Does 8% tax-free return sound appealing? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Does 8% tax-free return sound appealing? 

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In this issue:
» What is the gold silver ratio saying?
» Derivative losses come back haunting
» Will Merkel evict Greece from Eurozone?
» Dr Doom is finally bullish on...
» ...and more!

We are living in times when return of capital is a bigger worry than return on capital. Needless to say, investors are willing to compromise on returns, to any extent, for safety of their capital. The poor economic and earnings outlook have got investors averse to the idea of investing in stocks. Bonds and fixed income instruments, which were mis-sold on the premise of safety, have also eroded investor wealth in recent months. Thus, there is hardly anything beyond bank fixed deposits that investors wish to park their hard earned money in.

Every now and then, we get investor queries asking why they should remain invested in equities. That most stocks will return less than FD interest rates over the next one year is a no brainer! Well then, should anything beyond fixed deposits even feature in the asset allocation for retail investors? Our answer to this would be absolutely yes! While fixed deposits can offer assured returns for short term, they can hardly cover for inflation over the long term. And gold, although a necessary hedge against inflation and currency risks, cannot be a major portion of one's portfolio. It is therefore important to remain invested in equities. More so, in such times when the dividend yields are making up for the lack of capital gains.

Take the case of PSU banks for instance. Most of them have been battered over the concerns of treasury losses and non performing assets. The fundamentals of these entities have certainly deteriorated over the past one year. Some have the worst behind them. Others are yet to see some pain. Markets therefore have discounted the valuations of these entities to such an extent that they are now more valuable dead than alive. That is, most of them are trading at 50% of their networth. Important to remember that the PSU banks together corner 60% of India's banking sector. And their future, although bumpy, is secured by government holding. Thus the dividend payouts of these entities too are guaranteed to a great extent. And at current prices, the generous payouts can fetch investors yields that are very close to FD interest rates. What is more, unlike FD interest rates, the yields can only go up as the payouts increase year after year. Also, that dividends unlike FD returns is tax free in the hands of the investor makes the case stronger for the former.

Now, this is not to say that investors should grab every PSU bank or other stocks offering mouth watering dividend yields. The risks that some of them carry can indeed wipe out portfolio returns. Also one must avoid getting carried away by the lure of dividends. The exposure to such stocks, if at all, should be keeping in mind their balance sheet and management quality.

Source: Equitymaster

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01:35  Chart of the day
Above Rs 34,000 per 10 grams, the price of gold has gone up nearly 25% in couple of months! Given the possibility of global economic crisis and war with Syria, the possibility of investors rushing to the safe haven asset seems more real. Even the so-called gold bears, who were sounding its doom few months back, have now changed opinion.

But should one only focus on gold? Would other precious metals, for instance silver, have some upside? Well, the gold silver ratio could answer that to an extent. As per Investopedia, the ratio shows how many ounces of silver it takes to purchase one ounce of gold. The ratio between gold and silver over the past 50 years has averaged around 50. That is, on an average at least 50 ounces of silver is required to buy an ounce of gold. Hence, one can conclude that if the ratio is above 50, silver is a good buy. As per, the ratio currently stands at 58. So, probably investors should be looking at precious metals beyond gold.

Having said that, like any other investment, the exposure to precious metals should be limited. Also instead of looking for short term gains, they should be held in the portfolio as a hedge against inflation and currency risks.


Troubles for Ranbaxy just keep piling on. The company has been at the centre of a storm for faulty manufacturing practices, fraud and bad corporate governance. Troubles with the US drug regulators which began way back in 2006 have considerably damaged the company's reputation both in the domestic and the international markets. One would think that the company would a tleast try to rectify errors that it has made in other aspects of running its business. But that seems to not be the case.

Indeed, the company has been caught on the wrong foot with respect to its derivative hedges. Wrong calls on the rupee means that it will end up posting forex losses of around US$ 200 m in the September quarter! This would effectively take its cumulative loss on account of derivatives to over US$ 1 bn, which is massive. The problem is that Ranbaxy has just not learnt a lesson. The company had signed derivative contracts worth US$ 4 bn again way back in 2006. The global financial crisis unraveled in 2008 with complex derivative instruments being one of the culprits. And yet Ranbaxy chose to stick with such risky instruments. What is more, as per an article in the Mint, the company's CFO opines that the derivative loss will continue to reflect in the books for the next 2 years if the rupee keeps sliding. This is a classic case of bad management practices, we believe. And one needs to be very very careful about investing in such companies.

