»5 Minute Wrap Up by Equitymaster

On This Day - 8 FEBRUARY 2014
Have Indian savers got a bad deal?

In this issue:
» Was Bill Gross wrong about the theory of 'New Normal'?
» The change in real wages in Japan over past 15 years
» No change in FM's stance on gold imports
» Will investors prefer gold's poorer cousin?
» ...and more!

Ask any economist whether an economy that saves and invests is better than one that borrows cheap and spends. The reply will be that while both will show a good rate of growth for a temporary period. However, the former's growth model will be more sustainable. Also without any debt burden the 'saving economy' will remain fundamentally robust.

Now like our neighbours in China, Indian households too have had the inherent tendency to save. Even before the concepts of 'saving' and 'investing' were known in economic parlance, Indians accumulated gold. Not just as means of financial security but also to pass down generations. However, Indian savers do not seem to have got their due in terms of return on savings.

The fact is that the trend of investing in financial assets like stocks has been very short lived in India. Several scams, lack of transparency, mis-selling by brokers and mutual funds, corporate frauds etc have eroded whatever little trust Indians had in stock markets post 2002. The risk averse savers then chose to park money in bank fixed deposits. But those who chose to not diversify their investments ended up losing money than generating wealth!

As per the data put forth by the Urjit Patel Committee (RBI), fixed deposits have lagged the returns from gold and real estate for most of last 5 years. Even prior to that fixed deposit returns caught up with that on gold only in FY08. And when compared to consumer inflation, it seems that only gold that has offered any real returns.

Here we would hasten to add that this data is incomplete in the absence of stock market returns being plotted against that on gold. For stocks too have managed to offer substantial inflation adjusted returns over the past 10 years. However, since most Indian savers have given the stock market rally a miss, for them it has been a wealth eroding decade rather than a generating one!

Why Indians prefer investing in gold and real estate...
Source: RBI, Urjit Patel report
*Weighted average term deposit rates of banks across maturities

The lesson here is that Indian savers must learn to diversify their investment across asset classes. And while there is a certain degree of risk associated with each asset class, including stocks, realty and gold, they ultimately help keeping the portfolio returns positive. Most importantly, given the long term growth potential of the Indian economy, savers giving the stock markets a miss, may lose out on one of the most lucrative asset classes. A careful selection of investments coupled with appropriate Asset Allocation can help Indian savers undo the damage to their portfolio over the past decade.

Do you think Indians have got their due in terms of return on savings? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The US Fed's excessive money printing may have done the damage to the economy's debt burden. However, as the US central bank unwinds its QE policy and cuts down its bond buying programme, the recipients of the cheap liquidity supply are left to panic. The major currencies across emerging markets, with the exception of China, saw massive correction over the past year. Countries with high current account deficits have been the worst hit. Argentina, which is running out of forex reserves to protect its currency, has seen the Peso fall by as much as 37.9%. And as the US continues to taper the QE in a slow but steady manner the damage to these currencies is far from done!

Movement of emerging market currencies over the past year

In the aftermath of the financial crisis, bond king Bill Gross added a new term of the financial lexicon. He called it The New Normal. However, this wasn't how the US stock markets performed in 2013. For them, it was still the old normal what with the indices up more than 30%. So, why exactly did Gross' predictions did not pan out as expected. Well, if our understanding of Gross' theory is anything to go by, the new normal that he was alluding to had more to do with economic growth on the ground rather than prediction of asset prices. And he still sticks to his theory as he believes the US may not return to its earlier growth in a long time to come. So, have asset prices gone well ahead of fundamentals? He does think so. And therefore when they will retract like they are doing now, it is not going to make for a good picture. So expect a lot more volatility going forward. He also cautions investors who were simply levering up in order to generate higher returns. That era too has come to an end as per Gross. Well, we are with him on this one.

Japan is in a quandary. The current Prime Minister Shinzo Abe has unleashed this huge wave of liquidity into the Japanese economy. This program, dubbed as Abenomics, has been put in force seemingly with the aim of ending decades of deflation in Japan. Mr Abe is hoping that a rise in inflation will convince the Japanese that the economy is back on track. But there is a problem with that concept. Indeed, if inflation has to rise then it goes without saying that wages also need to go up. What is more, the increase in wages has to be higher than that of inflation. Only then will consumers be induced to spend more. But is Japan ready to dole out substantial rise in wages? It seems like quite a challenge.

