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The hidden message in India's coal reforms

Nov 8, 2014

In this issue:
» Who will bail out Gold?
» The asset class that stole the show from equities in 2014
» Will junk bonds continue to whet investor appetite?
» Roundup on global markets
» ...and more!


00:00
 
It took 42 years for Indian policy makers to realize the potential of optimizing the use of natural resources to stoke GDP growth. Private mining of coal for industrial consumption has been banned for over 42 years now. This despite the fact that India has amongst the world's largest reserves of coal. Not surprisingly, the country's power plants have been deprived of the mineral thanks to dependence on high cost imports. With a monopoly in coal mining for decades, the state owned miner, Coal India has had no incentive to bring in efficiency. With the annual produce of coal remaining static for years, India naturally falls short of coal to fuel the ambitious ultra mega power plants.

The situation is true not just to coal but to several other minerals such as iron ore and bauxite as well. India is blessed with the fourth-largest bauxite deposits in the world, a raw material for making aluminum. But unfortunately the country has not witnessed the opening of any large bauxite mine in more than 35 years. Investments in exploration of gold and copper mines have made no headway, in spite of the Supreme Court judgment to open up the sector.

At one point, countries like Brazil, Canada, Australia and those in Latin America were on par with India when it came to the utilization of natural resources. Today, these countries have moved far ahead of us. Primarily due to their government's keen focus on leveraging the availability of natural resources.

It was the liberalization of 1991 that ushered a new wave of growth in India. It allowed industries to break the shackles of quota system. Allowing private sector entities to own (through auctions) and mine precious natural resources can unleash a Megatrend in India similar to that seen in 1991. And according to us, the opening up of the coal mining sector is a very important indicator of the huge upside in Indian mining. Besides the coal mines, the government has finalized a list 31 leases for iron ore and bauxite mines to be auctioned by April 2015. In fact, with over 60,000 mining leases in its kitty, the Mines ministry is learnt to have decided to auction around 150 leases next year. Together these mines can, not just offer private sector miners sufficient access to natural resources, but also bridge the government's deficit.

Most importantly, it can offer investors the opportunity to fetch huge returns from natural resources that will play a pivotal role in India economic revival. Investing in the best mining companies, with the ability to sustain pricing power, can be an almost certain way to ride the Golden Decade Megatrend.

Do you think exploiting India's natural resources can offer a new lease of life to the economy? Let us know your comments or share your views in the Equitymaster Club.

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02:00
 Chart of the day
 
Since we spoke about pricing power of mining companies, let us give you the example of Coal India. Thanks to its access to almost all the coal mines in India, Coal India has been able to price its produce at a huge discount compared to international prices of coal all these years. Even after discounting the fact that the quality of coal is slightly inferior, Coal India can have a huge upside in pricing if it were to benchmark its prices to international ones. In fact while the international prices of coal have corrected by nearly 35% since the peak of 2011, Coal India's prices have remained stable. This indicates that large mining companies in India can sustain pricing power and create investor wealth, by optimizing the economies of scale.

'Pricing power' of Indian coal
Infomine.com

02:45
 
Taking about natural resources and particularly metals, one metal that is garnering a lot of speculative interest these days is gold. With gold finding no place to hide, there is hectic discussion around what possibly could set a floor so that the price of the yellow metal stabilizes? If CNBC is to be believed, the help could be forthcoming from none other than the Swiss National Bank. Apparently the tiny nation of Switzerland is likely to vote for a referendum this November-end on whether the country's central bank needs to keep 20% of its reserves in gold. If it indeed goes through, the central bank will have to buy around 1,800 tons of new gold over the next five years. And this would certainly keep the gold prices in good mood. However, as of now, it looks as if the referendum might not go through after all.

Another negative could be the Russian central bank offloading gold as it is burning through its reserves massively. Does all of this mean the days of gold as one of the preferred asset classes numbered? Well, we don't think so. As long as central banks across the world keep printing money, gold's ability to preserve purchasing power will keep the yellow metal in demand we reckon. Consequently, now is the good time to have at least 10%-15% of one's investments in gold.

03:15
 
Now, which asset classes are the FII inflows in to India headed to? While two more months are yet to go before 2014 comes to an end, it has certainly been a remarkable year as far as foreign institutional inflow into India is concerned. Total inflow, including both equity & debt, is just under US$37 bn as of now. This is the second highest inflow after 2010 which saw record US$39 bn into Indian markets. With two more months left for 2014 to end, we may well surpass the previous record.

