Gold is a bad investment. This is something that is being often heard lately. The naysayers have all come out of the closet after the recent fall in price of the yellow metal. While it was rallying, they didn’t have a word to say. One of the main reasons offered in favour of gold being a bad investment is that if we take official inflation into account, the yellow metal has still not crossed the price of $850 an ounce (one troy ounce equals 31.1 grams) that it reached in 1980. As Nick Barisheff, President and CEO of Bullion Management Groupwrites in his new book $10,000 Gold: Why Gold’s Inevitable Rise Is the Investor’s Safe Heaven “It seems that everyone has a story about someone they know who bought gold at $850 per ounce in 1980 and had to wait twenty eight years to break even. If we take “official” inflation into account, the gold price would need to reach $2,200 for that to happen.” So in other words the individual who bought gold when it touched a peak price of $850 per ounce is still to make money. Seems like a fair point. Now lets try and dissect this argument a little. Gold reached $850 per ounce on January 21, 1980, a then all time high. A day earlier it had closed at a price of $835 per ounce. And a day later it fell to a price of $737.5 per ounce.
As the above table shows, the price of gold remained above $800 per ounce only for two days. In 1980, the average price of gold was $612.5 per ounce. In 1979, the average price of gold was $306.9 per ounce. In 1978, it was much lower at $193 per ounce. So the point is only those people who bought gold around its very short term peak price of $850 per ounce, would have lost money. And that cannot be an effective argument against buying gold. In fact, that may happen to almost anything that is bought at its peak price. “If you buy an investment a cyclical peak, you will have to wait a long time to break even. The Dow Jones Industrial Average (which is America’s best known stock market index) did not surpass its 1929 peak until 1953 (twenty four years later). It did not surpass its 1968 peak until 1982 (fourteen years later),” writes Barisheff. Or lets take the case of the Japanese stock market index, Nikkei 225. On May 15, 2013, it closed at 15,096 points, and this when it has rallied by nearly 67.7% from mid November 2012. But it is still down 61.3% rom an intra-day high of 38,957 points that it achieved on December 29,1989. So anyone who had invested in the Japanese stock market at its peak in December 1989, and held onto his investment, would still be losing money. And then there is also the case of Nasdaq Composite, an American stock market index, which is a favourite with technology companies. On May 14, 2013, this index closed at 3462.61 points. It is still down by nearly 32.5% from an all time high of 5132.32 points achieved on March 10, 2000. “This even after a number of its stocks, which had become completely worthless were replaced,” writes Barisheff. Lest I be accused of giving examples of only foreign stock market indices, lets look at something closer to home. The BSE Sensex touched a then all time high of 4630.54 points on September 12,1994. This level was crossed nearly five years later in July 1999, when the dotcom boom was at its peak. In fact those who had invested in the Indian stock market at its 1994 peak would have started to make some real money only by 2005, after more than ten years of holding onto their investment. More recently, anyone who had invested in Indian stocks in December 2007, when the Sensex reached its then peak of 20,287 points, would still be losing money five years later. On May 15, 2013, the Sensex closed at 20,212.96 points. So much for stocks being a long term investment. And there is more to consider. As Barisheff points out “One cannot compare gold held in a vault to an investment in stocks. Stocks cannot be compared to gold when it comes to risk. Virtually all of the stocks that existed in 1700 no longer exist today, so at some point investors and their descendants would have lost their entire investment.” What also happens is that indices keep replacing stocks which are not doing well or have become completely worthless (as happened in the case of Nasdaq Composite). As Barisheff points out “Of the thirty stocks that made up the Dow (in reference to the Dow Jones Industrial Average) in 1929, only General Electric and Exxon Mobil (formerly Standard Oil) still form a part of the Dow today. Of the thirty stocks that made up Dow in 2000, only twenty-three are still Dow components today. If investors buy stock and that stock declines to zero, they lose their investment. They cannot simply replace it with another stock and ignore the loss (which is what indices do).” Another regular criticism against gold is that it does not pay any dividends or interest. This was the explanation given by the Bank of England in 1998, when it sold half of its gold reserves. “The British sold 395 tonnes of gold at an average price of $275.6 per ounce, and then the price of gold rose nearly 700 percent… Britain sold its gold for a total of $3.5 billion. At $1,900.3 an ounce, gold’s highest price of the last decade, this gold would be worth about $24 billion,” writes Barisheff. Of course $24 billion would have more than taken care of any interest income that the Bank of England would have earned by investing the $3.5 billion that it got by selling gold. Also the gold lying in the vault is not being put at any risk. As Barisheff puts it “Again, gold, like currency or any other asset that sits in a vault, will not earn interest or dividends. However, it is also not at risk. No asset class generates income unless give up possession of your capital and take the risk of not getting it back. The term “investing” implies risking for the sake of potential profits.” This is something worth thinking about, the next time you hear a so called expert saying, gold is a bad investment.
