Are stocks and MFs bearing the brunt of gold?

May 11, 2012

In this issue:
» China stops buying European government debt
» US stock markets may witness another 1987-like selloff!
» Upto 7% of India's annual food production rotting
» More subsidies on petrol may be in the offing
» ...and more!

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Even the rich today cannot deny that every penny saved is equal to every penny earned. Especially when liquidity is tight and high returns are hard to come by. But Indians have shown sufficient foresight with their savings. Since the time the Indian economy bore the merits of liberalization, our savings and investments reflected that. In fact that ratio of domestic savings to GDP (Gross Domestic Product) has been the highlight of the economy's growing fortitude. Having nearly doubled from 22% of GDP in 1991 to 40% in 2007, the rise in savings offered a major boost to investments as well. The domestic investments comprised nothing less than 36% of GDP in 2007. This was up from 26% in 1991. The healthy trend not just ensured that our GDP growth rates were enviable to the rest of the world. But the debt burden in the hands of Western households seemed unrelated in the Indian context. What is more, financial assets like stocks, mutual funds and debentures gradually became more acceptable to retail investors.

But a lot of water seems to have flowed under the bridge over the past 5 years. To begin with high inflation and negative real interest rates on bank deposits dissuaded retail investors. Stocks, debentures and mutual funds too gave jitters after the stock market crash of 2008. Moreover, lack of clarity on policy issues made investors sit on the edge. The insurance and mutual fund industries in particular saw a lot of regulatory flux. As a result some investors chose to completely stay away from them. Stock markets too failed to retain confidence of those having been cheated by unscrupulous brokers. In the meanwhile, gold as an alternative asset class got prominence. That its inflation hedging quality is vital to every investor's portfolio became well known. Hence steadily investments started shifting from financial instruments to assets like gold.

Not that stocks and mutual funds were an overwhelming proportion of Indian household investments earlier. Together they were less than 15% of GDP in 2007. Unfortunately, lack of confidence in their safety and returns has reduced the proportion further by 2012. As per HDFC, mutual fund assets under management (AUMs) have dropped from 12% of GDP in 2010 to 8% by 2012. Clearly, the decline in savings in financial assets is not just to do with favoritism towards gold. Also, the shiny metal, though necessary, cannot serve all investment needs. Therefore to boost the flow of savings to financial assets, the need of the hour is better regulation and more incentives. This in turn will ensure more economic stability to India's prospering middle class. At the same time it will save Reserve Bank Of India (RBI) the trouble of managing forex volatility due to excessive gold imports.

Do you think better regulation and incentives for household savings getting routed to financial instruments is a must? Let us know your comments or post them on our Facebook page / Google+ page.

 Chart of the day
After staying in the negative for most of 2010 and 2011, the real interest rates (adjusted for inflation) on one year bank deposits have of late moved back to the positive. However, banks are hoping to soon cut interest rates on deposits in line with the RBI's monetary policy. Hence, it now depends upon whether inflation remains tame enough for investors to make positive return on their money.

Data source: RBI, Equitymaster

Here's yet another indication of the deteriorating fundamentals in Europe. As per reports, China's sovereign wealth fund has stopped buying European Government debt amidst concerns of an economic crisis in the continent. Although it is still looking for opportunities there, the wealth fund has made it clear that it will no longer buy any Government bonds. Rightly so we believe. Most Governments in the continent are neck deep in debt. Thus making interest repayment look like a really tall order. Besides, unlike the US, none of the countries can print their own currencies and inflate their way out of the debt situation. This has made default a more likely scenario and obviously, China does not want to make itself a part of this wealth destruction. Instead, the wealth fund has trained its guns on Africa as it seeks to secure commodity supplies to feed its massive industrial machinery.

Dr. Doom, Marc Faber, has come up with another prediction. And again it's not too rosy. His prediction is that the US stock markets could witness a sell off similar to that in 1987 in the second half of the year. He has reasons to expect this crash. The earnings of most companies have seen a decline or a slowdown. The future looks even bleaker as most economies are going through a slowdown. With lower earnings most stocks start to appear expensive in terms of their Price-to-Earnings multiples. The only way to save the crash from happening would be another round of quantitative easing by the government. The government needs to provide some stimulus to the earnings. Unless it does the future outlook for stocks and hence the stock market looks gloomy.

Paradoxes can happen only in India. One would assume that food prices have been rising in India on account of shortage. But that does not seem to be the case. If foodgrains are not reaching the households of millions in India, it is because they are being left to rot in the open. Indeed, because the Indian government had been focusing on improving foodgrain production, the country has seen bumper harvests in recent times. But total apathy on the part of the government to provide adequate storage has led to foodgrains being simply wasted.

