World as I Think

Its kinda becoming like a economics/ fianance blog still I thought it might help some people who are looking for cues to invest in gold.This is part of a mail which I mailed across to my friend penning my thoughts about investing in gold. I have tried to ascertain the direction of gold prices given my current perceptions and level of knowledge.

Below is the chart( click the image for a better view) of different asset classes compared with each other on the logarithmic scale.

1. Equity and Gold have moved in opposite direction since 1970 .
2. Commodities including Gold, Copper and Oil have moved similary ( the linear trend ) .
3. US dollar moves in the opposite direction to gold (negative correlation is lower) but gold has moved more steeper in the upward direction in the recent past against the dollar.
4. Peculiarly, all the asset classes have been in the uptrend barring the dollar after a large infusion of liquidity in the global markets since the Fed cut the rates to 100 bps in 2001 .

Investment Corrolaries

Gold is a hedge against the dollar, it is presumed that it is better to invest in gold as it yields a higher return compared to the US dollar assets which would yield negative or paltry return (Fed has been aggressively cutting rates and is expect to come to 100 bps mid this year).Lower interest rates result in the depreciation of a currency (investors sell the currency with the lower interest rate and buy currency with higher interest rates{the supply demand theory} hence spot rates of $ has been tumbling) and the Fed is not expected to increase the interest rate again before growth picks up in the US.US is expected to get into a recession and feel the brunt for at least the next four quarters. Thus a sharp reversal in $ trend is not expected until next year, assuming US gets into a recession now.

Fed is expected to cut rates; as a consequence, liquidity is expected to be at higher levels once the credit crisis subsides, this should logically fuel the prices of all asset classes. Now if US gets into recession the equity class would not perform and it is widely expected that S&P 500 would fall by 20% if US gets into a recession, so ideally going by past, gold should be bought as an alternative to equities.

Commodities are expected to outperform given the demand supply mismatch due to huge demand from developing countries (esp China & India) but the real question is whether slow down in US & developed world would reduce the demand and hence reduce the deficit and hence result in a cool off in commodity prices.

To invest in gold or not now ?

Gold & commodities in my view are at least 10-15% below their peaks, so ideally, they must correct or reverse the trend after it. The real state of US economy must be clear by Q3 2008, so ideally any new trend should happen then. If the US Equities correct by 10-15% by then and economy picks up, we can be almost sure that the trend is going to reverse. That is when Fed should ideally start increasing the rates and dollar must see any reasonable strength. This would bring back the confidence in the dollar and investors must flee gold.

The risks to the above conclusions are that the US might enter into a stagflation environment (the US GDP/prices falls even though there is a steep increase in inflation/ cost of input materials which cannot be passed on to the cosumers as there is a lack of consumer demand in a recessionary environment).The probable reasons should be that commodities demand supply gap is persistent and the prices do not come down. This is a good scenario for considering gold as an investment.

If US shows the middle finger to the recession scare and returns to throttle in another two quarters, then gold would correct sooner or later.

It all depends of when uncle Sam is expects to come back with a bang.

Labels: economics

I have always had this strong conviction, every living organism is selfish and it tries to protect itself and survive when things are against the tide and tries to ride it when it soars up and in both the cases tends to overrule the greater good. I could get the glimpse of the selfish sadist in me today.

I have been investing in the markets for the last six months and have made some healthy profit till the beginning of this year. Things were in euphoric mode, investing in any crapy stock gave handsome profit and irrational exuberance prevailed. Experts were divided about the journey the indices were about to take, I was strongly advocating a case that Indian markets were headed south before going north again. I was greedy as well, I knew i had to move into cash but the nagging greed of marginal profit kept me in the market, One sane thing which i did was to move most of my investment into a single stock which was fundamentally strong.

It was a Monday, at last I said enough is enough, I was planning to move in to cash and book losses, Murphy reincarnated, the markets crashed by 10%, there was a huge dent in my the portfolio and I was in a precarious situation, the loses were far from marginal to be booked. I decided to wait with a false hope that prices would go up although I had advised my other friends not to dive into the market as the markets are expected to see a further carnage. A rational decision would have been to sell the stocks at lower prices and catch them at even lower prices. The markets fell by another 10% next day. There were few who short the market (selling a stock at higher prices without owning it, expecting it to fall so that you can buy them back at lower prices and settle the transaction) who were happy and talking about a further trough. People who were invested must have seen at least 30% shaved from their peak portfolio value, we were thinking, How sadist of the people who wanted a further fall (in fact it is a very rational expectation about the course of the market after the illogical upward movement since last October).

