to the sky high prices no company was able to get a pan-India license. As a result, the obvious logical next step was to form a roaming pact with other operators to be able to provide 3G services on a pan-Indian basis. But alas, the greedy government could not see the telecom companies taking this logical step. In the government's mind such roaming agreements represent loss of revenues to self. As a result, the Department of Telecommunications has decided to declare these roaming pacts as illegal.

The energy crisis in the country has hardly escaped anybody's attention. In times when energy security is integral to national security, over 75% dependence on crude oil imports doesn't paint a very reassuring picture. Besides, a huge dependence on oil imports also exhausts foreign reserves and pulls down the domestic currency. In such a situation, the decision to double the Strategic Petroleum Reserves (SPR, stockpiling energy assets for emergency use) by 2020 to secure ourselves from a future oil shocks could be a modest start not just to the national energy security, but something that could support our currency as well.

While the case for a national SPR is strong in case of physical shortage of crude, it comes with riders. The government plans to use it using it to counter price fluctuations. This may make SPR a tool in the hands of politicians to enhance their vote bank and can indefinitely delay fuel pricing reforms. In a country where major decisions remain politically motivated, it will need a clear cut predefinition of the scenarios and discipline to use SPRs so that they don't end up being commodity that can be traded to realize political ambitions.

Taking cues from its peers in Asia, the indices in Indian stock markets started off on a positive note today. However, selling pressure in power, infrastructure and steel stocks pushed the indices into the negative territory. At the time of writing, the BSE Sensex was trading lower by 77 points (down 0.5%). Indices across other key Asian markets closed higher while Europe has opened on a positive note.

 Today's Investing Mantra
"Almost by definition, a really good business generates far more money (at least after its early years) than it can use internally." - Warren Buffett

Editor's note: In yesterday's 5 Minute Wrapup we had incorrectly mentioned Hindalco in place of Tata Steel. The inconvenience to readers is regretted.

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5 Responses to "Do away with these myths about Gold!"


Dec 24, 2011

As long as the US$ is weak, Gold will hold its value in 2012. If US$ strengthen, the Gold will take a downward journey. But, US$ is weak and will not strengthen in the near future. Hence, come 2012, Gold will continue to keep its strength.


vivek raut

Dec 24, 2011

sir, under note on 3g, you said greedy government, same time you should have said cheating corporate in nexus with politician are responsible for this mess. if 3g was costly they should have not subscibed. this show compitation make people inhuman. actually in this era of high interest rate the only way corporate can go forward is increase productivity. globally there vast differance between poor & rich. i feel this decade will be decade of consolidation.


Naushad Patel

Dec 23, 2011

I believe that stocks worldwide are going to slump, and this will affect the Indian market as well

Secondly, money is being printed like mad, so I believe gold will hold its own barring some short-term blips



Dec 23, 2011

A well thought analysis. good reading - thanks



Dec 23, 2011


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