Up to 7% of the country's annual grain production goes to waste because of insufficient storage space and inefficient transport and distribution networks. So what is the solution? Some say that storage is not so much as a problem as distribution. Thus, one possible solution could be to liquidate the grain stock through additional allocations to the public distribution system (PDS). This would be to both APL (above the poverty line) and BPL (below the poverty line) families. The idea being to distribute grain before it decays. Others suggest a PPP (Public private participation) route to build storage facilities given how expensive they are to build. Food grains could also be used as part of workers' wages. Either ways, the government needs to pull up its socks urgently on this front. For no amount of monetary tinkering will bring India's inflation down unless such basic issues are not addressed soon.

The Indian rupee has declined significantly in the recent past. In order to avoid further depreciation, RBI has finally come with its rescue act. In the latest announcement, the central bank stated that foreign exchange earners should convert 50% of their forex holdings into rupee balances. Conversion into rupee will increase its demand and thereby support the currency. The said move will result in conversion of US$2-3 bn into rupees. However, the average turnover in the Indian foreign exchange market is about US$ 40 bn. Thus, in terms of volumes forced conversion will have a limited impact in salvaging the rupee. Also, we believe that the current move is just a temporary solution. The underlying problem of rupee depreciation stems from widening current account deficit (CAD). Waning foreign appetite for Indian stocks is an equal culprit. Thus, steps have to be taken in that regards. Overcoming CAD is a difficult task considering rising crude prices. However, government can at least take steps to create a congenial investing environment. This should attract capital flows and thereby support rupee.

If the current demand of oil marketing companies is anything to go by, the Indian government would again find itself at the same old crossroads. They would be facing the perennial dilemma of choosing between inflations and fiscal deficit. Actually, as per the government-owned oil companies, they are losing over Rs 7 per litre on sale of petrol. And they want the government to compensate for the same. True, petrol price is already de-controlled. However, petrol price hardly moved in tandem with the crude price. With the increase of crude price in the last five months, no revision in the petrol price has added losses to the oil marketing companies.

There are many options in front of the Indian government. Keeping inflation in mind, for the time being, the government can declare petrol as a regulated product. And compensate the companies for their losses. This would add to the expenditure of the government. Else, it can reduce the excise duty on petrol to compensate for the losses. In this case, the government would be losing on its revenue collection. Hence, both ways, fiscal deficit would come under pressure. And if, the government decides to go with the hike in petrol prices, inflation may again go out of the roof. What path will the government choose? We have to wait and find out. However, more financial pain seems to be in the offing.

Taking cues from their peers across Asian markets, the indices in Indian stock markets opened lower and continued to languish in the negative territory for the rest of the session. At the time of writing, the BSE Sensex was trading 34 points below the dotted line. The indices in most other Asian markets closed lower in today's trade. Those in Europe have also opened in the red.

 Today's Investing mantra
"It is natural to assume that industries which have fared worse than the average are "unfavorably situated" and therefore to be avoided. The converse would be assumed, of course, for those with superior records. But this conclusion may often prove quite erroneous. Abnormally good or abnormally bad conditions do not last forever. This is true not only of general business but of particular industries as well. Corrective forces are often set in motion which tend to restore profits where they have disappeared, or to reduce them where they are excessive in relation to capital" - Benjamin Graham

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3 Responses to "Are stocks and MFs bearing the brunt of gold?"

sunilkumar tejwani

May 12, 2012

Many innocent savers have lost money in numerous schemes floated by various so called reputed business organizations which include ICICI, H D F C, Bajaj to name the few. Savers have been cheated by their Corrupt & self seeker advisers by mi selling unit linked products. By selling these products, investors are shying away from any investment products. The need of the hour is to completely ban front loaded financial products. Otherwise we will be second to none like united states of America where every retail investor is subsidizing fat pay cheques of greedy executives of numerous listed companies.


Ashok Vaishnav

May 11, 2012

In spite of all hefty incetives, if Insurance has still not attained a respectable penetration across households, products related to financial markets can hardly be expected to have done any better.
In fact, by remaining a club of [relatively] few,finacial markets are yet to be percieved as 'safe' places for investment of [hard earned] money.
That is why Post Office Savings and [to some extent] bank deposits still rule the roost, irrespective whether they are better bets agianst the current and future inflation



May 11, 2012

Now on Food Frains rotting. I recollect sometime back on a PIL,
Supreme Court asked the Govt "why it cannot distribute the
grains freely to the poor? And if I recollect correctly, the
Hon.Agri. Minister said this is not possible. He can allow the
grains tprot, he can allow the grains to sell in the
international markets below MRP but will not give it to poor.
What sort of insensitive people we have running the country? On
Wed,day I happen to see Telecast of Loksabha proccedings, where
the matter talked was on "urgent public interest matters".
There was it appears just enough presenty to continue the
proccedings. Out of 4 questions, 3 were related corruption
emanating from food, roads and one on law/order of naxalite
problem in Gadchiroli. What apathy on the part of our learned
and most vocal MPs and then they complain about the .......
select choices expressed by the public.

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