As per an article in Business Week, over the past 15 years, real wages in Japan have dropped 15%. In the 11 months ending November 2013, the rise in wages stood at a measly 0.2%. Real income of households has actually seen a fall in December 2013. Certain Japanese corporates did see a rise in sales and profits. But has that been more a product of a weaker yen or a stronger recovery? The latter seems quite unlikely because there are no hardcore signs visible yet. Overall, it does seem quite unlikely that wages will rise substantially. That means that Japanese will not really be compelled to spend more. And this would once again highlight flaws in government strategies that rely on loose monetary policies to fuel growth.

There have been quite a few talks over slashing the import duty on gold. The same was hiked to 10% last year as an attempt to curb the high current account deficit (CAD) levels in India; as the latter was impacting the forex rates. While this move has been effective is curbing the volume imported gold -as volumes have reduced to monthly levels of 19 tonnes per month (in November 2013) as compared to 162 tonnes in May 2013 - it has raised the problem of gold smuggling. As per the World Gold Council, and as reported by the Hindu Business Line, nearly 150 to 200 tonnes of gold has been smuggled into India ever since the duties have been imposed. This has led to a potential revenue loss of US$ 1 bn in terms of taxes.

In any case, there seem to be two sides to the debate of whether gold duties should be curbed. A while ago, RBI governor, Dr Rajan had stated that this measure was not sustainable over the long run. The business daily has reported that the CEO of the World Gold Council has been in discussion with key policy makers, who have indicated that the curbs will be reduced soon, given the recovering economy and the burden of CAD reducing. However, going by the Mr. Chidambaram's latest statement, the Finance Ministry is not considering any proposal to curb gold imports as it is likely to impact the country's CAD position. Going by the words of the FM, it does seem that the country will continue to face issues with gold smuggling for a while now.

India's love for precious metals is as old as the mountains. For thousands of years precious metals have remained keepers of value. But nothing comes closer to gold when it comes to a safe haven investment. Nonetheless, silver which is also referred to as the 'poor man's gold' has grown in popularity as gold has become increasingly unaffordable for the poor masses.

In 2013, India was the biggest consumer of silver with estimated imports of about 5,400 tonnes. That's a steep 184% rise from 1,900 tonnes imported in 2012. When there is more political and economic uncertainty, when policymakers fail to protect purchasing power, people tend to flock to precious metals such as gold and silver.

There are strong reasons why demand for silver will continue to rise. As we mentioned above, silver is the preferred precious metal of the rural population that cannot afford to buy gold. Precious metals are integral to cultural customs, especially weddings. Moreover, the rural population does not have access to sophisticated financial products. Given the persistently high inflation, keeping too much cash is also risky. As such, precious metals such as silver are the most obvious choice for them.

In our view, investments in precious metals such as gold and silver should certainly be part of a person's overall asset allocation.

Global stock markets began the week on a negative note and this trend continued throughout the week. This was the second straight week where US monthly payroll report underscored the fragility of the US economic recovery. Only 113,000 US jobs were added in January, far below the 188,000 economists expected. Also, contrasting with the lackluster payroll numbers is a drop in the unemployment rate to 6.6%. The US markets closed 0.3% down for the week.

The Indian equity markets ended the week on a negative note. According to the advance estimates released by the Central Statistics Office, Indian economy is expected to grow 4.9% in 2013-14, dragged down by contraction in the manufacturing sector, a first since 1991-92. This would be a consecutive year of sub-five per cent growth. In the previous financial year, gross domestic product (GDP) growth was 4.5%. The Indian markets finally closed the week down by 0.7%.

Performance during the week ended February 7th, 2014
Data Source: Yahoo Finance

 Weekend investing mantra
"It's the nature of things that most small businesses will never be big businesses. It is the nature of things that most big businesses fall into mediocrity or worse. Most players have to die."- Charlie Munger

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