In fact, this may be a good time to revisit the basics of investing, before investors go on to select stocks for their portfolio.

While for Indians gold prices recently touched all-time highs, the international gold prices are well below peak levels. In fact, international gold prices had fallen substantially due to the likelihood of tapering of US Fed's massive quantitative easing program. As such, gold mining firms have been impacted adversely. Some major South African mining firms reported losses during the second quarter. The losses have prompted them to cut down costs. Some companies have scrapped dividends. That's not all. All the four major South African gold producers are now bracing for the first industry-wide strike since 2011. The National Union of Mineworkers (NUM) has notified gold miners that its members will go on strike from Sept 03, 2013.

Workers have been demanding a substantial hike in wages. But the managements of these companies seem unlikely to yield to their demands. It is worth noting that gold miners' salaries put them in the top 15% of earners in South Africa. In fact, if bonuses and allowances are included they pay can almost double. For a decade, workers have been receiving above-inflation pay raises. But given the slump in gold prices, this cannot continue. As per certain estimates, production stoppages will cost about US$ 34 million a day in lost revenue. This has prompted gold producers to hoard cash.

If you thought only Indian politicians are expert at looking the other way and playing blame games, it's time to reconsider we believe. For politicians are politicians, cut from the same cloth everywhere. Take for example German Chancellor Angela Merkel who's seeking a third term next month. At a public meeting recently, she accused her predecessor for supporting Greece's membership in the Eurozone. Schroeder, her predecessor, accepted the Greece into Eurozone and weakened the stability pact, alleged Merkel. Bother were fundamentally wrong and the reasons for our problems today, she concluded.

So, Merkel is having a problem with Greece. But is she going to go ahead and take the tough call of evicting Greece out of Eurozone? Certainly not we believe. She has overseen a massive bailout of Greece and is likely to provide more funds if required. Thus, her allegations are nothing but empty talks and are aimed at diverting the attention of the German public. We believe the whole of Euro and not just Greece's inclusion in it was a flawed idea. And the authorities are making matters worse by kicking the can down the road. They fail to understand that the more they try to cover up, the bigger the cost they will have to pay in the future.

Coming back to gold...Dr Doom is finally bullish on about this asset class! In a recent interview, Marc Faber has stated that he expects gold to hit new highs. He feels that the recent correction that the metal has seen is probably as bad as it will get. The chaos in the world will now help drive the next bull run for gold.

The chaos is basically the money printing exercise being carried out by the developed world. While US has suggested that it may taper off its QE program; there is still a lot of printing being done by the Euro zone as well as by Japan. And even if US switches off its printing presses, it still has a lot of problems that need fixing. It has an ageing population which would mean that entitlements and benefits that the government needs to give out will only increase. Add to this are the problems of higher interest rates and inflation which would eventually come in if the QE program is shut down.

So with all this volatility and uncertainty, the one asset class that will flourish would be gold. As such Dr Faber expects gold to go beyond the highs it had hit earlier. However the exact time frame by when this would happen is something no one can pinpoint. Not even him. This echoes our view on gold. We have always been strong supporters of having gold as a part of one's portfolio. It would act as an insurance policy when the tide takes a turn for the worse.

A possible US air strike against Syria for an alleged chemical attack on its own people caused a sharp reaction in financial markets. Global stock markets witnessed correction. Oil and gold prices spiked before the mood calmed down. Syria's unsettling situation compounded nervousness over a possible tapering of the US Federal Reserve's stimulus program, which could come as early as 18 September.

India's GDP for the first quarter of FY14 grew by just 4.4% against 4.8% in the fourth quarter of the previous financial year. The rupee continued to touch all time lows during the week, creating severe volatility in the Indian stock markets. The rupee slumped to a record low near 69 to the dollar on growing worries that foreign investors will continue to sell out of a country facing stiff economic challenges and volatile global markets.

The Indian equity markets closed the week higher by 0.5%. Majority of the sectoral indices ended in the red with banking (down 4.5%), PSU (down 4.5%) and realty indices (down 4.1%), witnessing the maximum losses. IT stocks witnessed a huge spurt clocking a jump of 6.4% during the week.

Source: Yahoo Finance, Kitco

04:50  Weekend investing mantra
"Proper accounting is like engineering. You need a margin of safety. Thank God we don't design bridges and airplanes the way we do accounting." - Charlie Munger
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