On the edge - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
On the edge A  A  A
8 OCTOBER 2008

The global stock markets continue to be hammered by fears that more banks and insurance companies around the world are on their way to bankruptcy. Across the world governments are stepping in to guarantee the bank deposits held by individuals.

According to a news story on Bloomberg: "We've approached the edge of the cliff," Leon Cooperman, 65, who manages $6 billion at hedge fund Omega Advisors Inc., said at the Value Investing Congress in New York. "Do we go over the cliff or begin to recede? History says we recede, but there's no guarantee. This is the most difficult financial environment I've lived through."

How close to the edge are we? Given another terrible day for stocks in the US on Tuesday, October 7th, we must be at the edge. According to the Bloomberg news story, "the S&P 500 slid 60.66 points, or 5.7 percent, to 996.23, extending its 2008 tumble to 32 percent in the market's worst yearly slump since 1937. The Dow Jones Industrial Average dropped 508.39, or 5.1 percent, to 9,447.11, giving it a 29 percent retreat in 2008 that would also be the worst in 71 years. The Nasdaq Composite Index lost 5.8 percent to 1,754.88."

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The Indian economy – with little connection to the mess in the global economy – is home to a stock market that has plummeted over -50% when measured in US Dollars. India has little economic connection with the mess in the global financial system. But India is guilty by association. Our markets are sliding in a free - fall.

The P-Note bridge we have built with the casino gamblers on Wall Street has made the Indian stock markets a lot less tempting for many of the large pension funds and pools of long term capital. The P-Note owners are an unknown entity. These unknown owners of unknown quantities of shares are selling unknown amounts of shares for unknown reasons.
We continue to see known losses on the value of our ownership in the Indian stock markets.

Meanwhile, BusinessWeek, the US magazine, says we are in the "Ice Age". To make the point, the inside story shows a ‘mammoth’ on Wall Street covered with ice.

Source: BusinessWeek

The dollar, branded as one of the weakest currencies in the world at the start of the year has emerged as one of the strongest currencies this year.

The Indian Rupee, which was expected by most people to be a strong currency, has slipped by -20% against the US currency and lost -11% against the Euro.

Gold has gained about +6% in USD this year and about +32% in Indian Rupees.

And that is not all: The ozone layer, found some 25 km above the earth’s surface, has a hole in it. The hole in the ozone layer above Antarctica is now about the size of North America. If the turbulence in the financial markets does not drive you over the edge, the ultraviolet rays from the sun will probably toast you.

Bunkering down
So with the barrage of financial bombs and ultra-violet rays raining down on us, what should one do?

Maybe it is time to put those black cardpaper sheets on the windows again. In 1971, as a child I went to the local kirana store and bought rolls of those black sheets. The Pakistani planes were on their way to bomb us. The blackened windows would allow us to keep our lights on in the night – without letting the Pakistani pilots spot our room lights and drop the bombs on our heads. They had no reliable radar, I guess, in those days. And the US arms companies had not yet developed those USD 20 million dollar missiles that stealth their way across the arid desserts and bomb the wrong targets. Blackened windows saved us in 1971.

During World War II, all of Europe "bunkered down". Planes were zipping on both sides of the English Channel and cities were bombed into oblivion. The hapless residents had only one escape: they huddled together, kept their heads down and hoped the bombs missed them.

We have seen financial panics before.
We have seen wealth evaporate before.
In 1987, the Dow Jones Industrial Average crashed from 2,641 on October 2nd to 1,739 on October 15th. That was a decline of -52%.In 2 weeks.
In 1998, the Dow Jones crashed from 9,338 on July 17th to 7,539 on August 31st.
That was a decline of -24%. In 6 weeks.
The current decline in the Dow is -49% from its peak of 14,093 established on October, 12, 2007. In 51 weeks.
If things are bad now, they were also pretty bad in 1987 and 1998 yet we survived as a species.

The India strategy
At the start of the year, I thought the worst case scenario for the Indian stock markets would be an Index level of 15,000 to 16,000.
We are -40% below those levels.
With little idea of where this carnage will end or when it will end.

My suggestion was to invest 80% of your portfolio in the Quantum Long Term Equity Fund, 15% in gold, and 5% in the Quantum Liquid Fund.

