The return of 'Gold standard' - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The return of 'Gold standard' 

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In this issue:
» 2,00,000 jobs to be lost in Indian auto ancillary sector
» Indian shipyards unaffected by global slowdown
» Banks' bad debts rise for the first time in 6 years
» Buffett makes a killing even in a fallen deal
» ...and more!

With currencies the world over losing value, we may once again see the return of the Gold Standard! The gold standard is a monetary system in which a region's common media of exchange are paper notes that are normally freely convertible into pre-set, fixed quantities of gold. The gold standard is not currently used by any government, having been replaced completely by fiat currency and private currencies backed by gold are rare.

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Having said that, according to the director of the world's third largest gold refiner, Swiss-based Argor-Heraeus, the smelters cannot work fast enough to meet demand from the nervous rich for gold. Having been in the gold business for 30 years, the gentleman has been quoted in a leading business daily saying that he had never experienced anything like this before. After the price for the precious metal dropped earlier this year, the trigger for the price to rise again has emanated from a much weaker dollar, making gold cheaper for holders of other currencies, and a renewed aversion to paper assets as governments and central banks pump large amounts of cash into the economy, stoking inflation.

Though Switzerland is not a gold miner, it is home to some of the world's largest refineries, which process an estimated 40% of all newly mined gold. Argor-Heraeus has commercial and central banks as its chief customers and it says it processes some 350-400 tonnes of gold every year. Also, in Switzerland, home to the world's largest private banking industry, demand for gold bars and coins shot up six fold to 21 tonnes in the third quarter of 2008, more than in any other European country. Retail investment in gold rose 121% YoY in 3QCY08. Customers buying gold bars from banks, which can weigh more than 10kg each, have to wait roughly a month.

According to the World Gold Council, although India, China and West Asia remain the biggest gold importers, mainly in the form of jewellery, demand for gold bars by retail investors has shot by nearly 60% in Switzerland, Germany and the US in the past few months.

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In the past, Indian auto makers have found it rather difficult to scale the Great Wall of China. Sample this. Between FY03 and FY08, while Chinese auto parts imports into India witnessed a huge 44-fold jump, Indian exports to China registered a meager 3-fold jump, turning the Rs 0.2 bn surplus into a huge Rs 19 billion deficit. However, this surplus is likely to narrow if the dragon nation shows some seriousness in implementing the latest WTO ruling. As per the ruling, China will have to lower the imports duty on certain auto parts that is currently as high as 25%. These auto parts are the ones that go into cars that do not have a high percentage of locally made components. China's move was aimed at encouraging the use of more locally made auto parts in car manufacturing. The move however has been seen by the WTO as China's breach of terms that it had originally agreed to when it became a part of the global trade body. If at all China implements the ruling, it will come as a big relief to Indian auto parts makers, who are already reeling under domestic demand slowdown.

Meanwhile as the US cries hoarse over the loss of jobs in the country, Indians have few reasons to feel better. Particularly those working for sectors that have close ties to the prosperity of the West. As per the Federation of Indian Micro, Small and Medium Enterprises (FISME), about 4,000 auto ancillary units are on the verge of closure due to the auto crisis in the US. And about 200,000 people are to become jobless due to this. Most auto ancillary companies have cut down the production levels, number of shifts and working days. Infact, the problem of job losses in India is not restricted to the auto sector alone but has contaminated small enterprises across the board that are finding it impossible to cope with the slowdown. FISME has also stated that India had over 85,000 sick micro and small enterprises (nearly 60% of total) at the end of FY08. The states of UP, West Bengal and Bihar lead the tally of sectors that have the maximum number of sick units.

Air carriers have to pay landing and parking charges to the Airport Authority. Carriers usually deposit a security deposit in advance in this regard. Sample the outstanding amount of dues and security deposit that various air carriers owe to AAI as reported by a leading business daily. Air India (Rs 7.4 bn, 0), SpiceJet (Rs 157.6 m, Rs 305 m), IndiGo (Rs 60 m, Rs 460.5 m), GoAir (Rs 38.1 m, Rs 130 m), Paramount (Rs 125 m, Rs 65 m), Kingfisher (Rs 2.9 bn, Rs 670 m) and Jet (Rs 327.8 m, Rs 556.6m).

It is interesting to note that the larger carriers, Air India and Kingfisher, have much larger dues compared to their security deposits. We find it unfair that certain players have an unfair advantage over others in such basic issues. If we cannot provide a level playing field for private capital, do we really have the right to expect them to participate in Indian infrastructure?

The global economy may be slowing down and India may be feeling some of the angst, but Indian shipyards seem to be sitting pretty. South Korea, China and Japan, which account for 84% of the global shipbuilding market, are facing the heat, as they have been facing several order cancellations in the dry and wet bulk carriers. But the impact on the order books of Indian shipyards has been miniscule. Take the example of ABG Shipyard, which is the largest private shipyard in India. The company has Rs 114 bn worth of orders to build 105 ships and is building 66 offshore supply vessels and 39 bulk carriers. The main reason for non-cancellation of orders with Indian shipyards has been attributed to the fact that many of them are into building of specialised vessels such as offshore supply vessels and semi submersibles used in the energy sector. Thus, while certain sectors in India such as auto are being burdened by the slowdown, shipyards have something to cheer about.

