How will the future treat 'investment' and 'speculation'?

Jul 17, 2013

In this issue:
» China's fondness for US Treasuries has not weaned
» Which could correct more - oil or gold?
» Projects worth a trillion put on fast track
» What will 100% FDI in telecom mean?
» ...and more!

"Now, speculation - in which the focus is not on what the asset will produce but rather what the next fellow will pay for it - is neither illegal, immoral nor un-American. But it is not a game in which I and Charlie wish to play." The words of Warren Buffett in his 2000 letter to shareholders of Berkshire Hathaway highlight the thin line separating two 'money making' tactics. This was only one of the many occasions when the legendary investor showed his disapproval for speculative activities.

Buffett like his mentor Benjamin Graham, built his investing philosophy on the intrinsic value of stocks. The focus, therefore, was on investing based on the predictability of future cash flows of a company. Needless to say the companies whose cash flows will be subject to minimal risks in the future ranked top on Buffett's buying list. For an investor, then, it matters a lot as to how the future will treat the businesses of companies he has bought. The speculator, on the other hand, only worries about whether a 'bigger fool' will want to overpay for the stock.

Global stock markets have hardly ever shown a distinct treatment for investment and speculative activities as they have in the past decade. The flow of easy money in the build up to the 2008 crisis encouraged speculative activities like never before. Not just stocks, bonds and realty, but assets of the most complicated nature attracted speculators. Wall Street cashed in on the speculators' greed for quick and easy money. What followed was a blood bath in the markets. And the relegation of speculators to 'criminal status'. Despite that, neither has global liquidity dried up, nor have speculators learnt enough lessons. But given the proportion of risks that the future could throw up, investors should rather be wary of the consequences.

It is the individual's choice to invest for creating long term wealth or indulge in frivolous speculative activity for supernormal returns. However, we believe that the coming decade will be more ruthless to speculators and relatively benign to serious investors. If the past has been reason enough, speculators should take cues about the future for a rethink.

Do you think investing as against speculation will pay off in the future? Please share your comments or post them on our Facebook page / Google+ page

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 Chart of the day
Oil and gold are not giving a tough time to Indian policy makers alone! The prices of the two most sought after commodities in the world have been extremely unpredictable for several months now. And one can hardly hazard a guess as to which one will trip the other as the global economy braces with more difficult times. A look at the oil to gold ratio (barrels of oil that can be purchased with an ounce of gold, both valued in US dollar terms) may offer some cues. If one looks at the oil to gold ratio over the past 7 decades, the average stands at around 14.7 barrels of oil per ounce of gold. The ratio currently stands a little over 16 barrels. Hence if one bets on reversal to the mean, a correction in oil prices does not seem imminent. Nevertheless, one cannot ignore the fact that lower demand from two biggest consumers, the US and China, could bring oil prices below long term average.


While we are at recent times, global investors have turned increasingly bearish on gold. The biggest trigger to the gold price decline has been Ben Bernanke's comments in June about a like tapering of the monetary stimulus program. It must be noted that the US Fed's quantitative easing (QE) program includes monthly bonds purchases of US$ 85 bn. The reason for the prospective pullback of the QE program was the seeming improvement in the US economy. A recovering economy coupled with lower liquidity pumping spelt bad news for the yellow metal which is known to be a hedge against inflation.

But over the last one week, gold prices have shown some recovery. This was after the US Fed Chief changed his stance on the QE program. He indicated that the stimulus program may have to be continued as the Fed was still far away from achieving its economic mandates. So the likely continuation of the QE program has pushed up gold prices. But prices are still 24% lower (in US dollar term) than the start of the year. Does this mean gold could be a good investment opportunity now? As per an article in CNN Money, this could indeed be a good buying opportunity. Demand for gold, especially physical gold, is expected to remains robust in the long term in countries such as China and India. On the other, gold supply continues to remain tight. Simple economics suggests that high demand and short supply would eventually gold prices higher. However, one must note that gold prices could continue to be highly volatile in the short to medium term.