The article originally appeared on www.firstpost.com on May 16, 2013
Stock markets and economies do not always go together. Take the case with India right now. The stock markets have done reasonably well this year. The economy clearly hasn’t with economic growth slowing down to around 5.5%. As Russell Napier a consultant with CLSA and a financial historian of repute puts it “I maintain a very positive long term view on India and the Indian economy and how it develops. But, and it’s a big but, that financial history tells you that economic growth and return from equities are not linked at all.” Napier is also the author of the bestselling Anatomy of the Bear – Lessons from Wall Street’s Four Great Bottoms. The most important thing is to buy equities when they are cheap because when they are cheap that’s when you make good return, feels Napier. So how cheap are Indian stocks? “Indian equities haven’t been cheap for a very very long period. And the best measure of cheapness that I look at is the cyclically adjusted price to earnings (PE) ratio because it has been a good guide in America for future returns. In India the cyclically adjusted PE is now at 24. If you look at the history of America that is right at the top end of the range. And suggests that we are going to have pretty poor lowish returns from India over a prolonged period of time,” says Napier. Cyclically adjusted PE is calculated by using ten year rolling average earnings. India is now on 24 times cyclically adjusted PE. This number has to fall if Indian stocks are to become attractive investment propositions. “The volatility of the market though is great, and I think and I hope we will get a chance to buy Indian equities cheaper, and get them cheaper sometime soon,” feels Napier. “Certainly if they ever get below 15 times cyclically adjusted PE you should be looking to buy some of them. And there is every reason to think that they will go lower than that, and then you should be buying a lot of them,” he adds. Napier is looking at a global deflation shock and the stock markets falling all over the world. As he says “I see all the markets global equity markets coming down to the extent of this global shock.” Despite the fact Napier feels that Indian stocks are expensive he would rather buy Indian stocks than Chinese. “Chinese are stocks probably at very viable sort of valuation levels. But I wouldn’t buy any of them because I don’t consider them to be corporations. I don’t consider the management to wake up in the morning and seek to push up the return on capital to the benefit of shareholders. And therefore those equities are cheap I don’t fundamentally want to buy,” explains Napier. And how is India different? “Not every Indian company as you are also aware is going to do the best for all its shareholders. But because Indian companies come from the private sector so it is more likely you are going to find companies in India who work to benefit there shareholders and not just the small family unit in the company,” says Napier. “Hence when it comes to buying stocks cheaply I want to do that in India and not in China. But in India at the minute they remain still very expensive,” he concludes. The article originally appeared in the Daily News and Analysis (DNA) on October 15, 2012. http://www.dnaindia.com/money/report_russell-napier-sees-all-equity-markets-falling_1752478 Vivek Kaul is a writer. He can be reached at [email protected]
Vivek Kaul A major reason for announcing the so called economic reforms that the Manmohan Singh UPA government did over the last weekend was to get India’s burgeoning oil subsidy bill which was expected to cross Rs 1,90,000 crore during the course of the year, under some control. One move was the increase in diesel price by Rs 5 per litre and limiting the number of cooking gas cylinders that one could get at the subsidisedprice to six per year. This was a direct step to reduce the loss that the oil marketing companies (OMCs) face every time they sell diesel and cooking gas to the end consumer. The other part of the reform game was about expectations management. The announcement of reforms like allowing foreign direct investment in multi-brand foreign retailing or the airline sector was not expected to have any direct impact anytime soon. But what it was expected to do was shore up the image of the government and tell the world at large that this government is committed to economic reform. Now how does that help in controlling the burgeoning oil bill? Oil is sold internationally in dollars. The price of the Indian basket of crude oil is currently quoting at around $115.3 per barrel of oil (one barrel equals around 159litres). Before the reforms were announced one dollar was worth around Rs 55.4(on September 13, 2012 i.e.). So if an Indian OMC wanted to buy one barrel of oil it had to convert Rs 6387.2 into $115.3 dollars, and pay for the oil. After the reforms were announced