Things calmed down in the market, I borrowed some money and bought the stocks at lower prices and averaged out my portfolio (process of averaging the cost of stock by buying the stocks at lower prices when one has the same stock at higher prices).The Fed came to the rescue of the US markets and sense of relief spanned across the globe, the markets recovered, the markets had technically rebounded from the bottom. I woke up yesterday and to my surprise the markets didn't bounce back even after Federal reserve cut the rates again, something told me that this is a temporary relief and almost completely sold my portfolio and moved to cash, booking marginal loses.

There are several logical reasons why I felt the markets are going to crash again

The US is expected to slow down significantly and hence the US markets are expected to severely correct. US still contributes to 25% of the world GDP and it would definitely impact the other markets. The markets would be first stripped completely before giving their due of "growth stories”. Any number of bailout, be it credit, residential, insurance or economic stimulus is not going to solve the structural problems of US. It's time for the cycleonomics, what goes up should comes down!.

It’s high time the bubbles burst; the cruel some part of the current bull run is that almost all the asset classes (equities, commodities and real estate) are at the peak. Sooner or later they are going to burst.

An market should go up to the extent to which the earnings grows. Indian companies have had an average growth rate of 20% and the trend is expected to growth by 15% to 20% for the next five years atleast.We gained a massive 50% in the last four months of last year without any valid change in the fundamentals, so essentially they have to correct by 25% to be fairly valued. The FII's who had parked the money in our markets are booking handsome profit taking it back to their country.

Technical analysis suggests that we are in the last leg of the downtrend of the "Elliot wave", so ideally we should fall another 15%.

So you must be asking what is sadist about this?. I am expecting the market to fall steeply, now that i am safe.Infact, I know that most of my friends have their portfolio are in negative territory and retail investors would get slaughtered if it moves further down but I still feel happy about my call. In fact, we are all facing the brunt for chasing greed and irrational prices but we all loose money and sleep!

Labels: economics

We always have these fancy arguments about why we would not want to pay taxes or to be politically right why we would want to manage our taxes properly. We would rather blame the government institutions for it, Neither do we get social security nor great infrastructure, the entire system is corrupt, there is no point paying taxes as it does not reach the right destination.

We always want to argue "Why should I pay taxes when most of the country does not pay taxes?"Rest of the country evades taxes and whats wrong if we only manage them?. I don't get facilities like what the citizens of US or any westerner cherishes. A fair argument, isn't it? We always compare the developed countries for everything else?.

Lets for a change take the example of the developed world in terms of what they do to their agriculture sector. In the US, during the year 2003, agriculture exports continued to be sold well below the 1970 and 2000, EU share in agricultural exports increased from 28.1 per cent to 42.7 per cent. France increased its share from 5.7 per cent to 8.1 per cent, Germany from 2.6 per cent to 5.9 per cent and United Kingdom from 2.7 per cent to 4.1 per cent

The world is expected to behave like an ostrich when it comes to the WTO violations from the world's only super cop. Whether it is the additional federal support of US $180 billion for the next 10 years that has been promised for American farmers, or the grant of US $110 million for export promotion that has recently been announced, the WTO seems helpless. There are 6 million farmers in the US compared to 600 million in India.

The total quantum of farm subsidies given by the developed countries works out to 340 billion US dollars a year or almost a billion dollars a day.

Impromptu, you might want to say this, Even the Indian government gives subsidies to the farmers, they get free electricity, free seeds, and fertilizer subsidy and sometimes they even get a waiver on all the loans. Very true, but did you know this, in effect the farmers have to incur a negative subsidy(Measured by Aggregate Measure of Support), i.e the farmers have to forgo thier income. If only the government procured their farm products at the prevailing global prices or marginally increase the minimum adminstered price for the commodities, their lives would be better.

