»5 Minute Wrap Up by Equitymaster

On This Day - 1 SEPTEMBER 2010
Are you like a frog in heating water?

In this issue:
» India has huge coal reserves, but then...
» Will new-born ULIPs be any better?
» Gold may rise to US$ 1,500 an ounce
» India's GDP growth-Good, bad, ugly
» ...and more!!

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Warren Buffett's partner at Berkshire, Charlie Munger, gave a famous speech at the Harvard Law School in 1995. This speech was titled 'The Psychology of Human Misjudgment'. Therein he cited a small lesson from frogs. He said, "If you throw a frog into very hot water, the frog will jump out, but if you put the frog in room temperature water and just slowly heat the water up, the frog will die there."

Well, we don't know whether the current generation of frogs is intelligent enough to understand this mystery. But we are sure the stock market investors generally do not take a leaf out of this. So, when stock prices rise or fall fast, investors get into or get out of them. But when the rise or the fall is slow (like the slowly heating up water), investors take that as the new normal. In such a scenario, they create this self belief that stock prices will continue to move up, or they'll continue to move down.

We are seeing something similar happening now. The Indian economy is showing signs of renewed strength. And cheap global liquidity is flowing in great abundance. This is taking Indian stock prices higher (except the minor volatility we see every now and then).

But we believe that buying into any rally as of now can be dangerous. This is given that the global economy is still hanging on the fine thread of stimulus. Stocks remain reasonably valued, and corporate earnings are not showing signs of sustaining.

So a better way now for you would be to get cautious with your investing. Be patient and wait for the right valuations. After all, you would not like to be a frog in water that is slowly heating up, but can burn you later.

 Chart of the day
Today's chart of the day shows India's prominent position on the world coal map. The country ranks fifth in terms of coal reserves, and has a 7% share of the global reserves. In fact, India, along with the four top players together account for almost 80% of the world coal reserves. Anyways, as far as the domestic coal situation is concerned, despite this huge reserve, Indian users continue to face scarcity of the commodity. This is given that coal production has not kept pace with the surging demand from power plants and other key consumers.

Source: BP Statistical Review of World Energy June 2010

Insurance linked investments plans were in the eye of storm recently. Popularly called ULIPs, these typically subjected investors to higher charges on the pretext of high returns. So much so that the SEBI called for a ban on ULIPs some time back. The insurance regulator IRDA however had its way promising to revamp ULIP products. The tussle between two regulators in fact led the government to appoint a super regulator. But what is the fallout of this tussle?

ULIPs have now attained a new investor friendly avatar! They seek to offer limited options to investors and charge lower fees. Also instead of mimicking mutual fund schemes, ULIPs will now have a larger insurance component. We wonder if such an attempt would bring back investor faith to the product. Mired in allegations of mis-selling, ULIPs may have to go a long way before they really become 'investor-friendly'.

It is said that all that glitters is not gold. But what if gold itself is glittering like never before? As per a recent Bloomberg survey of international analysts, traders and investors, the consensus is that gold may rise as high as US$ 1,500 an ounce next year. That's roughly 20% higher than current levels. One German analyst, whose forecasts have been most accurate this year, epitomises the all-round optimism about gold. He believes that whatever happens to the global economy, there is only one way gold can go - up. That's because if there is a swift economic recovery, higher jewelry demand would take prices higher. If the economy worsens, demand from investors looking for a safe haven will kick in.

Noted commodities guru and emerging market investor Jim Rogers is advocating owning 'real assets' such as silver, rice, and natural gas. Since the supply of these assets is limited, they will always find takers. Plus, they have an intrinsic value, which cannot be diminished. Rogers believes that investing in these assets is important especially in a world where central banks have debt laden balance sheets due to quantitative easing. These banks in the US and Japan have been destroying their currencies' value. They have flooded the world with paper money.

Rogers laments, "In America, Bernanke just says we'll print more money, we'll spend more money, even though the US is now the largest debtor nation in the history of the world." Central banks are destroying the saving and investing class, he states. We are going to have a lot more currency turmoil over the next 2 or 3 years because of the huge imbalances that exist in the world. The world economy is still in trouble. Owning real assets, opposed to paper assets, will be a good way to insulate oneself from these imbalances.

Rating agencies have been criticized to the core since the onset of the global crisis. Their 'strong' ratings for 'weak' economies left a lot to be desired. Investors who relied on these ratings suffered major setbacks. It was inevitable that the regulatory bodies punish these agencies for their misguiding ratings. The first sign of it was when US stock market regulator SEC pulled up Moody's for its 'miscalculations' on some European debt ratings. Moody's itself admitted that due to a glitch in its computing software, the ratings appeared higher than what they were supposed to be. It was just a matter of time that Moody's be punished for this.

Hence it came as a shock to us when SEC dropped all charges against the rating agency on grounds of 'uncertainty in jurisdictional nexus'. This means that SEC (based in the US) wasn't sure if they were judicially responsible for punishing Moody's for giving wrongful ratings in Europe! It's funny that SEC realised this three months after it filed the charges for the same. Interesting to see how muscle and wealth power can help one get out of the soup so easily.

India's economy grew by 8.8% YoY during 1QFY11. This is the fastest pace since the heady days of early 2008, and is good news. But the bad news lurking just behind the corner is that inflation continues to remain high. Hence, it is widely expected that the RBI will persist with its aggressive monetary tightening to control inflation. It has already raised interest rates several times so far this year. We expect more of the same when it meets again on September 16.

However, the real worry is whether India's GDP growth numbers are actually correct in the first place? The 8.8% YoY growth is as per 'supply-side' estimates arrived from sectors like agriculture, industry and services. However, 'demand side' estimates arrived from private and government consumption, investment and net exports peg the GDP growth number at only 3.7% YoY. This huge gap between the different growth estimates is confusing. Some experts believe that the lack of demand is the real culprit behind the high inflation. Some point out that the method of calculation itself might be flawed.

So, what's the response of the ministry of statistics? "We have checked the data. There is some seasonal impact as well as some differences in import and export figures which can't be simply calculated on the basis of inflation." Caught in all these technicalities, all the common man can hope is to participate in all this growth and pray for food prices to come down.

Anyways, Indian markets had a strong day today. The BSE-Sensex was trading with gains of around 155 points (0.9%) at the time of writing this. Today's gains were largely led by buying in stocks from the realty and metal sectors, which otherwise saw weakness over the past few days. Among other key Asian markets, all except China (down 0.6%) closed with gains.

 Today's investing mantra
"One of the biggest mistakes is to focus on a stock price instead of its value." - Warren Buffett

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