Even the RBI has changed its view on Gold! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Even the RBI has changed its view on Gold! 

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In this issue:
» Thousands of businesses shutting down in Italy
» US firms' record dividend payout
» India's ranking in consumer price inflation
» Is Japan unearthing a new energy resource?
» ...and more!

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Contradicting views on gold have claimed reams of newsprint over the past many months. Some experts believe that the dream run in gold is over and prices have peaked. Other contest that gold has hardly lost its safe haven lustre. Particularly since there is no end in sight to money printing in the Western economies. Also with currencies devaluing like never before the chances that only gold will be able to stave off inflation is a real possibility. But those hoping to become rich over night by investing in tons of gold have surely been disappointed off late.

The India government has its own pessimistic and myopic views on gold. It believes that the yellow metal is the key culprit for India's current account deficit problem. It also imposed additional taxes to act as a deterrent to buying gold. But at the same time showed no inclination in making other investment avenues more palatable. The meek attempt at hedging inflation with inflation indexed bonds also does not seem to be a winner. Hence the verdict is that Indians will continue to park their surpluses in gold.

What is however encouraging is that the Reserve Bank of India (RBI) has changed its views on gold. It does recognize the problem caused by excessive gold imports. However, the central bank has concluded that gold is the best possible liquid investment at the current juncture. Moreover, it believes that gold could be the key to resolving the bottlenecks in financial inclusion. Earlier RBI had cited the need to have a lower loan to value ratio (LTV) on lending against gold as compared to home loans. Banks were allowed to lend only up to Rs 60 for every Rs 100 worth of gold mortgaged with it. As against up to 85% of the value of your property by way of home loan. But that may no longer be the case. As per the recommendation of a Working Group commissioned by the RBI even gold may fetch up to 75% LTV going forward. RBI's confidence in the 'banking potential' of the yellow metal is not without statistical backing. For bank loans against gold have multiplied 4 times in the last 4 years. And customers even in semi urban and rural areas find gold as the easiest collateral to offer for bank loans.

Thus while many of its counterparts in emerging markets are buying more gold as reserves, the RBI is doing its bit by encouraging gold as a financial asset. We believe that the fundamentals of global money supply do show a strong possibility of gold being one of the most lucrative asset classes in the long term. If India can use this opportunity to make the economy financially inclusive it will be a cherry on the cake. Having said that, as with stocks, investment in gold too can reap results only over the long term, that too with correct asset allocation.

Do you think the RBI is right in encouraging bank lnding against gold? Please share your comments or post them on our Facebook page / Google+ page

01:35  Chart of the day
India has seen a 'new normal' at least as far as inflation is concerned, over the past 3 years. The average wholesale price inflation (WPI) during this time frame has been around 8.7%. This against an average WPI of 5.2% between 2001 and 2008. Even in 2009 inflation was benign at 3.8%. However, the inflation levels have stuck well above RBI's comfort zone since then. This has also caused many to argue that probably the RBI should revise its inflation target upwards. This approach will also help the central bank be a little more lenient on monetary policy. However, the RBI has refused to go by this logic. While we understand the RBI's reluctance to accept higher levels of inflation as 'new normal', it cannot turn a blind eye to divergence between WPI and CPI (consumer price inflation). Even as WPI has cooled off in recent months (6.6% in January 2013), India has been amongst countries showing the highest rise in consumer inflation over the past year. Thus the RBI should shed its inflation target in terms of WPI and adopt one in CPI terms instead.

Data source: Economic Survey 2012-13

Do you know exactly how bad things are inside the Eurozone? If not, here is something very shocking. At US$ 2 trillion, Italy is one of Europe's largest economies with about 6 million companies. And it is also one of the worst affected by the crisis. The country saw nearly 365,000 businesses shutting down last year. That is like a 1,000 businesses going belly up every single day. It must be noted that the economy contracted by 2.4% during this period. The small and medium-sized businesses are the worst hit. In fact, 50% of the small firms are being unable to pay their employees on time.

Italy's economic worries are not new. Its economic growth during a major part of the last decade was just half that of the European Union. Who is to be blamed for this? Some major factors include a clumsy bureaucracy, rigid labour laws and declining competitiveness in the global markets. The Italian government took up austerity measures last year to deal with the crisis. Tax increases and spending cuts have pushed Italy into one of the worst recessions of any Eurozone economy.

Italy's crisis, in a way, represents the overall gloom in the Eurozone. It poses serious long term risks to growth and stability in the zone. In an increasingly interconnected global economy, the adverse impact of this is going to be felt everywhere. India is certainly not immune.

Neil Armstrong had once said "Well, I think we tried very hard not to be overconfident, because when you get overconfident, that's when something snaps up and bites you." This is true in every phase of life. Including investing. And this is the theme explored by author Carl Richards in his book "The Behavior Gap". The biggest mistake that investors tend to make is overconfidence. This is true not just for the larger investors but also for the smaller ones. Therefore Richards has devised a 3 point questionnaire that in our opinion, every investor should answer before investing. The first is "If I make this change and I am right, what impact will it have on my life?" This means you have to clearly know and understand the outcome of your investment decision. The second is "What will happen if I am wrong?" This is where humility comes in. One has to acknowledge that not all decisions that they make are the right ones. But the important thing is to understand the implications of the wrong ones; learn from them and move on. The third and last question to ask is "Have I been wrong before?" This is the one where most investors falter. It is easy to gloat in one's success but difficult to acknowledge one's mistakes. But unless you do, you will never ever think back on the learning from the mistake. And if you don't, it is most likely that you will suffer from overconfidence. And overconfidence will eventually kill your investments.