On this note, let us ask you one question with regard to the inflow figures here. Mind you, there is a high probability of you not getting this one right. Out of this US$ 37 bn that India has attracted so far, how much would have been in debt and how much in equity?

Well, answering here may tantamount to a wild guess more than anything else; but most people would have certainly put in a higher number for equities. And if you are one amongst them, let us tell you that your guess is wrong! Out of the US$ 37 bn, roughly US$ 22.6 bn or 61% of money has gone into debt markets. This is despite the fact that Indian equities remain one of the most attractive asset classes currently. Most of the debt money has gone into government bonds. The reason is simple - interest rate arbitrage. Yield for investing in Indian government bond is 7-8% while interest rate in the developed world is in the region of 2-3%. This clearly makes Indian debt market more attractive to foreign investors. Rupee stability has helped further. Earlier, when Rupee was more volatile, this interest rate differential was wiped out by currency fluctuation.

We reckon that if inflation remains under control and RBI does engage in rate cuts, bond markets would rally further. This shall attract even more money into debt markets. As such, apart from equities, even Indian bond investors are in for a return extravaganza!

03:41
 
Bond investors in the US though have been showing their preference for a peculiar category of debt. It is well known that the US Fed's loose monetary policies have distorted global financial markets. One of the outcomes of this had been a preference for junk bonds. Because interest rates in the US has been close to zero for quite some time now, investors' appetite for junk bonds gained because of the higher yields offered.

Interestingly, even after the Fed has wound up QE3, junk bonds have still generated interest. That said, even among these, the ones that are very low grade have not found any takers. Further, bonds of certain sectors have also not attracted investors. Bonds from the energy sector is one such example given the sharp correction in crude prices. Overall though, junk bonds continue to remain a risky proposition. And only when interest rates begin to rise in the US, will the preference for these bonds wane.

04:22
 
The global stock markets performance for the past week stood mixed. The stock markets in US (up 1.1%) ended the week at new high on the expectations of positive economic data, lower interest rates and positive outlook for earnings. The recently announced jobs data showed steady gains, however, the stagnant wages tempered optimism. A steep decline in rouble and problems around Ukraine weighed heavy on the European stock markets. The stock markets in Germany and France were down by 0.4% and 1.0% respectively during the week.

Coming to Asian stock markets, the stock markets in Japan (up 2.8%) led the gains during the week . The markets gained ground from investor expectations regarding money inflows with European Central Bank suggesting possibility of further monetary policy measures to counter economic weakness and downward price pressure in the Eurozone. The stock markets in China and Hong Kong were down by 0.1% and 1.9% respectively during the week while stock markets in Singapore gained 0.4%.

The Indian stock markets witnessed flattish performance over the week, taking a retreat on account of profit booking. Among the sectoral indices this week, realty and pharma were clearly the top performers while metal and power stocks registered maximum losses.

Performance during the week ended November 8, 2014


04:50
 Weekend investing mantra
"Interestingly, we have beaten the market quite handsomely over this time frame, although beating the market has never been our objective. Rather, we have consistently tried not to lose money and, in doing so, have not only protected on the downside but also outperformed on the upside." - Seth Klarman

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee.

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Equitymaster requests your view! Post a comment on "The hidden message in India's coal reforms". Click here!

3 Responses to "The hidden message in India's coal reforms"

VSMani

Nov 8, 2014

Bring in best practices by getting best managed companies in the field and also to avoid crony capitalism.If these are done it is a good attempt.

Like (2)

Amit Purty

Nov 8, 2014

Dear publisher, The article about the hidden message in India's coal reform has been a thorough in knowledge article. The natural resources are not the renewable resources. They would sometimes or the other be going to be exhousted. The government and the policy makers and also the advisors are to be careful about the sustained utilisation of the resources amulgumated with the resources outside ant the import policies. The import of the oil from Gulf countries by USA is one of the example. The bauxite mining depends upon the use and its utilisation by the Indian as a country and its neighbours. The leasing to the private companies are a part of the liberal economic policies which also require for strict monitoring by the government. If possible a different body or a branch of the police authorities with specific proactive, preventive and deterrent policing can be thought of.

Like (2)

Deepak M. Padher

Nov 8, 2014

Do you think exploiting India's natural resources can offer a new lease of life to the economy?

View:- Yes ! Certainly BUT in short term. We may get sweet fruits to eat today.
This exploitation will ruin the India in long term ( May be after 60-80 years and 60-80 years is not a big period in some country's history).This is considering greedy nature of our people. We definitely going to ruin mother nature and thereby ruining futures of coming generation.
Instead Govt. should focus on alternate energy sources.

Like (3)
  
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