the rupee started increasing in value against the dollar. By September 17, one dollar was worth around Rs 53.7. Now if an Indian OMC wanted to buy one barrel of oil it had to convert Rs 6191.6 into $115.3 to pay for the oil. Hence, as the rupee increases in value against the dollar, the Indian OMCs pay less for the oil the buy internationally. A major reason for the increase in value of the rupee was that on September 14 and September 17, the foreign institutional investors poured money into the stock market. They bought stocks worth Rs 5086 crore over the two day period. This meant dollars had to be sold and rupee had to be bought, thus increasing the demand for rupee and helping it gain in value against the dollar. But this rupee rally was short lived and the dollar has gained some value against the rupee and is currently worth around Rs 54. The question is why did this happen? Initially the market and the foreign investors bought the idea that the government was committed at ending the policy logjam and initiating various economic reforms. Hence the foreign investors invested money into the stock market, the stock market rallied and so did the rupee against the dollar. But now the realisation is setting in that the reform process might be derailed even before it has been earnestly started. This was reflected in the amount of money the foreign investors brought into the stock market on September 18. The number was down to around Rs 1049.2 crore. In comparison they had invested more than Rs 5080 crore over the last two trading sessions. Mamata Banerjee’s Trinamool Congress, a key constituent of the UPA government, has decided to withdraw support to the government. At the same time it has asked the government to withdraw a major part of the reforms it has already initiated by Friday. If the government does that the Trinamool Congress will reconsider its decision. How the political scenario plays out remains to be seen. But if the government does bow to Mamata’s diktats then the economic repercussions of that decision will be huge. The government had hoped that the losses on account of selling, diesel, kerosene and cooking gas, could have been brought down to Rs 1,67,000 crore, from the earlier Rs 1,92,000 crore by increasing the price of diesel and limiting the consumption of subsidised cooking gas. If the government goes back on these moves, the oil subsidy bill will go back to attaining a monstrous size. Also, what the calculation of Rs 1,67,000 crore did not take into account was the fact that rupee would gain in value against the dollar. And that would have further brought down the oil subsidy bill. In fact HSBC which had earlier forecast Rs 57 to a dollar by December 2012, revised its forecast to Rs 52 to a dollar on Monday. But by then the Mamata factor hadn’t come into play. If the government bows to Mamata, the rupee will definitely start losing value against the dollar again. This will happen because the foreign investors will stay away from both the stock market as well as direct investment. In fact, the foreign direct investment during the period of April to June 2012 has been disastrous. It has fallen by 67% to $4.41billion in comparison to $13.44billion, during the same period in 2011. If the government goes back on the few reforms that it unleashed over the last weekend, foreign direct investment is likely to remain low. One factor that can change things for India is the if the price of crude oil were to fall. But that looks unlikely. The immediate reason is the tension in the Middle East and the threat of war between Iran and Israel. Hillary Clinton, the US Secretary of State, recently said that the United States would not set any deadline for the ongoing negotiations with Iran. This hasn’t gone down terribly well with Israel. Reacting to this Benjamin Netanyahu, the Prime Minister of Israel said “the world tells Israel, wait, there’s still time, and I say, ‘Wait for what, wait until when? Those in the international community who refuse to put a red line before Iran don’t have the moral right to place a red light before Israel.” (Source: www.oilprice.com) Iran does not recognise Israel as a nation. This has led to countries buying up more oil than they need and building stocks to take care of this geopolitical risk. “In the recent period, since the start of 2012, the increase in stocks has been substantial, i.e. 2 to 3 million barrels per day. These are probably precautionary stocks linked to geopolitical risks,” writes Patrick Artus of Flash Economics in a recent report titled Why is the oil price not falling? At the same time the United States is pushing nations across the world to not source their oil from Iran, which is the second largest producer of oil within the Organisation of Petroleum Exporting Countries (Opec). This includes India as well. With the rupee losing value against the dollar and the oil price remaining high the oil subsidy bill is likely to continue to remain high. And this means the trade deficit (the difference between exports and imports) is likely to remain high. The exports for the period between April and July 2012, stood at $97.64billion. The imports on the other hand were at $153.2billion. Of this, $53.81billion was spent on oil imports. If we take oil imports out of the equation the difference between India’s exports and imports is very low. Now what does this impact the value of the rupee against the