Of Samosas and Gold... - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
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17 JANUARY 2008

There are 3 things of lasting value in India: the HDFC brand name, the Infosys brand name, and gold.

My experience shows that when anyone from HDFC or Infosys makes a statement or a commitment, the word is their bond.
And you can weigh that in gold.
There are many more Indian groups that are not quite "as good as gold" but will soon get to that golden status, in my opinion. But, for now, there is only HDFC and Infosys in that category.

But what do you weigh gold against?

Gold, historically, was a currency. A medium of exchange. If you wanted to buy a piece of land, it was priced in gold. If you wanted to buy food, it was priced in gold. But gold is a bulky item and one could not always check its purity while a transaction was taking place. So, somewhere down the line, to facilitate commerce, gold was substituted for paper currencies.

Paper currencies were paper notes issued by the central bankers of the world in lieu of a certain amount of gold they held in their vaults. This worked reasonably well for a long time until governments - and the politicians that run them - started winking at each other and, in the process, began hood winking the general public. A government in power wished to get re-elected, so it began making promises. And going on wild expeditions like a teenager pumped up with hormones. The grander the stupidity of the idea, the more determined the teenager.
Like fighting the terrorists in Iraq.
Giving everyone in India roti, kapda, aur makaan.
Or jobs for all programmes.

All very noble causes, beyond any doubt.

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But every cause - no matter how noble - needs to be financed.
Even Mahatma Gandhi's noble cause of gaining Independence for India had to be financed.
The Birla family used to say that they had to spend a lot of money on Mahatma Gandhi to keep him poor. Ashrams don't survive on love and fresh air.
And government grants and wars need to be funded.
So either there has to be a Birla giving you a continuous cash injection or there has to be a tax collection as a source of revenue.
A Birla will want a favour in return - not always possible to agree to.
Raising resources to fund extravagant projects by asking people to pay more in taxes is not what politicians are good at.
And raising taxes is what you do when you want to lose an election, not when you want to win an election.

In truth, there is only one way to pay for what you want to spend on: to have the money to pay for it.
But that was before the winking started.

So, urged on by politicians who wished to spend - but knew they could not ask for higher taxes - central banks began changing the ratio of paper currency to gold they had in their vaults.

The central banks did this in two ways: they printed more money, so there was less gold per unit of paper in circulation out there.

Or they sold the gold they had, which also resulted in more paper in circulation per unit of gold they had.

The smarter central banks did both: they printed more paper and they sold gold.

Consider the USA.
In 1941, the US had gold holdings of 650 million ounces at Fort Knox.
Today, there is only 147 million ounces of gold in Fort Knox.
The US got rid of 503 million ounces of gold.
At today's price of USD 900 per ounce, that is USD 453 billion.
To put that in context, that gold which they depleted would have allowed them to own 30% of all the companies listed in the Indian stock market - at the current share prices.

But the fact that the US sold their gold is only half the story.
The other story is the amount of money that the US central bank has printed: the amount of US Dollars floating out there in the world.

In 1956, the US economy was about USD 2,200 billion in size - about 2x as large as where India's economy is today.
In 1956, to keep that economic activity alive, the US central bank had issued about USD 280 billion of paper to act as a currency, as the engine oil to keep the engine of the economic activity of the real economy humming along.
And the amount of gold in Fort Knox in USA was about 650 million ounces.

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Today, the US economy is about USD 11,000 billion in size - so it has grown by 5x over the past 52 years.
The money supply of US dollars floating around the world (last reported in June 2006) at USD 10,298 billion - an increase of 37x.
The amount of gold in Fort Knox is 147 million ounces, a decline of 77%.

I won't bore you with why this suggests that there is an economic disaster waiting to happen, but imagine you are running your household.
In 1956 you spent 1 unit of a currency to buy all the goods you needed.
Fifty years later you need 7x more money to buy the same basket of goods.
That is inflation.
That is when you ask yourself, "what is all this paper really worth?"
That is when you tell yourself: this money I earned today is worth less than what it was last year. Or last week. Or yesterday.

Embarrassed by its printing of excessive paper and diluting the inherent value of its own currency, the US government decided not to publish the value of the amount of US Dollar currency sloshing around the world.
Seeing all the revelry and laughter in the bar, the bar tender yells, "Alright, folks, I am not counting any more on how many drinks I give you all. Take as much as you want. Drink as much as you want."

Not only will the bar tender ultimately go bust, but so will his patrons.
So much for the concept of "responsible" drinking.
So much for the belief that central bankers will act as a storekeeper of value of the currency.

What is true of the US central bank is true of most central banks - and governments. Their responsibility is to print and produce paper to finance dreams.
Dreams the politicians and the governments can sell to win votes.
By the time the dreams sour, the politicians will not be around to foot the bill.
They will have become consultants somewhere earning a nice fee.
It matters little to the politicians, that there will be a bill to pay.
It matters to us.
Because we will pay it.

I ask my father and my uncles about their childhood and I get another lesson in economic history.
What did a plate of samosa cost in 1947? One anna, they say. One anna was one sixteenth of a rupee. For 2 samosa. Today, at an udipi restaurant, the samosa will cost Rs. 20. That is a price increase of 303 times in 60 years.