Now, who is enjoying food at lower prices? of course, you and me who have our food subsided by the farmers. Next time, while we eat, lets remember the 600 million farmers out there who are subsidizing our food.

Labels: economics

The previous two posts have kindled me and I have more queries and answers for myself. I had a interesting comment by Deepak who had completely agreed that the growth/income distribution was definitely lopsided but suggested that the benefits of this have however started to trickle down albeit slowly. He had remarked that we should not forget that the so called higher income people who are earning higher income for the nation as a whole and contributing their best possible. I would certainly accept it, I can see it everywhere, the construction industry, hospitality industry, the security guards so on and so forth.

The IT/ITES sector currently contributes about 3.6% to the GDP and currently employs about 2 million people (India's population is 1100 mn).The recent CRISIL Survey done on behalf Nasscom suggests that for every job created in the sector, four are created in the rest of the economy. Several of these jobs are created among the less educated workforce. It effectively translates to about 8 million jobs created by IT. It is a good picture isn’t? It has done what it could do best.

Let me plug in some figures which shows the growth rate of various sector of the economy



I tried to crunch the growth rates of different sectors. The growth rates from the period 1990-2007 are 2.85%, 6.71% and 8.41 % for agriculture, industry and services respectively.
We are becoming a services driven economy and it shows up in the following table which paints the contribution of different sectors to the economy


The following observation tells the story, about 60% of the people have grown at 2.85% and about 20% of the people have grown at 8.50%.

This is not the end of the story; real growth of the income is much skewed. The Consumer Price Index (CPI) has increased by about 7.93% for agricultural labors and has increased by about 7.5% for industrial workers for the period 1990-2006.

The essentially means that 600mn people have de-grown by 5% and about 200mn people have grown by 1% in effective. Let me probe a little more, about 2mn (0.18%) people contribute to 3.6% of the GDP and the per capita contribution is too much. (That’s why I shout that these people have too much of money compared to rest of the population).When the per capita income is high they have enough money to spike the demand and contribute the best to the inflation.

I have no two views that we should grow as an economy but we can leave about 60% of the people behind us. All I want is the means to improve the life of rest of India.

The FM did something of the aam aadmi stuff this time and you know what Pranab Roy said during an interview with the FM, he freaked out saying that the markets would go down if this was the reformist attitude FM had to paint to the corporate world. Mr. Pranab “Why don’t you understand that the investors are a bunch of 50mn people whereas there are also other people in India as well”.

I certainly believe that Capitalism is the way out to bring about economic prosperity to the society. I don’t believe in skewed capitalism and it is the duty of the government to take everybody together.

I don’t want a future where we would have reservations for the farmers and downtrodden for the mistakes we commit now!!!

Labels: economics

It would be easily the most scrutinized topic in any casual or serious discussion of recent times; the real estates are tooo hot in Chennai. The prices seem to have consistently risen over by 30% every year for the past three years. There seems to be a mad rush for apartments and individual properties in every damn place in the city, in fact the real estate prices have skyrocketed in any corner where there have been signs of economic activity.

There are innumerable theories floating around to explain the recent spike in prices

• The builders are artificially constraining the supply of apartments and hiking prices till the prices spiral up to desirable levels.
• There is too much NRI money, estimated to be around $15Bn, which has been infused into the system and that has lead to the speculation of the prices.
• There is hot money chasing properties which would be sold out once there is a desirable appreciation.
• The Morons in IT industry/new economy jobs have higher income levels and can’t stop the mad rush for home loans irrespective of interest rates.
• There is a supply side shock and if we consider the demographics we need millions of homes and limited land supply.

Every reason seems to be possible, I thought, I'll give a shot at this. There is gonna be some finance in this post and non finance reader have to pardon me. I would try to explain the concepts in a common man's perspective. Here we go

I have collected the prevailing rental prices and the flat rates in the city and have summarized the same in the table below

The valuation summary has been presented below

You might have understood the first two columns, monthly rent (per Sq.ft) and yearly (per Sq.ft) rent which are quite straight forward.