dollar? An exporter gets paid in dollars. When he brings those dollars back into the country he has to convert them into rupees. This means he has to buy rupees and sell dollars. This helps shore up the value of the rupee as the demand for rupee goes up. In case of an importer the things work exactly the opposite way. An importer has to pay for the imports in terms of dollars. To do this, he has to buy dollars by paying in rupees. This increases the demand for the dollar and pushes up its value against the rupee. As we see the difference between imports and exports for the first four months of the year has been around $55billion. This means that the demand for the dollar has been greater than the demand for the rupee. One way to fill this gap would be if foreign investors would bring in money into the stock market as well as for direct investment. They would have had to convert the dollars they want to invest into rupees and that would have increased the demand for the rupee. The foreign institutional investors have brought in around $3.86billion (at the current rate of $1 equals Rs 54) since the beginning of the year. The foreign direct investment for the first three months of the year has been at $4.41 billion. So what this tells us that there is a huge gap between the demand for dollars and the supply of dollars. And precisely because of this the dollar has gained in value against the rupee. On April 2, 2012, at the beginning of the financial year, one dollar was worth around Rs 50.8. Now it’s worth Rs 54. This situation is likely to continue. And I wouldn’t be surprised if rupee goes back to its earlier levels of Rs 56 to a dollar in the days to come. It might even cross those levels, if the government does bow to the diktats of Mamata. This would mean that India would have to pay more for the oil that it buys in dollars. This in turn will push up the demand for dollars leading to a further fall in the value of the rupee against the dollar. Since the government forces the OMCs to sell diesel, kerosene and cooking gas much below their cost to consumers, the losses will continue to mount. The current losses have been projected to be at Rs 1,67,000 crore. I won’t be surprised if they cross Rs 2,00,000 crore. The government has to compensate the OMCs for these losses in order to ensure that they don’t go bankrupt. This also means that the government will cross its fiscal deficit target of Rs 5,13,590 crore. The fiscal deficit, which is the difference between what the government earns and what it spends, might well be on its way to touch Rs 7,00,000 crore or 7% of GDP. (For a detailed exposition of this argument click here). And that will be a disastrous situation to be in. Interest rates will continue to remain high. And so will inflation. To conclude, the traffic in Mumbai before the Ganesh Chaturthi festival gets really bad. Any five people can get together while taking the Ganesh statue to their homes, put on a loudspeaker, start dancing on the road and thus delay the entire traffic on the road for hours. Indian politics is getting more and more like that. Reforms, like the traffic, may have to wait. Mamata’s revolt is single-handedly worsening the oil bill, thanks, in part, to the rupee’s worsening fortunes. By not raising prices now, the subsidy bill bloat further, and in due course we will be truly in the soup. The article originally appeared on www.firstpost.com on September 20, 2012. http://www.firstpost.com/economy/how-mamata-is-denting-the-rupee-and-bloating-the-oil-bill-461919.html Vivek Kaul is a writer and can be reached at [email protected]
Have you ever heard someone call equity a short term investment class? Chances are no. “I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it… You can build a case for equities on a three year basis. But long term investing is all rubbish, I have never believed in it,” says Shankar Sharma, vice-chairman & joint managing director, First Global. In this freewheeling interview he speaks to Vivek Kaul. Six months into the year, what’s your take on equities now? Globally markets are looking terrible, particularly emerging markets. Just about every major country you can think of is stalling in terms of growth. And I don’t see how that can ever come back to the go-go years of 2003-2007. The excesses are going to take an incredible amount of time to work their way out. They are not even prepared to work off the excesses, so that’s the other problem. Why do you say that? If you look at the pattern in the European elections the incumbents lost because they were trying to push for austerity. And the more leftist parties have come to power. Now leftists are usually the more austere end of the political spectrum. But they have been voted to power, paradoxically, because they are promising less austerity. All the major nations in the world are democracies barring China. And that’s the whole problem. You can’t push through austerity that easily in a democracy, but that is what is really needed. Even China cannot push through austerity because of a powder-keg social situation. And I find it very strange when people criticise India for subsidies and all that. India is far less profligate than many nations including China. Can you elaborate on that? Every country has to subsidise, be it farm subsidies in the West or manufacturing subsidies in China, because ultimately whether you are a capitalist or a communist, people