Gold bull run could be sooner than expected

Jan 12, 2011

In this issue:
» Is politics trumping economics?
» The biggest party poopers for auto companies in 2011
» India's green energy targets may be cut short
» Some more IPO reforms in the pipeline
» ...and more!!

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 Chart of the day
China's US dollar reserves have recently swelled in excess of US$ 2.5 trillion. This is more than double India's current GDP. Also it is amongst the largest in the world. Little wonder that Fed Chief Ben Bernanke is happy to keep the dollar printing press running overtime. This is while the Chinese policymakers are losing sleep over it. Japan is not too far behind, fretting over the precarious state of US and European economies. Amongst the largest economies in the world, China and Japan have the maximum share of currency holdings in their national reserves. The steady decline in the value of their reserves is therefore a concern to them.

China may want to keep its currency artificially low to retain its export competitiveness. But in the bargain accumulating foreign exchange that is steadily shedding value is a losing proposition. As per Wikipedia, the two behemoths had barely 1.7% as 3% of their reserves in gold respectively at the end of 2010. Meanwhile, economies like the US and Europe had nearly 70% of their reserves in gold at the end of 2010. They will therefore be happy to see the value of the yellow metal escalate. However, the fact that the biggest economic growth drivers in the world (BRIC nations) hold the maximum currency reserves could be a potent disaster. If the dollar and the euro keep steadily losing value the BRIC economies may choose to dump them in favour of gold. Important to note that central bank holdings are just a fifth of the world's gold holdings. Looks like the next round of gold bull-run will come sooner than expected and would perhaps be larger than ever.

Data source: Casey's Daily Dispatch, Wikipedia

Here's another example of politics trumping economics. Japan, world's third largest economy, is looking to buy Euro bonds in order to help the European economies get out of their current mess. Moneynews reports that Japan will use existing euro assets in its forex reserves to buy more than 20% of bonds to be issued by the Euro zone. Important to add that China had pledged a similar support to the troubled European nations only recently.

Clearly, Euro bonds cannot be termed as one of the most attractive asset classes in today's environment. Especially against the backdrop of the amount of debt most of the Euro nations have piled on. Devaluation through money printing is a strong possibility here. Hence, fixed income options like bonds should not be on top of any rational investor's buying list. But Japan does not seem to be in a mood to listen. It perhaps does not want to look small in the eyes of one of its biggest trading partner, especially against its arch rival China. The decision, we believe, has political compulsions to it rather than investment benefits.

2010 was a year to party as far as the auto companies in India are concerned. The auto sales zoomed by 31% for passenger cars during the year. This made India the second fastest growing market in the world. It lagged only to China. The biggest contributors to this spectacular growth were a super growing economy and the launch of new models. Market for commercial vehicles grew by a whopping 47% for making India the fastest growing market in the world in this segment. Again the surging economy was the biggest driver of this growth.

But would these good times continue in 2011? We are doubtful of that. One of the biggest party poopers for the auto companies would be the rising interest rates. In light of the surging inflation in the country, the central bank plans to raise interest rates in the days to come. This makes the cost of financing autos go up. In addition to this, the inflation has led to higher commodity prices which translate to higher raw material costs for the auto companies. They would definitely look on to passing some of these higher costs on to the consumers. These factors would dampen demand. And the performance of 2010 may not be repeated in 2011.

Despite gold's consistent rise over the past few years, there is no shortage of buyers of the same. Indians have been known as the largest buyers of physical gold in the world. Now the frenzy is also being seen in the paper gold i.e., gold exchange traded funds or ETFs. As per AMFI data, funds under management in Indian gold ETFs climbed to a record Rs 35.2 bn in 2010 from Rs 13.5 bn in 2009. As demand remains good, and awareness about ETFs grows, we see even higher investments in gold ETFs in the future.

India's quest for energy security has led it to focus on solar power as an alternate source of energy. There are two main reasons for the same. First, that India so far has been relying a lot on coal as its energy source. But coal brings with it quite a few problems. There is too much carbon emission. Plus, the quality of coal in India is also not up to the mark. Second, India imports nearly 70% of the fuel that it consumes. And since India's appetite for energy continues to rise, the country has been increasingly looking at other sources of energy.

Solar energy in that sense has fit the bill. But all is not hunky dory. True, India aims to have 20 gigawatts of solar generating capacity by 2022. And that the government auctioned 620 megawatts of solar projects to 37 companies is an encouraging sign. But because solar power is more expensive, India has committed to a feed-in tariff for solar power. This was estimated at Rs 18 per kWh. However, aggressive bidding by project developers has led to discounts being offered as a result of which solar energy projects are now looking less attractive in terms of returns. That's not all. Thinner margins and lack of payment guarantee system means that solar developers' find it difficult to secure bank financing. Indeed, unless these concerns are addressed, India's attempts to become energy sufficient will be only be on paper

IPO reforms have been the order of the day in the current SEBI chief's regime. Looks like he is not yet done with them. The latest one was enhancement of the retail investor category limit of Rs 200,000. However the hike in the retail investor category limit has done more bad than good especially for the unwitting small investors. As shares are allotted in proportionate basis, the hike in the upper limit favors HNIs or large retail investors who apply for the maximum allotment of Rs 200,000. Resultantly, the chance of allotment to small bidders especially in oversubscribed IPOs is further reduced.

Realizing this, SEBI now intends to introduce a counter-regulation so that even those who bid for the lowest number of shares are allotted some shares in IPOs. It is certainly going to be a difficult task to keep the interest of millions of small investors. Especially of those who flock to subscribe to the high profile IPOs.

We are only a month and half away from Budget 2011-12. The Indian economy has done well in recovering growth momentum from the slowdown. But there are some key areas that need to be fixed. Only then can we sustain the growth momentum going forward. In a pre-budget deliberation with India Inc., the finance minister raised some legitimate concerns. Slow pace of infrastructure development is a major concern. The other one is poor investment in R&D. Our domestic R&D spending as a ratio of GDP is very low compared to other emerging economies. The government alone cannot address these concerns. The private sector will have to share a significant onus of these challenges. Looks like the forthcoming budget could have something to offer to private companies to increase their contribution to infrastructure and R&D.

Led by strength in auto, banking and engineering stocks, the Indian indices succeeded in making inroads into the positive territory in the final hours of trade today. The BSE-Sensex was trading 272 points higher at the time of writing this. The BSE Midcap and BSE Small cap indices were up 1.2% and 1% respectively. Other Asian markets also closed higher with the Indonesian and Hong Kong markets leading the pack of gainers. The European markets have opened on a positive note.

 Today's investing mantra
"Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value." - Warren Buffett

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3 Responses to "Gold bull run could be sooner than expected"


Jan 12, 2011

I do remember having said that the increase in upper limit of Rs 2 lakh for retail investor is not good. As the common retail investor applies only for Rs 40000 to 50000 amount with the hope that he will get some shares.However in recent IPO's like MOIL real retail investors were the biggest loosers. So the limit should be reduced to Rs 1 lakh again and all the applicants be allotted some shares.



Jan 12, 2011

Am a fan of your newsletter, however, there seem to be two errors in the analysis on solar energy in today's newsletter.
Solar projects' costs are continually coming down allowing developers to bid aggressively.
Secondly, payment security is still guaranteed under the JNNSM through IREDA and NVVN.
Anyhow, solar projects require large area - so land acquisition concerns need to be incorporated in the discussion.


A.Joy Antony

Jan 12, 2011

Seems to be good but let me have some more time to give the full result

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