It is well known that China is the biggest holder of US Treasury securities. That is why it has also been quite vocal about the expansionary policies of the US Fed. Plus it has questioned the status of the US dollar as the world's reserve currency. Despite this, China's holdings of US Treasury securities rose to a record in May 2013. One reason for this has been that other foreign investors have been selling their holdings. For instance, Japan, the second-largest holder, cut its holdings to US$ 1.1 trillion. The other reason could be that the Chinese central bank wants to take advantage of high yielding Treasuries for longer term duration. It must be noted that the US Fed's possible tapering of its bond purchase program has pushed up the yields on the 10-Year Treasury note. The dollar has also rallied against other currencies. Consequently, as per an article on Moneynews, China's holdings increased by US$ 25.2 bn to US$ 1.3 trillion according to Treasury Department data. Whether this augurs well for China going forward remains to be seen.

There are advantages in size. There's absolutely no doubt about that. However, the same size becomes a liability if a radical transformation takes place in an industry. The transformation that totally changes the established order of doing work. And if an article on the zerohedge portal is to be believed, a similar transformation is just waiting to happen in the field of manufacturing. It has argued that in few years time, we could witness a new industrial revolution. A revolution that will be brought about by the internet. Of course internet has been around for quite some time. But the emergence of technology like digital manufacturing and 3-D printing will make large manufacturers redundant and will turn any internet user with the requisite tools into a producer. Thus, just as almost everyone is a blogger today, everyone will become a manufacturer tomorrow. Thus, large manufacturing companies are likely to lose significant market share. And who faces the biggest threat from this change? Well, it is the current mass manufacturing powerhouse of the world China we believe. Thus, the biggest threat to China does not come from the looming credit crisis. But from the transformation we just highlighted. Therefore, the dragon nation will do better to quickly move itself up the value chain. Or it risks putting millions of its citizens out of work.

Delay in approvals has stalled most infrastructure projects for several years now. And this has created issues for both infrastructure companies as well as banks who have lent to such projects. However, government is keen to resolve this issue as soon as possible. For one, the government is keen on taking inputs from banks as to how the execution bottlenecks can be eradicated. Since banks have appraised these projects they are aware of the hurdles which are causing delays.

The ministry also plans to create a special cell that will address the issues relating to execution. This cell will constitute of all the concerned parties involved including banks. It is believed that better coordination amongst concerned parties will speed up execution. It may be noted that the ministry has worked out a list of 98 stalled projects (worth over a trillion rupees) which must be put up on fast track. If the government delivers in this regard then not only will it speed up execution and thus growth but it will also help increase the velocity of money. Right now most banks are unwilling to lend to companies whose projects are stalled as there is a fear of fresh loans turning bad. Clearance to stalled projects will increase disbursement and also reduce the risk of non-performing assets.

The government took a bold step towards reforms and went ahead to increase FDI limits in 12 sectors. This includes the telecom sector. Here the government has increased the FDI limits from 74% to 100%. The move is being applauded by many as this is expected to help the foreign partners of the Indian telcos. Now they can simply infuse equity to fortify their expansion plans rather than piling on debt which they had to under the previous norms.

The government also thinks that could trigger the much needed consolidation in the sector. That seems to be highly unlikely unless the government decides to clarify its own policies on mergers & acquisitions in the sector. So far the policies on the subject have been vague and inconclusive.

The biggest hope that the government has is that this would attract fresh foreign capital into the sector in the long run. But the question is would companies really be interested in increasing their exposure to the Indian telecom sector? The sector is burdened with regulatory issues and intense competition. Margins of the existing players have been getting narrower and narrower. Even the incumbents have found the environment getting less and less conducive. This would act as a major deterrent for any new entrant. Therefore simply increasing FDI limits would not really help the sector or its players. The government needs to improve the regulatory framework if it wants to improve foreign investor sentiment towards the sector.

Continued profit booking in banking and commodity heavyweights has kept the key indices in Indian equity markets below the dotted line today. The BSE Sensex was trading lower by around 42 points at the time of writing. Key indices in Asia, except China and India, closed higher today while markets in Europe have opened in the negative.

 Today's investing mantra
"You can't be a good value investor without being an independent thinker."- Joel Greenblatt

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