are people. They don’t necessarily change their views depending on which political ideology is at the centre. They ultimately want freebies and handouts. In a country like India, they don’t even want handouts they just want subsistence, given the level of poverty. The only thing that you can do with subsidies is to figure out how to control them. But a lot of it is really out of your control. If you have a global inflation in food prices or oil prices you are not increasing the quantum in volume terms of the subsidy. But because of price inflation, the number inflates. So why blame India? I find it absurd that the Financial Times or the Economist are perennially anti-India. They just isolate India and say that it has got wasteful expenditure programmes. A lot of countries hide things. India, unfortunately, is far more transparent in its reporting. It is easy to pick holes when you are transparent. China gives no transparency so people assume that whatever is inside the black box must be okay. That said, I firmly believe the UID program, when fully implemented, will make subsidies go lower by cutting out bogus recipients. If increased austerity is not a solution, where does that leave us? Increased austerity, while that is a solution, it is not achievable. If that is not possible what is the solution? You then have a continual stream of increasing debt in one form or the other, keep calling it a variety of names. But you just keep kicking the can down the road for somebody else to deal with it as long as the voter is happy. Given this, I don’t see how you can have any resurgence. Risk appetite is what drives equity markets. Otherwise you and I would be buying bonds all the time. In today’s environment and in the foreseeable future, we are overfed with risk. Where is the appetite to take more risk and go, buy equities? So are you suggesting that people won’t be buying stocks? Well you can get pretty good returns in fixed income. Instead of buying emerging-market stocks if you buy bonds of good companies, you can get 6-7% dollar yield, and if you leverage yourself two times or something, you are talking about annual returns of 14-15% dollar returns. You can’t beat that by buying equities, boss! Even if you did beat that by buying equities, let’s say you made 20%, it is not a predictable 20%, which has been my case for a long time against equities. Equities are a western fashion. I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it: it is about the whole entertainment quotient attached to stock investing that drives investors. There is 24-hour television. Tickers. Cocktail discussions. Compared with that, bonds are so boring and uncool. Purely financially, shorn of all hype, equities have never been able to build a case for themselves on a ten-year return basis. You can build a case for equities on a three-year basis. But long-term investing is all rubbish, I have never believed in it. So investing regularly in equities, doing SIPs, buying Ulips, doesn’t make sense? I don’t buy the whole logic of long-term equity investing because equity investing comes with a huge volatility attached to it. People just say “equities have beaten bonds”. But even in India they have not. Also people never adjust for the volatility of equity returns. So if you make 15% in equity and let’s say, in a country like India, you make 10% in bonds – that’s about what you might have averaged over a 15-20 year period because in the 1990s we had far higher interest rates. Interest rates have now climbed back to that kind of level of 9-10%. Divide that by the standard deviation of the returns and you will never find a good case for equities over a long-term period. So equity is actually a short-term instrument. Anybody who tells you otherwise is really bluffing you. All the fancy graphs and charts are rubbish. Are they? Yes. They are all massaged with sort of selective use of data to present a certain picture because it’s a huge industry which feeds off it globally. So you have brokers like us. You have investment bankers. You have distributors. We all feed off this. Ultimately we are a burden on the investor, and a greater burden on society — which is also why I believe that the best days of financial services is behind us: the market simply won’t pay such high costs for such little value added. Whatever little return that the little guy gets is taken away by guys like us. How is the investor ever going to make money, adjusted for volatility, adjusted for the huge cost imposed on him to access the equity markets? It just doesn’t add up. The customer never owns a yacht. And separately, I firmly believe making money in the markets is largely a game of luck. Even the best investors, including Buffet, have a strike rate of no more than 50-60% right calls. Would you entrust your life to a surgeon with that sort of success rate?! You’d be nuts to do that. So why should we revere gurus who do just about as well as a coin-flipper. Which is why I am always mystified why so many fund managers are so arrogant. We mistake luck for competence all the time. Making money requires plain luck. But hanging onto that money is where you require skill. So the way I look at it is that I was lucky that I got 25 good years in this equity investing game thanks to Alan Greenspan who came in the eighties and pumped up the whole global appetite for risk. Those days are gone. I doubt if you are going to see