»5 Minute Wrap Up by Equitymaster

On This Day - 29 JULY 2010
"Read this book now", says Warren Buffett

In this issue:
» No correlation between rains and food price inflation
» World's largest steel producer is trying to flex its muscles
» Highly rated corporate are giving RBI a competition
» The Gold bubble is far from bursting yet
» ...and more!!

An obscure little book is capturing reader imagination like never before. 'When Money Dies' by Adam Fergusson was last heard retailing as high as Rs 73,000 at an online retailer! In fact, as per reports, this book has caught even Warren Buffett's fancy. The world's greatest investor has termed it a must read. Now, what exactly is this book and why this new found interest in it? This book is perhaps an indicator of the dangerous times that lie ahead of us. It highlights how an unchecked growth in money printing can cause disastrous consequences if not controlled on time.

We all know that enormous amount of money has been printed in most parts of the world, particularly in the US. And this is certainly quite inflationary. The only thing that is keeping it in check is the fact that people are holding on to their money and not spending it as quickly as before. However, such a scenario may not last long. People's willingness to spend money can change so suddenly that it can catch economists completely by surprise. And then all hell can break loose. Inflation can go completely out of control. So out of control that as per the book, during the German hyperinflation of 1920s, it took 1 trillion German marks to buy just one unit of English currency! Money lost its value so fast that it was not unusual to see people taking home their wages in suitcases or covering their wall with paper money because it was cheaper than wallpaper. Rest assured there are even more chilling accounts in the book of how the economy completely broke down in Germany.

We may certainly not have an inflation as bad as that happened in Germany. But we are definitely setting ourselves up for a huge disaster if we do not act on time. As the author of the book recently mentioned, "Politically, now is the only time tightening can be done. In a year or so it won't be possible politically any more". We hope Messrs. Bernanke and company are listening.

While we try and get our hands on a copy of the book, which book would you recommend as essential reading for a stock market investor? Tell us about it (or post on our Facebook page)

 Chart of the day
July 21st 2010 turned out to be a day of great significance for the e-world or for the world of social networking sites to be more specific. This was the day when Facebook, the world's largest social network reached a total of 500 m members. Indeed, these numbers are not to be baulked at. As today's chart of the day shows, if Facebook were a separate physical nation, it would have become the third largest country in the world, behind only China and India. In fact, this is not all. As per The Economist, if Facebook continues to grow as rapidly as in the three months to July, it will reach one billion in about 15 months from now! Little wonder, businesses across the world are falling head over heels to associate themselves with the mother of all online social networks.

Source: The Economist

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One of the key features of commodity companies is that they are price takers. That is, they have to take prices as given and cannot dictate them. This lack of pricing power is because users don't care who supplies the commodity. It's all the same, more or less. Hence, players industries like steel try and minimize competition by buying them out. When we talk about consolidation in the steel industry, the first name that comes to mind is ArcelorMittal. As per The Wall Street Journal, the world's largest steelmaker will try to increase its prices for steel by 10% this year. That will help preserve profits at a time when raw-material costs have escalated and steel demand is expected to weaken throughout most of the world.

Now, such a step would be fool hardly for the average steel player. Seeking a price increase when demand is beginning to soften is risky. Rivals could come in and offer lower prices. But not for a company with the largest production capacity. In fact, as per L N Mittal, it has already succeeded in passing on the higher raw-materials costs in some of its new contracts with auto companies. He believes the industry will take out production to match supply and demand and keep prices strong. Time will tell whether AcelorMittal can buck the industry trend. Over the long term though, he expects that global steel consumption is on track to rise 10% YoY.

Last year's failed monsoons had put the Indian government in a state of unease. With agricultural production getting impacted, the fear was that food prices would rise. And rise they did. But an interesting article in the Mint states that there may not be much of a correlation between a bad monsoon and food prices. Surprised? Take last year for instance, even when monsoon deficiency was as high as 23%, agricultural production managed to grow by 0.2%. This is pretty decent considering the consensus that production would decline.

The reason? The relation between deficient rains and agricultural production has come down over the years because of better irrigation. Secondly, the share of agriculture in the overall GDP has been declining. Statistics by Credit Suisse have shown that inflation in India has rarely been caused in Indian by lack of rains. So, what would account for the surge in food prices last year? Mismanagement by the government, letting food grains rot, increase in procurement prices and a structural change in the rural economy. On the first two atleast, the government will seriously have to clean up its act.

The RBI is facing stiff competition. And that too not from banks but AAA rated non-banking companies. Even though the RBI has made parking funds with it more attractive, banks would rather lend to the best rated corporate. This is despite the fact that the latter would fetch them nearly the same return that RBI would offer. Especially after this week's rate hike. The reverse repo rate at which banks lend to the RBI now stands revised at 5%. This is what even the AAA corporate was paying banks for short term borrowing. But that was before the base rate became effective.

Now with most banks having base rate at around 7-7.5%, the short term borrowing rates have become unattractive. And the large corporate can no more exercise their negotiating powers like they did with sub-PLR rates. Hence bankers have appealed to the RBI to allow 'sub-base rate' lending for short term borrowing. If the RBI gives into this request the whole purpose of implementing base rate will be defeated. We hope the RBI stands tall to its claim of being an 'independent banker'.

Investing in gold is the latest trend. Prices of the yellow metal have been trending upwards in the recent past. But in the beginning of this year, legendary hedge fund guru George Soros called gold the ultimate asset bubble. Six months on, investment experts are still trying to decipher the meaning of this comment. If Soros' investments in gold are seen, it appears that he is using the asset more as a hedge than as a speculation.

In the past, gold has had a bull run of 15-18 years in a currency fiat era like the one we are experiencing at present. If the past is an indicator, then we are already midway into the bull cycle for gold. In the uncertain environment, with shocks and surprises still in store, diversification into gold still makes a lot of sense. Therefore while Soros thinks that gold will 'bubble', the indicators suggest that this bubble will last for quite some time.

Meanwhile, after starting the day in the negative, the Indian indices moved into the positive and were trading marginally above breakeven at the time of writing. Finance heavyweights like HDFC and ICICI Bank were seen making the major contributions to the gains. Most of the other Asian indices also closed in the positive whereas Europe has also opened on a positive note.

 Today's investing mantra
"The news is always a mix of positive and negative. When markets decline, people point to the negative news; and when it increases, the positive news is emphasized." - Bob Farrell

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