'A Euro 72 bn global powerhouse in electronics and electrical engineering, operating in the industry, energy and healthcare sectors' - is how the website of German corporate giant Siemens AG describes the company. However, 'powerhouses' these days are no longer synonymous with ethics, transparency and corporate governance. And that seems to be the case with Siemens AG as well. The giant has recently pleaded guilty in a US court to a massive global corruption scandal that won it contracts around the globe from Argentina and Venezuela to Bangladesh, Iraq and Turkey. The company has agreed to shell out - hold your breath - fines of US$ 1.3 bn for its misdeeds. The penalty to be paid in the US court alone is to the tune of US$ 800 m which will be nearly 20 times more than what any other foreign company has paid in the United States for corruption. The court in the company's home country has charged it US$ 530 m.

It pays to remain in cash during times of excessive euphoria. If one still hasn't understood the virtues of the same, look no further than Warren Buffett. Before the subprime bubble burst, Buffett's investment vehicle Berkshire Hathaway was sitting on a mountain of cash. He simply could not find companies that were valued reasonably. But as the bubble burst and most of the other institutions scrambled for liquidity, it was Berkshire's turn to go for the kill. Taking advantage of the market correction and its strong liquidity position, Buffett, over the next few months invested billions of dollars in companies that he believed had turned incredibly cheap. Not only this, the savvy investor that he is, Buffett also managed to extract very favorable terms from some of the companies. These terms are now helping the Oracle of Omaha to rake in the moolah.

As per reports, Constellation Energy, a nuclear power generator, which had earlier agreed to an acquisition by Buffett, has now agreed to sell half its nuclear power generation business to French giant EDF. But Buffett is not sulking. As per terms agreed upon earlier, he is likely to earn a whopping 130% on his initial investment of US$ 1 bn into Constellation Energy. The sum will accrue to Berkshire Hathaway by way of termination fees, interest income, cash and ownership of around 28 m Constellation shares. Now, that's called snatching victory from the jaws of defeat.

The RBI in its annual account of the health of the Indian banking sector (Trends and Progress in Banking) has expressed concern over the quality of growth that the banks have pursued in recent years. As per the report, bad debts of Indian banks rose (in absolute terms) for the first time in six years in FY08. According to the RBI, banks have seen rapid growth in credit during the previous three years and the subsequent rise in interest rates has led to the slippage in asset quality. The rise in non-performing assets (NPAs) has particularly been evident in case of private sector banks as against their PSU and foreign peers. The woes in the real estate sector have also contributed to the higher NPA levels as bank lending to this sector expanded to 19.3% of total credit in FY08, compared to 1.6% in FY04.

Source: RBI

Contingent liabilities or off-balance sheet exposure of banks is another area that has worried the RBI, particularly after the role this played in bringing down the US banking and financial sector. The off-balance sheet exposure of Indian banks increased by nearly 88% YoY in FY08 (80% in FY07) as more companies rushed to hedge their foreign exchange contracts to tide over the volatility in currency markets. Following the significant rise in contingent liabilities, the off-balance sheet exposure of banks at the end of March 2008 was more than three times the size of their consolidated balance sheet. While for the foreign banks it was 2,830% of their total assets, for private and public sector banks it was 302% and 62% respectively.

The Wall Street Journal has reported a strange correlation between job losses and road accidents in the US. The Insurance Research Council in the US finds that 1 % increase in the unemployment rate is associated with 0.5 % increase in uninsured drivers. This is because the jobless individuals are now letting their previous policies lapse. And that's bad news for everyone on the road.

With higher auto insurance rates also worsening renewal rates by motorists, the only option for careful people is to take uninsured-motorist coverage themselves! After all, unusually large number of drivers involved in fatal accidents turn out to be unlicensed and uninsured.

After years of severe shortage of teaching staff in government schools and colleges, the policy makers have finally paid some heed to the education sector. The government has announced a revised salary package for university and college teachers, which offers hefty hikes in their pay effective from the 1st of January, 2006. The government will be shelling out Rs 90 bn annually from the exchequer for paying these revised salaries and allowances to over 500,000 university and college teachers in India. Whether this move will have the desired effect on quality of education in India? Only time will tell.

Another move by the Indian government that is as debatable as the above, if not more, is that it has gifted US $4.5 m to Harvard University to establish a fund in honour of Professor Amartya Sen on the occasion of his 75th birthday. The fund is intended to help Indian students pursue higher education in that institution. But the question is - is it right to use government money to facilitate the fund-raising activity of Harvard? That too when resources for higher education in our own country are inadequate? The Harvard University recently lost more than US$8 bn (nearly 22% of its corpus) due to the entire credit crisis and crash in the stock markets. And is thus understandably desperate to augment its resources.

The benchmark BSE-Sensex reacted positively to reports of lower inflation and managed to close nearly 4% higher in today's trade. The recent cut in petrol and diesel prices pushed inflation (measured in terms of WPI) down to 6.8%, the lowest in nine months, even as the Finance Ministry said that this made room for further easing of interest rates. Inflation, which touched a peak of 12.9% in August 2008, has fallen for the sixth straight week mainly on account of fall in crude prices in the international market. Crude oil prices have dropped from nearly US$ 147 a barrel in July to US$ 40 a barrel recently. While most other Asian markets also closed higher, the European indices have stated the session on a mixed note.

04:56  Today's investing mantra
"When companies deteriorate, they usually do so for one of two reasons: Either there has been a deterioration of management, or the company no longer has the prospect of increasing the markets for its product in the way it formerly did" - Philip Fisher.
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