In Warren Buffett's latest letter to shareholders, there is an interesting portion on dividends. At its core is the argument that if a company is enjoying strong returns on capital and has growth opportunities to pursue, it is better off re-investing its profits into the business rather than paying dividends. And this does make perfect sense, isn't it? Unfortunately though, this advice from the sage of Omaha seems to be getting the snub from the corporate sector. And that too of his own native country. There are reports about how US firms are paying record dividends these days. In fact, they are just 7% shy of the dividends per share record created back in 2007.

So, what explains this anomaly of US Inc not paying heed to Buffett's advice? It's the overall environment we believe. The macroeconomic uncertainty seems to be pretty high in the US. This in turn is forcing companies to hold back their investment plans and instead hoard cash on the balance sheet. Also, since interest rates are at record lows, lot of firms are taking on debt and paying it back in the form of dividends or buy backs. Thus, dividends could be exciting news from an individual shareholder point of view. But it does not seem to be in his best long term interest or that of the overall economy at large.

When the Dow Jones Industrial Average (DJIA) hit 14,300 mark recently the US stock markets completed a four year bull cycle. Over the last four years the markets have returned approximately 129%. This makes the current period rally as the sixth best ever bull run in the US stock market history. Sustenance of the rally for such a long period of time and scaling new highs in between suggests that the US market is in a structural bull run.

But doesn't the current investing environment seem paradoxical to this fact? Despite such strong returns, equity as an asset class is still viewed with suspicion. Most investors are circumspect about investing in equities at the moment. And that's because they know that the current rally is fueled by artificially loose monetary policy followed by Federal Reserve. It is true that corporate profits have increased and unemployment rate has declined over the four year period. But it is the federal intervention which is a key trigger driving the markets right now. And once the intervention ends markets would lose steam. Thus, the current bull run is situation specific. So, while it may find a place to be sixth largest one in terms of returns score card it lacks broad investor participation. As such, it may well rank right at the bottom, if assessed on a sentimental score card.

Given the ever increasing appetite for oil and gas, efforts to find new sources of energy have picked up considerable pace in recent times. The developed countries especially have been looking to become independent on the energy front. While the Middle East remains dominant in oil and gas production, mounting geopolitical risks in those regions means that many countries are looking for alternate sources of energy. The shale gas revolution in the US is one such example. And now Japan has moved closer to unlocking a potential new energy source. This is the extraction of gas from the deposits of methane hydrate. The latter is a mixture of frozen water and methane and is sometimes called 'fire ice'. However, whether this prospect is commercially viable is the key question for Japan. One estimates production costs for methane hydrate-derived gas at about nine times the US benchmark for LNG. Japan, however, can take hope from the fact that the same doubts had earlier lingered over shale gas extraction and which is now being commercialized. Either way, Japan does not consider itself having too much choice. The country has no conventional fossil fuels of its own. Plus its nuclear industry has been in shambles on account of the earthquake and tsunami.

Profit booking in commodity, bank stocks and auto stocks has kept the benchmark indices in the red throughout the session today. Backed by weak cues across Asian stock markets, the key indices in Indian equity markets opened lower and languished in the red. The BSE Sensex was trading lower by around 180 points at the time of writing. Other major Asian markets closed lower while markets in Europe opened flat to positive.

04:50  Today's investing mantra
"I think you have to learn that there's a company behind every stock, and that there's only one real reason why stocks go up. Companies go from doing poorly to doing well or small companies grow to large companies." - Peter Lynch

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    Equitymaster requests your view! Post a comment on "Even the RBI has changed its view on Gold!". Click here!

    5 Responses to "Even the RBI has changed its view on Gold!"


    Mar 22, 2013

    As an enlightened economist told rightly, we are mining the gold from deep caverns of earth only to store safe vaults.
    Assigning such a high-value and hoarding it is senseless. All concerned i.e., Financial Institutes, countries and citizens should make an earnest and focussed effort to demystify the importance and value / utility of gold and instead look at avenues in investing in technology, agriculture, medicine and research related ventures which yield better returns and do a lot good to humanity.


    Suresh Kiswani

    Mar 14, 2013

    Gold and Real Estate values should have parity in LTV lending quantums with equal parity to lending rates.Treat the assets on par values.



    Mar 13, 2013

    Gold adversely affects the US Dollar.Low Crude price also does the same.India needs to reduce Crude import,as the OMCs are WRONGLY claiming LOSSES and hence the so-called IMAGINARY under-recoveries in Lakhs Of Crores of Rupees.
    Both the above seem due to US pressure.
    Please google for:-

    Like (1)

    Rajiv Sehgal

    Mar 13, 2013

    1. The volatility in gold prices is much lower in comparison to other asset classes such as property, equities etc.
    2. The demand for gold to embellish human beings will never recede. In short, gold will forever remain in demand.
    3. I strongly support LTV of 75% against collateral of gold.

    Like (1)


    Mar 13, 2013

    As we could smell corruption and speculation involve in real estate and equity isn't timed now for huge investment in absence of sustainable global as well national economic recovery despite only mix of uncertainties and illusion the yellow metal gives conviction to investor of no steep southward move no matter it won't give exponential growth and so RBI inclination seems a prudent one.

    Like (1)
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