a broad bull market emerging in equities for a while to come. And this is true for both the developing and the developed world? If anything it is truer for the developing world because as it is, emerging market investors are more risk-averse than the developed-world investors. We see too much of risk in our day to day lives and so we want security when it comes to our financial investing. Investing in equity is a mindset. That when I am secure, I have got good visibility of my future, be it employment or business or taxes, when all those things are set, then I say okay, now I can take some risk in life. But look across emerging markets, look at Brazil’s history, look at Russia’s history, look at India’s history, look at China’s history, do you think citizens of any of these countries can say I have had a great time for years now? That life has been nice and peaceful? I have a good house with a good job with two kids playing in the lawn with a picket fence? Sorry, boss, that has never happened. And the developed world is different? It’s exactly the opposite in the west. Rightly or wrongly, they have been given a lifestyle which was not sustainable, as we now know. But for the period it sustained, it kind of bred a certain amount of risk-taking because life was very secure. The economy was doing well. You had two cars in the garage. You had two cute little kids playing in the lawn. Good community life. Lots of eating places. You were bred to believe that life is going to be good so hence hey, take some risk with your capital. The government also encouraged risk taking? The government and Wall Street are in bed in the US. People were forced to invest in equities under the pretext that equities will beat bonds. They did for a while. Nevertheless, if you go back thirty years to 1982, when the last bull market in stocks started in the United States and look at returns since then, bonds have beaten equities. But who does all this math? And Americans are naturally more gullible to hype. But now western investors and individuals are now going to think like us. Last ten years have been bad for them and the next ten years look even worse. Their appetite for risk has further diminished because their picket fences, their houses all got mortgaged. Now they know that it was not an American dream, it was an American nightmare. At the beginning of the year you said that the stock market in India will do really well… At the beginning of the year our view was that this would be a breakaway year for India versus the emerging market pack. In terms of nominal returns India is up 13%. Brazil is down 3%. China is down, Russia is also down. The 13% return would not be that notable if everything was up 15% and we were up 25%. But right now, we are in a bear market and in that context, a 13-15% outperformance cannot be scoffed off at. What about the rupee? Your thesis was that it will appreciate… Let me explain why I made that argument. We were very bearish on China at the beginning of the year. Obviously when you are bearish on China, you have to be bearish on commodities. When you are bearish on commodities then Russia and Brazil also suffer. In fact, it is my view that Russia, China, Brazil are secular shorts, and so are industrial commodities: we can put multi-year shorts on them. So that’s the easy part of the analysis. The other part is that those weaknesses help India because we are consumers of commodities at the margin. The only fly in the ointment was the rupee. I still maintain that by the end of the year you are going to see a vastly stronger rupee. I believe it will be Rs 44-45 against the dollar. Or if you are going to say that is too optimistic may be Rs 47-48. But I don’t think it’s going to be Rs 60-65 or anything like that. At the beginning of the year our view that oil prices will be sharply lower. That time we were trading at around $105-110 per barrel. Our view was that this year we would see oil prices of around $65-75. So we almost got to $77 per barrel (Nymex). We have bounced back a bit. But that’s okay. Our view still remains that you will see oil prices being vastly lower this year and next year as well, which is again great news for India. Gold imports, which form a large part of the current account deficit, shorn of it, we have a current account deficit of around 1.5% of the GDP or maybe 1%. We imported around $60 billion or so of gold last year. Our call was that people would not be buying as much gold this year as they did last year. And so far the data suggests that gold imports are down sharply. So there is less appetite for gold? Yes. In rupee terms the price of gold has actually gone up. So there is far less appetite for gold. I was in Dubai recently which is a big gold trading centre. It has been an absolute massacre there with Indians not buying as much gold as they did last year. Oil and gold being major constituents of the current account deficit our argument was that both of those numbers are going to be better this year than last year. Based on these facts, a 55/$ exchange rate against the dollar is not sustainable in my view. The underlyings have changed. I don’t think the current situation can sustain and the rupee has to strengthen. And strengthen to Rs 44, 45 or 46, somewhere in that continuum, during the course of the year. Imagine what that does to the equity market. That has a big, big effect because then foreign investors sitting