Equitymaster interviews Dr Doom - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Equitymaster interviews Dr Doom 

A  A  A
In this issue:
» Have governance standards at Infosys got diluted?
» Why shadow banking is a threat to Indian and Chinese financial system
» ECB's bond buying program has no limits!
» How to curb ponzi menace?
» ...and more!

He does not need an introduction. Only a mention of his name is sufficient to draw the attention of investors. This gentleman is none other than Dr Marc Faber; a widely followed contrarian investor and the editor and publisher of "The Gloom Boom & Doom Report".

Recently we got an opportunity to interview this investment guru. His inputs on current state of the world economy, gold prices, and emerging markets particularly India were very enlightening. He also made three very interesting predictions which may help investors in their long term investment decision making process.

We know that the world economy is in a sort of crisis. Dr Faber believes that the current situation is a result of excessive leverage in the West. But it is the response to this crisis that worries him the most. The money printing exercise undertaken by the central banks in the West is not a long term solution to the current debt problem. Not only can it lead to monetary inflation but also asset price bubbles. This leads to divergence in asset values. In short, paper investments be it stocks or currencies are facing this divergence risk now. Hence, one has to be really careful in taking exposure to equities.

With respect to commodities, he has a slightly different view. While most industrial commodities are down due to lack of demand these asset classes are comparatively better placed than equities to weather the current crisis.

When it comes to gold he is of the opinion that the recent correction was overdue and current fall should be seen as attractive opportunity to buy the metal. In fact, his portfolio still consists of gold that was accumulated at an average price of US$ 300 to US$ 400 per ounce. True, gold may not fetch the highest returns for a long term investor's portfolio; importantly it may not beat returns from equities. However, with current uncertainty where investors have had to take a haircut on their banking deposits in Cyprus, gold's relevance in the portfolio has increased all the more. Not only does it hedge you against inflation risk but also against currency risks. The fact that Dr Faber holds as much as 25% of his portfolio is sufficient proof of his trust in the qualities of the yellow metal.

When it comes to emerging market equities he is bullish on India but is concerned about the governance structure. Nonetheless, huge untapped potential still exists in the country which will enable it attract foreign capital.

He also made three very interesting predictions for the future. For one, he feels that the rally in US stock markets could easily die down soon. With stock markets being highly integrated these days it gives investors a sense on what's going to happen with other markets. Secondly, he feels that the bond market rally is probably over. With very little room to reduce interest rates from these levels this is pretty much true. Lastly, he believes that the Japanese markets are probably out of its two decade bear run. Thus, there is an additional channel where liquidity created by the western central banks will flow from here on.

In short, Dr Faber was not too optimistic about the stock markets in general. His exposure to real estate, commodities and gold signify that. Over all the gist is that investors will do well over the long term if they have a proper asset allocation in place.

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01:55  Chart of the day
The month of June is associated with onset of rains. However, coincidentally it is also associated with rupee depreciation. Today's chart of the day shows how on all 5 occasions in the past rupee has had its worst performance against US dollar in the month of June. Though June month depreciation is a mere co-incidence market participants are worried about the sudden steep decline in rupee. The depreciating rupee is an indication that country is not attracting enough foreign inflows. At the same time it also indicates that foreign capital is fleeing Indian markets. Rising inflation and increase in demand of dollars by oil companies has put further pressure on the rupee. Increasing demand for gold which is bought and sold in dollars has also hurt rupee. All these factors have led to sudden fall in rupee.

But the question is will this fall continue and will rupee breach its lowest level of 57.16 against the US dollar as witnessed on 22 June 2012. While it is difficult to say whether this will happen or not the recent steep fall gives an indication that unless some sort of external intervention takes place the fall might continue. That's because all the odds are currently stacked against rupee. Foreign fund flows are drying up. Also, current account deficit is widening. Inflation is high. All these factors indicate that there is a case of further downside from current levels for the rupee.

Data source: Bloomberg, Business Standard, Economic Times

The Indian IT industry received a piece of news in the past fortnight. This was of the return of Mr Narayana Murthy to Infosys Ltd. This would mark his second innings with the company. But this time around his appointment has raised quite a few questions. And that too questions related to corporate governance. This is for a company which has been revered for its high corporate governance. The thing is that Mr Murthy's return means that the company has decided to bend its own rules. Infosys has a policy by which the retirement age has been set at 60 years. Even during his retirement, Mr Murthy had stated that randomly changing the rules and policies reflect poorly on the governance of the company. But just a couple of years down the line, this case no longer holds true. To get the company out of the slump that it is currently in, it has decided to change its rules and get Mr Murthy back on board. The bigger problem is Mr Murthy's appointment of his own son. This is nothing short of nepotism.

