Gold is not an investment - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Gold is not an investment 

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In this issue:
» Gold is not an investment, its money itself
» The sad story of airlines
» Is the worst over for US banks?
» Governments responsible for the crisis
» ...and more!!

James Turk, the founder of, has some interesting observations to make about the realities that lie beneath the 'investment' status of gold. His main point is that gold is not an investment, but is money itself.

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The following table tracks gold's performance over the past 8 years in terms of 9 different currencies.

Source: GoldMoney

His thesis is that given these exceptional results, gold prima facie may look like a great 'investment'. But in reality, gold is not appreciating, rather currencies are getting debased.

Source: GoldMoney

The price of crude oil in terms of gold, for example, has basically remained unchanged over the 59 year period since 1950. Thus a gram of gold today buys essentially the same amount of crude oil it did in 1950. So, it there has been no appreciation from owning gold in real terms, but it has nevertheless achieved something very important: preserving purchasing power. Which, after all, is what money is supposed to do, but has failed to do so far because of inflation. After all, governments can keep making new money out of paper, but cannot possibly make new gold.

There is a wide consensus among experts that if the current rally has any chance of sustaining, zombie banks need to be brought back to life. After all, you don't get a growing economy without well- functioning banking machinery. Few quarters back, US banks were anything but well functioning. But the latest quarterly results seemed to have helped dispel some of those beliefs. After Goldman Sachs stumped analysts with better than expected profits, it was the turn of J P Morgan to do so. Thus, not one but two big banks have managed to avoid the coat of red on their P&L statements. In fact, J P Morgan even went to the extent of disclosing a very important metric, pre-tax, pre provision earnings, which shows that its profits are indeed genuine and not a result of some accounting wizardry. Furthermore, genuine profits will also help the firm in raising money from investors to shore up its depleted capital. So, have the US banks turned the corner? Not quite yet. For one, J P Morgan's costs for providing for and writing off bad loans have continued to rise and secondly, even as per its CEO's admission; deterioration in the economic environment could increase the bank's losses and hurt its core business. Who knows, the current rally might have false legs after all.

Banks in the US and Europe are enjoying a fresh wave of profits from the government's efforts to nurse the industry back to life. Historically low interest rates have lured back customers to the borrowing table and the once frozen credit market has shown signs of revival. But as the Wall street Journal has put it, there is still a lot of stress. The journal says, "This silver cloud has a dark lining. Millions of consumers continue to default on their mortgages, home equity and credit card loans. Corporate loan losses are just starting to pile up. And the residential housing crisis is seeping into commercial real estate with a vengeance."

The US government's stress test findings due to be released in May will throw more light on whether the banks' are witnessing a temporary rejuvenation or whether they have the wherewithal to endure more stress, if required, in the future.

India was supposed to soon launch the 8th round of auctions of oil and gas blocks (NELP VIII). But that's now been deferred. Apparently prospective bidders were not happy that the natural gas producers would not get the tax breaks that oil producers would. After all, explorers do not know going in, whether they'll hit oil or natural gas. It may be noted that this issue had surfaced in the 7th round as well. It's high time we got our act together in such matters. After all, we depend on others for over 70% of our hydrocarbon requirements. So the last thing we need is to alienate investors into the sector, especially when the prospects for discovering natural gas seem bright in certain regions in India.

Investment banks have paid the price for precipitating the current financial crisis. But, in an interesting article, The Economist states that the governments' obsession about home ownership has contributed as much to the meltdown as any investment banker. So where did these governments go wrong? The answer lies in subsidising private housing. Under the false notion that ownership encourages stable neighbourhoods and local democracy as compared to renters, governments went all out to subsidise housing. But rather than foster a culture of saving, millions of people instead used their homes as collateral for general loans thereby fuelling consumption. The bubble then bust and the rest they say is history. Therefore, what the governments need to understand is that while subsidies may provide people with homes, the latter should not then become too dependent on government handouts.

Aviation is arguably among the most difficult industries from the owner's perspective. It suffers from disadvantages in both input costs and pricing power. The highly capital intensive nature of operations and vagaries of crude oil prices make costs hard to control. The presence of many competitors and commoditisation of tickets due to travel portals exert a great deal of pressure on ticket prices. Little wonder then, that bad news continues to pour out from the Indian civil aviation sector.

As per DNA Money, airlines have not hiked fares despite 3 hikes in aviation turbine fuel prices in the last 45 days to the tune of 18%. Airlines fear any hike will reduce air traffic which has already declined on a YoY basis. Basically, any hike in prices is nullified by decline in volumes, a tell tale sign of a commodity market.

Another article in the Business Standard reports how foreign airlines are pulling out of India. Apparently, high airport charges and a decline in premium inbound traffic has exerted severe pressure on margins. In fact, leading international airlines have cut back on over 100 flights in the last 6 months. While the global slowdown has an impact on the aviation industry worldwide, the cost structure in India seems to be particularly bad. As per the article, airport charges are declining anywhere between 10% and 50% worldwide, but increasing in India to the tune of 10%.

In another story, The Economic Times reports that Jet Airways, one of the leading Indian carriers, is all set to cut nearly 400 jobs as part of a restructuring exercise. It plans to do away with offices in multiple cities and centralise back end operations to its Mumbai location. It also plans to automate services like passenger check in a bid to reduce the employee count.

While some of these factors might seem unique to the present circumstances, we believe the structure of the industry does not allow owners to breathe easy. During a boom, airlines suffer from over supply and skyrocketing fuel prices. During a bust, they struggle to fill the seats. Not the kind of business a long term investor would want to be in.

In spite of a strong selloff during the final hour of trade, stocks in India ended on a firm note as buying activity recouped during the final minutes of trade. The BSE-30 Index ended with gains of nearly 75 points. Stocks from the realty and banking space led the pack of gainers, while stocks from the metal, FMCG and healthcare space bore the brunt of profit booking. As for global indices, Asian markets such as Japan (up 1.7%) and Hong Kong (up 0.1%) ended in the green, while China ended the day on a weak note (down 1.2%). Stocks in Europe are currently trading firm.

04:45  Today's investing mantra
"One lucky break, or one supremely shrewd decision-can we tell them apart?-may count for more than a lifetime of journeyman efforts. But behind the luck, or the crucial decision, there must usually exist a background of preparation and disciplined capacity... these opportunities will knock at his particular door. One must have the means, the judgment, and the courage to take advantage of them." - Benjamin Graham
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2 Responses to "Gold is not an investment"


Jul 22, 2010

Gold is definitely Gold and needs investment.I would appreciate if you can give more ideas or information regarding Gold ETF Funds!!! Because even my bank HDFC guys also have no info.


praveen yada

Apr 17, 2009

it`s a DUTY in a traditional indian family to keep on buying gold.

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