What did an apartment in South Bombay cost? Rs. 55,000 for a 3,000 square feet apartment in Breach Candy, that works out to Rs. 18.33 per square foot. Today, the apartment would cost Rs. 40,000 per square foot. That is an increase of 2,182 times.

In 60 years, we have lost so much value in our currency.

And I step back in history. What was the one currency that has withstood the test of time? Of wars, of famines, of happy times, of disasters. The one currency that cannot be debased by governments, much as they try.
The one currency that acts as a currency should: a store of value.
And yet, ironically, is today undervalued.
Because we are all living in some world of dreams and have lost sight of "value".
A dream created by the governments, the central bankers, and the financial engineers that increasingly hijack financial flows.

When the modern world emerged from World War II and there was the grand dream of rebuilding Europe and Japan, the central bankers of the world got together and froze the price of gold at US$ 35 per ounce in 1946.

For much of the 25 year period between 1946 and 1971, recognizing that the US spending on the war with Vietnam and the war with its own poverty was forcing the US central bank to print more money than it should (since no politician wanted to raise taxes to finance these dreams) the major central banks in the world struggled to keep the price of gold steady between US$ 38 and US$ 42 per ounce. Finally, in 1971, the central bankers effectively surrendered and admitted they could no longer conceal the fact that paper currencies were worth less than gold.
By 1972, gold had surged to US$ 72 per ounce: more than 2x the frozen price of USD 35 per ounce set in 1946.

The famous Hunt brothers from Texas tried to artificially "corner" the silver market in 1979. Gold responded to that catalyst. If silver can increase in value on the basis of being a currency, gold - the true currency - could also surge in value. Gold breached USD 850 per ounce. But when the silver bubble burst, gold declined sharply. Sensing victory, the central banks ensured that gold remained a forgotten asset class. By the end of 1999, gold was beaten down to USD 263 an ounce.

Central bankers were selling gold. In August 1997, the Australian central bank announced they would sell 167 tonnes of gold - that was 67% of their gold reserves. Here was a gold producing country dumping gold. The price of gold fell 3% on this news. Not wanting to disrupt the price of gold as they encashed their profits, the major nations had a Central Bank Gold Selling Agreement in place that mapped out how they would sell gold and limited the gold sales to 500 tonnes per year.
Imagine their confidence. All paper money is, in the final analysis, backed by gold. And here the central bankers sold gold. That was their faith in paper. That was their way of telling the world that the central bankers knew what they were doing. Trust us.

We did.

And like history has shown, time and again, blind trust will only make you poor.

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What did the central bankers do with our trust? They sold it to the financial engineers and the large financial firms - for the profits of those financial emperors.
Every time the large finance companies come close to bankruptcy by taking stupid risks that go against them, they get bailed out.
Lending to Latin America in the 1980's.
Lending to Asia in the 1990's.
Lending to Russia in the 1990's.
And now by lending to the folks in USA to buy homes when they could never afford a home in the first place and lending even more to the folks in USA to go shopping for some silly "Made In China" toys and machine made baskets and plastic decorative pieces when the consumers have enough debt to drown themselves and their unborn grand children in.

Every time the private banks lent money and surrendered risk they were rewarded by fat salaries and bonuses. Every time the private banks head for bankruptcy they come back to the central banks and say, "TBTF - too big to fail." And every time the central bank - and the governments which control them - blink at the financial geniuses and bail them out. They have done it again. By printing more money. Lots of it. They have lost count of how much they have printed. They have stopped counting.

Sure, gold has had a great run. From USD 300 per ounce in the year 2000 to USD 900 today. An increase of 300% in 7 years. Not bad.

But where was gold in 1944, when my uncles were buying samosa?
At USD 35 per ounce. So, gold has increased by 26x since then.
And a samosa has increased by 303x.
And property had increased by 2,182x.
The BSE 30 Index was introduced in 1979 and has increased by 210x since then - maybe if there was a BSE 30 Index going back to 1947, it would have shown an increase of 400x.

Whichever way you slice it, dice it, or cut it - other things have gotten more expensive and gold has gotten relatively cheaper!

The price of gold has to increase by 12x from today to keep pace with the increase in prices of a samosa.
Or the price of samosa has to come down from Rs 20 to Rs 1.72 to make it equal to the weight of gold you would have needed in 1947 and in 2008 to buy the same samosa.
Which do you think is more likely?
Will the price of a samosa come down to match the price of gold?
Or is the price of gold likely to go up to match the price of a samosa?

I thought a lot about it.

I love the prospects of what returns I can get in the Indian stock market. So we set up the Quantum Long Term Equity Fund and I invested in that Fund, just as I hope you did. And I think we will do well. I like the managements that the Fund invests in and I believe these businesses can deliver good returns in the long run.

I have been buying gold for some seven years now. I made my first purchases when the central banks were selling. But we have decided to launch the Quantum Gold ETF - the least costly and easiest way to buy gold. And I am subscribing to it. In full disclosure, I already own some gold - but now wish to buy a lot more of it. Why? Because the central bankers have proven to me, once again, that they have little respect for maintaining the value of the paper currencies they print. Luckily, they have no control about how much gold they can create. And if they want to restore value to the paper they print, they will need to go back and buy that gold they sold in 1999.
And they won't get it cheap.
It will cost them a lot more.
So the next time the central bankers around the world order samosa for their afternoon tea breaks - payment will be accepted only in gold.


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