These questions of corporate governance are something Infosys must reply to if it wishes to continue harping on its high standards. True that Mr Murthy's phenomenal leadership is something that has helped the company in the past. Undoubtedly we can expect this to continue into the future as well. But should this growth come at the cost of governance?

Thanks to it, financial instruments with 17.5 trillion yuan of outstanding loans are unregulated. Thanks to it, small firms in China pay interest rates as high as 20-24%. Yet, the system of shadow banking in China is thriving. For the uninitiated, these are entities not regulated by the Chinese central bank. They do issue loans and hold deposits. But their loans and investments are often less liquid and riskier than their deposits purport to be. Importantly, in the absence of a regulator, players in this business can be predatory.

Unlike India, China imposes a ceiling on interest rate for bank deposits. Thus, as per an article in Economist, the Chinese shadow-banking system has evolved to merely help banks evade deposit ceilings. Also lack of access to credit forces small firms in China to borrow from the shadow banking system at astronomical rates. Now that is a malaise even India cannot claim to be free of. Until recently micro finance lenders in India lent to the poor at unreasonably high rates. Money lenders still thrive in Indian villages that do not have access to bank credit.

Thus, whether in India or China, the system of shadow banking will thrive until there is financial inclusion. Also financial policy making must be more liberal and transparent.

Time and again we have raised our concerns about central bank going on a money printing spree. The central banks of developed economies have been running massive bond buying programs.

We came across an interesting article in the Wall Street Journal. As it turns out, the European Central Bank's (ECB) bond buying program hasn't gone down well with several German critics. It is argued that ECB's bond buying quite resembles a scheme of government financing with money printing press. And such an approach is fraught with risks of fiscal recklessness and inflation. As such, the ECB's program has been challenged in Germany's constitutional court. This week the court is set to consider claims of the ECB critics.

One major issue that has been raised is that the ECB is creating risks for German taxpayers. But unfortunately, the German elected representatives cannot control these risks. For instance, no German court can stop the ECB's program which is said to be unlimited. So the court's ruling may not directly impact the ECB program. But it might add significant political pressure and create uncertainty in the financial markets.

What do you think is a solution to a financial crime that just doesn't show signs abating? Should there be setting up of new regulators to tackle the same or the current regulations need to be more strictly enforced? Well, there is certainly a case for the latter if the laws are not being enforced strictly currently. And this is exactly the stance that the RBI seems to be taking with respect to Ponzi schemes. It is of the view that an amendment of the regulations would not be sufficient to tackle this ponzi menace and an effective implementation of laws is more important. The central bank is certainly right in its assessment we believe. The examples of Ponzi schemes that have come to light are mostly illegal and unlawful. Therefore, they can hardly be called as coming under the RBI's ambit. What is needed is more effective surveillance by state Governments and an extremely strict stance towards the perpetrators of such a crime.

In the meanwhile, the Indian equity markets were trading in the green. At the time of writing, the BSE Sensex was up by 92 points (0.5%). Sectoral indices represented a mixed bag with software and oil and gas stocks witnessing maximum gains. However, stocks in the healthcare and consumer durables were leading the losses. Barring Indonesia and China, most Asian stock markets traded in the green with Japan and Taiwan leading the gains. The European markets have opened on a mixed note.

04:50  Today's investing mantra
"It takes character to sit there with all that cash and do nothing. I didn't get to where I am by going after mediocre opportunities".- Charlie Munger

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    3 Responses to "Equitymaster interviews Dr Doom"

    Dr.Bhupen Desai

    Jun 18, 2013

    Please interview Mr.Jim Rogers.



    Jun 13, 2013

    How about searching at home and finding some value investors who have succeeded in Dalal Street-- Rakesh Jhunjhunwala , for instance? regds



    Jun 11, 2013

    We havent heard Mr Jim Rogers ,the Commodity Guru - who left US to China to settle down seeking greener pastures (but the US seems to be turning the tables now with long term Energy finds that could make it self sufficient) for a long time.
    Pl.try and get him.

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