Buy gold before your bank buys too much of it - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Buy gold before your bank buys too much of it 

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In this issue:
» Currency war in the offing?
» S&P, Moody's divided on India rating
» Indian coal reserves to last a century!
» Will India supersede US, China by 2030?
» ...and more!

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We have looked at Sensex to gold ratio in the past. Oil to gold ratio more recently. In each case there was a strong likelihood that the yellow metal will continue to outperform. Especially given the likelihood of central banks in the West not ceasing their unprecedented money printing exercise. Fearful of runaway inflation investors were to remain overweight on gold. However it seems that a completely new class of investors is going to buy the precious metal like never before. And given their buying power, the price of gold is very likely to move into unchartered territory.

The new set of rules by the Basel Committee (Basel III), which mandates capital and regulatory standards for global banks, has re-designated gold. In other words gold has been reclassified as a Tier I asset for commercial banks from a Tier III capital under Basel I and II. Now, for capital adequacy purposes, banks need to assign weights to Tier I, II and II capital. As Tier III capital, gold was earlier given a weightage of 50%. So, Rs 100 worth of gold was valued at Rs 50 earlier. But under Basel III, gold is treated as Tier I capital and accounted at full value. So instead of buying perpetual bonds or government debt, banks have every reason to buy gold. Basel III comes into effect from 1st January 2013. And needless to say that the demand from commercial banks worldwide is certain to drive up prices. In the past too, demand for gold from central banks has been a major boost for gold prices.

Thus, notwithstanding further rounds of monetary easing by US and European economies, the price of gold could move up several notches by 2014. This is yet another evidence of how gold's golden days may not be over yet. Not by a long shot perhaps. Thus, if you haven't started making gold a part of your portfolio, it still isn't too late to do the same.

Do you think gold price will rise substantially from here on? Share your views or you can also comment on our Facebook page / Google+ page

01:30  Chart of the day
It is no secret that wage hikes, except in few economies like China, have been abysmal over the past 3 to 4 years. The real wage hike (adjusted for inflation) has been very nominal even for a country like India, thanks to sticky inflation. In fact as per a recent global wage report released by International Labour Organisation (ILO), if not for China, real wage growth between 2007 and 2011 was stuck at an average of 1%. Going forward too, for a consumer driven economy like India, managing real wage growth rate would be critical for GDP growth.

Data source: ILO

We've never understood how promoting exports through currency manipulation can be a sound long term strategy. After all, when you are deliberately depreciating your currency, its purchasing power goes down. And this can never be a good thing. Another drawback is the one highlighted by Sir Mervyn King recently. The outgoing Bank of England governor is concerned that simultaneous depreciation of currencies by most countries is a dangerous trend. And this could lead to currency wars as per him.

Sadly, there seems to be hardly any signs towards rebalancing the same. Countries like US and UK accuse Germany and China of not letting their currencies appreciate and thus increase imports. The latter two on the other hand argue that developed economies like US should stop excessive money printing. For this is what is leading to unhealthy appreciation in currencies of surplus countries and making them support the same. Quite a convoluted state of affairs indeed and what would happen next is anybody's guess. What we know for sure though is that having some money in gold won't hurt at all.

In the race to become global super power, access to cheap energy is biggest challenge. With shale gas glut, the US has made a big move to secure its position. However, it's a different scenario back home. India meets around 80% of its crude oil needs from imports. Already under pressure due to rising energy demand and stagnant production, the supply threat due to US sanctions has spurred Indian oil and gas companies to go for overseas acquisitions. It has hardly been a month since Oil and Natural Gas Corporation Ltd. (ONGC) paid a huge amount to own a stake in Kashagan oil field. It is back into action with Canadian oil sands the next target.

In the latest development, a consortium of leading state oil companies led by ONGC is aiming a stake in Canadian oil sands. These oil sands could be worth over US$ 5 bn. However, before Indian companies claim the share, they have high hurdles to clear. And it is not just high price of the assets. The firms are now facing tougher rules from Canada on foreign control of the country's oil sands.

While clarity is still awaited on the new rules, Indian oil firms look really desperate and reflect the country's insecurity on energy front. The price at which Indian companies are going on acquisition spree is likely to leave them with little capital to maintain the momentum. Even if they succeed, the extra supplies so ensured will not be enough to meet rising energy needs. The only long term solution to ensure energy security is to frame reasonable policies to promote investment in domestic energy assets.

So what does it mean when one rating agency warns India of a downgrade and another believes prospects to be better? It all depends on the factors on which the assessment has been made and how it is interpreted. For instance, Standard & Poor's (S&P) gave a warning that India still faced one-in-three chance of a downgrade. This is in its sovereign rating to junk grade over the next 24 months. The reasons cited for this are high fiscal deficit, rising debt burden and the possibility of the political climate worsening or reforms failing to take off. In contrast, Moody's is a bit more optimistic on the country's growth prospects. It believes that the slew of reforms introduced by the government is an encouraging sign. And the exit of the Mamata Banerjee led Trinamool Congress is another positive. This is because it does away with internal opposition to reforms to a certain extent. In a way there is something of note in both these assessments. Ultimately, the key here is how effectively the government can implement the reforms it has announced. If it does help in improving the business climate in the country and fuelling growth there is no reason for a downgrade and certainly more reason to expect improved prospects.

India is the third-largest producer of coal in the world. However, the country's domestic consumption is large. As a result, India net imports coal to meet the needs of power companies, steel mills and cement producers. India's coal demand is expected to increase multifold within the next 5 to 10 years. This is due to the completion of ongoing power projects, and demand from metallurgical and other industries. The government has said that India's estimated proven coal reserves of 118 bn tonnes are expected to last the country for over 100 years.

This will be enough to meet the growing demand. Government-controlled Coal India Limited (CIL) dominates the domestic coal supply market with an 80% market share. Although there have been delays in raising coal production in the past, the government has said that most of the issues regarding delays in obtaining environment clearances and land acquisition issues are being taken care of.

Over the last couple of decades, we have witnessed phenomenal changes in the global economy. One may be prompted to wonder how it will all be two decades from now. A US intelligence report makes some interesting forecasts. One, China's economy will supersede the US economy in less than two decades. On a broader scale, Asia will surpass North America and Europe combined in global power by 2030. On the other hand, the report suggests that economies of Europe, Russia and Japan will continue their gradual relative declines. While China may take over as the economic powerhouse, the US is unlike to lose its superpower status. The reason being that US is still the only country that is able to pull together coalitions and channelise resources to combat global challenges.

What about India? Where will it stand in the coming decades? As per the report, while China will continue to march ahead of India, the gap could begin to seal by 2030. It is expected that while China's growth rate would slow down, India's growth rate would rise. In fact, India could be the rising economic giant that China is today.

Of course, one must not forget that these are only forecasts. Nobody really knows whether this will happen or not. So, while it may be interesting stimulation to the brain, one must not take such calls too seriously. Above all, such forecasts must have nothing to do with your investing decisions.

After a brief stint in the positive territory, the benchmark indices in Indian equity markets nosedived into the red as profit booking in FMCG, energy and engineering stocks took toll. The BSE Sensex was trading lower by around 58 points at the time of writing. Other major Asian markets closed a mixed bag while Europe also opened flat to positive.

04:50  Today's Investing Mantra
"I don't want a lot of good investments; I want a few outstanding ones." - Philip Fisher
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1 Responses to "Buy gold before your bank buys too much of it"

Shreyas Phadnis

Dec 13, 2012

The Basel III reclassification could equally trigger a negative move on Gold. Why?
What was worth 50 is now worth a 100. So banks can sell some of its gold to generate liquidity.

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