Table 1: Some protection, but still some pain
Quantum Long Term Equity Fund Quantum Gold Fund Quantum Liquid Fund Total
Allocation 80% 15% 5% 100%
Return since January 2008 -36% 25% 6.9% -24%
How did that do? Ouch! Yes! Good! Oh, no!

Source: Daily Nav data of Quantum Mutual Fund Schemes, BSE Sensex daily closing data

Despite the "Ouch!" of the equity allocation, I stay with this approach.

The logic is the underlying belief that India’s economy will continue to grow at an impressive 6.5% every year for the next few years. And economies grow because companies and businesses are growing. Over time, this means more profits for the companies. And – in the long run – higher profits means higher share prices. It is this fundamental belief that makes me retain that large 80% allocation to stock markets.

But, what if I am wrong?
What if the world is indeed on the edge and – god forbid – falls of the cliff?
Then gold is my insurance.
A world falling off the cliff means that people have lost faith in the central banks and the paper currency that they print.
So far, this year, the US Dollar has emerged as the world’s strongest currency.
That is because the world believes that the Europeans and the Japanese have little clue on what to do next.
The Japanese are still trying to figure out how to get out of the recession that they entered into in 1990.
The Europeans, also working by committee across various languages and various cultures, will debate for the next few years on what to do next.
The Americans, meanwhile, are taking action.
Over the weekend, if necessary.
They are letting firms go bust, they are rescuing firms, they are forcing shotgun marriages and mergers.
No one knows if it will work – that is why the stock markets are still falling – but the Americans are trying to fix the problem.
In times of crises, the world votes with its money.
And they are flocking to the US Dollar.
The source of this global financial problem is the excessive debt in the USA and yet – paradoxically – the US Dollar has gained ground.

In the war of paper currencies, the US Dollar has won.
It is the undisputed king.

But there is another currency out there, one that has survived wars and famines and centuries of history.

Gold – the currency of last resort

What if – a terrible thought – but, what if…the world does fall over the edge?
Into a deep abyss.
Then, in my opinion, even the US Dollar will fall.
And it has only one other currency to fall against.
And that is gold.

Gold is your life insurance for this equity portfolio.
If the equity markets fall of the cliff, the value of the gold you own could increase dramatically.
How much? Maybe 4x the present price. Maybe.
So your Rs. 15 in gold will be worth Rs. 60.
Your Rs. 80 in equity will be worth Rs. 40.
You add up the portfolio and you are sort of safe.
Your insurance of buying gold has helped.

Table 2: Into the deep cliff?
Equity Gold Liquid Total
Initial investment 80 15 5 100
It could change by -50% +400% +6% a year  
Possible value 40 60 5 105
  A big ouch! Yahoo galore! Steady +5%

And what if the world does not fall of the edge.
And survives, then thrives?
Then the Rs.80 in equity is worth Rs.160 – a 2x increase over the next 18 to 24 months.
And your Rs. 15 in gold is worth Rs. 7.5 – a 50% decrease.
Not bad for your overall portfolio: valued now at Rs. 173.

Table 3: Back from the brink?
Equity Gold Liquid Total
Initial investment 80 15 5 100
It could change by +100% -50% +6% a year  
Possible value 160 7.5 5 173
  A big yahoo! ouch! Steady +73%

Look at the sky
So, yes, keep the black cardpaper on the windows.
Avoid the bombs.

But live your life.

Hug your children.
Hug your wife.
Hug your family.
Be kind to your neighbours.
Send a thank-you note to the P-Note owners who are selling out of India.
Visit a church, gurdwara, mosque, synagogue, and temple.
And bask in the joy of the sun’s rays (before the ozone hole gets larger).

As my old friend, Eduard, emailed me yesterday: After the dust settles, there might be new stars in the sky.

Yes, Eduard, you are right: I will peek behind the blackened windows to look for those stars in the sky.

Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold Fund
Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

Other Views on News:

» Mutual Fund Roundup: September 2008
Taking cue from the global economic scenario, the stock markets witnessed intense volatility in the month of September and closed in negative terrain. Read on...

» Money is nothing
We hate to start the day on a sour note. But the (financial) world around us is so full of despair these days, that this is what we begin with and this is what we end at. Read on...

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