»5 Minute Wrap Up by Equitymaster

On This Day - 13 DECEMBER 2010
Are you financially intelligent?

In this issue:
» India's biggest worry - rising current account deficit
» Rise of gold, silver continues unabated
» This could severely hurt India's auto boom
» Indian students to get Chinese lessons
» ...and more!!

------------------------------ "Price of gold could go down 20%, 30%"... ------------------------------
"Silver is speculative..."
"You don't get rich buying gold..."

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Financial literacy is important for your financial well-being. How often have you come across this statement? Maybe too often! Even our efforts at Equitymaster revolve around this very aspect. We try to educate investors to help them make sound investing decisions.

In short, the idea to 'know finance' to make better investing decisions seems unquestionable. Or does it?

A study done at the University of Pennsylvania suggests otherwise. As per it, there is a big downside of getting financially intelligent. And this is what it has to conclude. Financial intelligence increases the confidence levels in an investor which leads him to make worse investing decisions!

The study reports - "...finance courses increase confidence, but this could reflect overconfidence..." It also cites an example - "Over-optimism and over-confidence in finance decision making is widespread. In a 2005 survey, 65% of Americans believed they were 'very' or 'highly' knowledgeable about personal finance, although they performed abysmally on objective questions about the subject."

This sums up the reason why so many investors run into financial problems despite being financially intelligent. We believe the idea of financial knowledge in isolation isn't enough. The need is to combine emotional intelligence with it as well.

As Warren Buffett once said, "Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."

 Chart of the day
Here's something that can spoil the party for the Indian economy. We are talking about the country's rising current account deficit (the surplus of imports over exports). The deficit, which was just over 1% in FY08, is now nearing the 4% mark (it stood at 3.7% in the quarter ended June 2010). What's the worrying part is that a large part of this deficit is being funded by hot money flows (in the form of FII investments) into India. If the FIIs were to pull out from the country, the problems for the Indian economy can multiply at the blink of an eye.

Data Source: CMIE, Planning Commission

With gold prices skyrocketing, investors are turning to its next best alternative - Silver. The metal is now close to its 30-year high, and is inching forward daily. Silver demand in India averages around 2,500 tonne a year, and given the increased demand, India could import around 20% more of the element. New demand is coming from the rural areas. With unaffordable gold prices, and a good monsoon this year, people are eagerly looking for ways to preserve their wealth. The festival season and the current marriage season are also buoying demand. This has caused silver to outperform gold in terms of returns this year. And its run doesn't seem over as yet!

Indian markets had a good outing today. The BSE-Sensex was trading with gains of around 165 points (0.8%) at the time of writing this. Today's buying was led by stocks from the realty and metal sectors.

Among other key Asian markets, while China closed with gains of 2.9%, Japan and Hong Kong were up 0.8% and 0.7% respectively.

We read annual reports of companies with great interest. The kind of insight that can come out once in a while is indeed worth the effort. Like the one which came to us when we were going through annual reports on some of India's biggest four wheeler companies. We observed that Maruti's working capital requirements were quite high in comparison to its sales as compared to the domestic biggies. We thought how stupid it is for Maruti to not squeeze its suppliers and vendors more and thus, enhance its own return on net worth. The prudence of that arrangement has now beginning to make itself crystal clear. Maruti was of the view that there is no point squeezing its suppliers hard and gobbling up the excess profits all alone. This is because it knew that if the growth of its suppliers is constrained in the future, Maruti's growth may also take a huge hit.

An article in Forbes India has further reinforced this point. It shows how a severe shortage of auto parts is perhaps acting as the biggest spanner in the wheels of promising growth that the Indian auto industry could see in years to come. The Indian auto components industry feels that they have been in done in by the lack of faith shown by the auto manufacturers and hence, now face huge resource crunch to come up with new capacities and increase their R&D. We believe the problem will have to be sorted out soon or else the Indian economy will face another huge bottleneck.

Now this is very interesting when it comes to India's educational system. The Central Board of Secondary Education (CBSE) has asked schools to introduce Chinese as a subject from the next academic session. It may not be long before we find sixth graders literally doing the 'Chinese whispers'.

There are good reasons to learn the Chinese language (Mandarin). The pivot of business is gradually shifting from the West to China. The Chinese economy is already the world's second biggest after America. Soon, Indians will do business in China just the way they do business in the US and Europe today. Currently, about 150 Indian companies operate in China while there are about 40 Chinese companies doing business in India. China has already overtaken the US to become India's largest trade partner. However, India is only the fourteenth largest trade partner for China. Also, China is quickly shifting from an export-driven emphasis to a domestic consumption model. And unlike many other economies where business deals are scripted in English, in China, Mandarin is the language of all agreements. To add to all this, the rule of law is weak in China. So knowing the country's language, culture and customs will be a key to doing business and building trust.

It must also be noted that the Chinese are busy polishing their English. This will pose a risk to our 'English advantage'. And not just that! They are also taking lessons in Hindi. So the CBSE board's recommendation is quite timely. Though putting the education board's plan to practice may seem difficult now, given the scarcity of teaching staff and infrastructure. But the perils of ignoring the inevitable may cost more in the years to come.

Growth has never come in very easily to any economy. History shows that economies have had to undergo major overhauls to bring in the growth catalysts. For India the catalyst is better infrastructure. But it seems that it will take a lot more than just planning and funding to make that a reality. Indian banks do not have the ability to fund US$ 1.2 trillion worth of projects. Insurance and pension funds can be the key to channelizing such funds into infrastructure. But there are some other hurdles as well, chief amongst them being acquiring land and environmental clearance. True, the industries and the government must adequately compensate the land owners. Also as a developing economy we cannot be environmentally callous. But we have to walk the fine line between growth and the quality of it.

The likes of Rajiv Lall and Deepak Parekh, heading IDFC and HDFC respectively, see this kind of growth potential from very close quarters. And they seem worried about the manner in which India will address the dual issues. Long bureaucratic delays have already postponed big ticket FDI projects. Some others are now unwilling to commit long term funds. We believe that our intention of balancing the quality of growth is noble. But the pace at which politics responds to economic needs at times impedes the long term interests of the nation.

 Today's investing mantra
"You shouldn't just pick a stock - you should do your homework." - Peter Lynch

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