Is this the intrinsic value of gold? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Is this the intrinsic value of gold? 

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In this issue:
» Why are realty prices not coming down?
» Interest rates and not the economy take a U-turn
» Another downgrade for India
» RBI Governors' tryst with curse
» ....and more!

His Nobel memento notwithstanding, we aren't particularly huge fans of Paul Krugman. Simply because we prefer to be on the other side of his economic ideologies. Thus, when he said recently that absence of inflation is the evidence that inflation is absent, we again felt like opposing him. In fact, an analyst named Dylan Grice has done just that - much better than us we should say - punch big holes in Krugman's theories.

The absence of inflation that Krugman is talking about has existed in all of the recent crises. The view that there is no inflation was strongly held during the US subprime crisis. Yet, it led to unprecedented wealth destruction. So was the case during the Asian financial crisis and the Japanese crisis of the late 80s. Even here no warning bugles of high inflation were sounded by policymakers. Still, there was huge loss of wealth.

Thus, as Grice points out, before each episode of instability was an episode of stability. And therefore, it would be dangerous to assume as Krugman is doing that the current stable times means there would be no instability. And why do we think that this too would end in serious instability? Simply because, the technique that is being applied to create stability is eerily similar to ones used in all the previous crises.

To be fair to so called pundits, even they want to make this world a better place. However, they don't seem to have done enough research on the right way to achieve this. Their measures have done nothing but trade near term stability with an even larger instability down the road.

And the evidence is for all of us to see. We are living in a world not only more indebted than before, but also beset with other problems like negative real interest rates, sovereign default, money printing, high unemployment and growing distrust.

But nowhere is this causing a bigger damage than in the price of gold we believe. Krugman like thinkers are busy believing that current low gold prices are justified because there is hardly any evidence of inflation. However, as we've highlighted, the costs of applying the wrong technique usually lie hidden for some time but eventually express themselves.

Therefore, in a world where there will be hardly any place to hide, gold will be the only asset that would be capable of preserving purchasing power for many years to come. And this is its true intrinsic value we believe. Thus, gold accumulation as a certain percentage of one's portfolio would not be a bad idea at current price if one already hasn't bought into it.

Do you think there will eventually be a period of high inflation and instability? Please share your comments or post them on our Facebook page / Google+ page

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01:33  Chart of the day
Which countries come to mind when you think about India's biggest trade partners? US? China? Well, these countries are certainly amongst India's biggest trade partners but neither of them is the biggest. That honour goes to the UAE. Indeed, with oil imports being our biggest import, the oil rich UAE is the country we do the maximum trade with. Not far behind is China, the manufacturing powerhouse of the world. While we do not have data, our understanding suggests that we would be running a trade deficit with both of these nations, certainly not a good sign. What will help boost our currency and forex reserves is more exports from and not imports into India.


A U-turn is what everyone is hoping and praying for. But that is with respect to economic growth. Unfortunately, as we have been expecting, it is the interest rate cycle that has taken a premature U-turn. Rates are once again moving up! This trend can have far reaching consequences on the already struggling economy and corporate profits.

For investors too, a rise in interest rates can have significant impact on investing decisions and asset allocation. For instance, significant rise in interest rates could have banks and corporate deposits luring investors. Here too steep promises can be extremely deceiving! But what worries us most is the fate of individuals and corporates who are leveraged. While betting on a cut in interest rates all this while, they are suddenly in for a shock. And as rates keep getting higher, retail and corporate defaults could once again become the norm.

Real estate prices typically move in cycles. And the Indian market has witnessed two cycles over the last 15-20 years. One was from the period of 1994-99. And second was from the period of 2004-09. As per the author in a First Post article, both the cycles were triggered by favorable policies. While the first one was the outcome of industrial boom, the second one emanated from services boom. Analyzing the price movement in both the cycles presents an interesting co-relation between market prices and the state of real estate market. In fact, it shows that property prices do not truly reflect the state of the real estate market.

For instance, take the case of the second cycle. Excessive debt, rising interest rates and economic slowdown led to a correction in property prices. But soon prices started heading northwards. In fact, prices even crossed the peak of 2009 within a span of 2-3 quarters. But the state of the property market was completely different. Sentiments and unit sales both were down. As such, the price rise was not a true reflection of what was happening in the property market. Overall, the effectiveness of price as a measure to gauge the state of real estate market became doubtful.

If prices do not reflect the true reality then which measure should be used? It seems that volumes can turn out to be a better gauge of the state or realty market. It can help understand the true movement of inventory in the market which is a correct reflection of sentiments. Also, prices are more manipulative we believe which makes their usefulness questionable.

Being the governor of the RBI is quite a tough job. The past few governors would certainly acknowledge this fact. For instance, S Venkitaramanan became the governor in 1991. This was just when India was grappling with a severe economic crisis. Bimal Jalan took over the mantle in 1997. This was when the Asian financial crisis was creating problems for the rupee. And the latest is Mr Subbarao who was appointed governor just days before the global financial crisis intensified.

However, in recent times, it is not just the worsening of macroeconomic factors that has made the job an arduous one. Indeed, Mr Subbarao would agree that the government and its ineffectiveness has also played its part in worsening matters. Keeping in mind the economic health of the country is one aspect of the job. But Mr Subbarao also has to deal with the added pressure of not always bowing down to the whims and demands of the FM and the finance ministry. As reported in an article on Mint, Mr Chidambaram has indicated that the central bank will soon have a new governor. If history is any indicator, it will certainly not be a smooth ride.

A major headline in most of the media is that Goldman Sachs has downgraded India to 'Underweight'. The reason is the sluggishness in economic activity with no visible signs of a recovery in investment demand. All this is on account of our twin deficit problem that has brought the Rupee under pressure. In addition to that, as per the investment bank, the foreign investors would be turning averse to India as US Fed is expected to taper off its QE program. They have also suggested that investors would do well to be selective when it comes to stock picking.

Readers of our 5 Minute Wrapup would recall that we have been saying the same things for quite a while now. The country is seeing a slowdown due to the lack of policy reforms and implementation. This has hurt the deficit situation which in turn has brought our currency under pressure. The government has to wake up and act quickly on these fronts rather than forming new states and coming out with press conferences saying all is well. Otherwise this maybe just the first of many downgrades for our country.

Meanwhile, indices in the Indian stock market are trading volatile today with the Sensex lower by around 35 points at the time of writing. Weakness in realty and energy sectors was the maximum. While Asian stock markets closed strong today, Europe is also trading in the positive currently.

04:57  Today's investing mantra
"I have resolutely turned my back on efforts to predict the future" - Benjamin Graham
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1 Responses to "Is this the intrinsic value of gold?"

Rajesh kumar seth

Aug 2, 2013

sir, with due respect to our policy makers,i believe they r handling the crisis in a very wrong manner,the gap between our imports and exports is increasing which is the root cause of all our problems but we r trying to cover up this gap by FDI which in longer term will again harm us,the biggest example infront of us is of colas and pepsi they first invested here killed the local brands and now they have monopolised the local market,they invested once and now they r reaping profits on it, instead of this we should encourage and support our corporates to fight them out,we r getting dependent on imports of even very small items like crackers for deewali or colours for holi which does not help our economy in any way,the government even should educate people to be patriotic and should not import such petty things,it is like self imposing restrictions, we should take very strict actions to improve the situation like banning 100% gold imports for next five years and u will see that our economy will become the top most economy in the world.
with regards,

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