Then what is this thing called PV of Rent. It is in the present value of the rent, which I would get from the asset in financial terms. It is essentially the current worth of the monthly rent which I would get every year. i.e getting Rs 60(current year)+Rs 60 (next year)+Rs 60(year after that) and Rs 60 in eternity which is worth Rs 895 now.

It is not worth Rs 1200 (Rs 60 *20 years) because the value of the money decreases due to inflation (rate at which my purchasing power decreases) and it has some adjustment for the risk in the asset (I am not going to confuse with risk adjusted expected returns so on and so forth) .Just get the concept that it is gettin an mothly rent of Rs 60 is worth only Rs 895 now.

It is assumed that the investor would expect at least a return of 10.5% (current floating home loan rates). The net rental present value is computed after considering a 3% annual maintenance expenditure of the annual rent .it is assumed that the annual rent would increase by about 4% year on year.

Suppose, we demolish the building, we may loose the rental income but there is always this value of the land that we can get. On an average the land price is at least 60% - 70% of the flat cost. So if we buy a flat for 10 Lacs, the land price is at least 7 Lacs, to be precise. If a Sq.ft cost about Rs 1000, a healthy proportion of about Rs 700/- can be easily apportioned towards the land price.The present value of the land essential captures this component of the price paid towards the flat price. The land price is assumed to be around 65% of the existing price while valuing the properties.

Now we need to compute the current worth of the tax benefits. We can avail a waiver of around Rs 2.50 lacs and save ourselves about Rs 75,000 every year. I have assumed the exemption amount to be around Rs 2.0 lacs (the interest component in the EMI is expected to decrease over the period) over the loan period.The current worth of the tax benefit is expected to be around 5.0 Lacs which translates to an average tax benefit of Rs 374/ Sq.ft (Rs 494 -1000 Sq.ft; Rs 353 -1400 Sq.ft; Rs 274 -1800 Sq.ft ).

The present value of the asset (6th column) is computed based on the expected future income (rent), land price and tax benefit.

The current price is based on the regressing the current market prices of rent and land prices. The equation turned out to be

Market Land Price/Sq.ft = -983.4 + 574.1 * Market Rent/Sq.ft
Current Asset Price = Market Land Price/Sq.ft * (1+Registration charges)

The government registration charges are usually about 10% of the Land price.

For all people who thought the Indian housing bubble is a reality we have to reconsider it, the calculations say that the asset prices are trading at a discount of about 10.8%.

There is more incentive for people to buy small homes which are in the suburbs where the assets are at a discount of about 25%.

If you were a frenzy fan of real estates and you wanted reasons to invest in the real estates, you can be sure that the real estates are not in a state of bubble. If you were skeptical of the valuations (Actually I was not convinced at that point) and need to cross check various scenarios,here we go.

we would try to take the worse case scenarios to the various variable that can signigicantly affect the valuations.

Upward bias on the Land Price

There could be a current upward bias in the land prices due to higher rentals which have been prevailing in system due to supply constraints of apartments. The other thing could be that the rentals could be on the higher side compared to the prevailing land prices. For instance, parts of velachery demands a rent of about Rs. 8/ Sq.ft, whereas land prices float around the Rs 2800 mark. We can test them right way

We can see that the current market price of the assets are at a premium of about 30%, if we consider that the land is worth only 30% of the current flat price, which is approximately the land price before three years. It seems to be fairly priced if the land is worth 50% of the current flat price.

The housing starts in sub urban areas, redevelopment in the existing areas and the SEZ (Special Economic Zones) can put the prices down as the demand would ease in the future. The demographics of India however suggest that the housing demand isn’t going to stop in the mid term. The demand rentals are expected to be in the upper spectrum as there is a constant movement of labor in the country towards zones of higher economic activity.

Concerns on Interest rate moving north

The next concern is about interest rates, the home loan rates have been increasing in the recent past and are slated to be high in the mid term (that is what the treasury yield curve seem to suggest).The table below kind of summarizes the premium or discount in the property if the interest rates increases or decreases.

Limited Tax benefits as the Property value increases

The next issue could be that a segment of people who buy the flat may not have the tax benefit and the tax benefit is capped to the people who buy properties of higher value.

The table below summarizes the premium or discount in the asset according to the property value purchased..

Labels: economics

Labels: economics