in the sidelines start to play catch-up. Does the fiscal deficit worry you? It is not the deficit that matters, but the resultant debt that is taken on to finance the deficit. India’s debt to GDP ratio has been superb over the last 8-9 years. Yes, we have got persistent deficits throughout but our debt to GDP ratio was 90-95% in 2003, that’s down to maybe 65% now. So explain that to me? The point is that as long as the deficit fuels growth, that growth fuels tax collections, those tax collections go and give you better revenues, the virtuous cycle of a deficit should result in a better debt to GDP situation. India’s deficit has actually contributed to the lowering of the debt burden on the national exchequer. The interest payments were 50% of the budgetary receipts 7-8 years back. Now they are about 32-33%. So you have basically freed up 17% of the inflows and this the government has diverted to social schemes. And these social schemes end up producing good revenues for a lot of Indian companies. The growth for fast-moving consumer goods, mobile telephony, two wheelers and even Maruti cars, largely comes from semi-urban, semi-rural or even rural India. What are you trying to suggest? This growth is coming from social schemes being run by the government. These schemes have pushed more money in the hands of people. They go out and consume more. Because remember that they are marginal people and there is a lot of pent-up desire to consume. So when they get money they don’t actually save it, they consume it. That has driven the bottomlines of all FMCG and rural serving companies. And, interestingly, rural serving companies are high-tax paying companies. Bajaj Auto, Hindustan Lever or ITC pay near-full taxes, if not full taxes. This is a great thing because you are pushing money into the hands of the rural consumer. The rural consumer consumes from companies which are full taxpayers. That boosts government revenues. So if you boost consumption it boosts your overall fiscal situation. It’s a wonderful virtuous cycle — I cannot criticise it at all. What has happened in past two years is not representative. It is only because of the higher oil prices and food prices that the fiscal deficit has gone up. What is your take on interest rates? I have been very critical of the Reserve Bank of India’s (RBI) policies in the last two years or so. We were running at 8-8.5% economic growth last year. Growth, particularly in the last two or three years, has been worth its weight in gold. In a global economic boom, an economic growth of 8%, 7% or 9% doesn’t really matter. But when the world is slowing down, in fact growth in large parts of the world has turned negative, to kill that growth by raising the interest rate is inhuman. It is almost like a sin. And they killed it under the very lofty ideal that we will tame inflation by killing growth. But if you have got a matriculation degree, you will understand that India’s inflation has got nothing to do with RBI’s policies. Your inflation is largely international commodity price driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing. In fact, growth is the only antidote to inflation in a country like India. When you have economic growth, average salaries and wages, kind of lead that. So if your nominal growth is 15%, you will 10-20% salary and wage hikes – we have seen that in the growth years in India. Then you have more purchasing power left in the hands of the consumer to deal with increased price of dal or milk or chicken or whatever it is. If the wage hikes don’t happen, you are leaving less purchasing power in the hands of people. And wage hikes won’t happen if you have killed economic growth. I would look at it in a completely different way. The RBI has to be pro-growth because they no control of inflation. So they basically need to cut the repo rate? They have to. But will that have an impact? Because ultimately the government is the major borrower in the market right now… Look, again, this is something that I said last year — that it is very easy to kill growth but to bring it back again is a superhuman task because life is only about momentum. The laws of physics say that you have to put in a lot of effort to get a stalled car going, yaar. But if it was going at a moderate pace, to accelerate is not a big issue. We have killed that whole momentum. And remember that 5-6%, economic growth, in my view, is a disastrous situation for a country like India. You can’t say we are still growing. 8% was good. 9% was great. But 4-5% is almost stalling speed for an economy of our kind. So in my view the car is at a standstill. Now you need to be very aggressive on a variety of fronts be it government policy or monetary policy. What about the government borrowings? The government’s job has been made easy by the RBI by slowing down credit growth. There are not many competing borrowers from the same pool of money that the government borrows from. So far, indications are that the government will be able to get what it wants without disturbing the overall borrowing environment substantially. Overall bond yields in India will go sharply lower given the slowdown in credit growth. So in a strange sort of way the government’s ability to borrow has been enhanced by the RBI’s policy of killing growth. I always say that India is a land of Gods. We have 33 crore Gods and Goddesses. They find a way to solve our problems. So how long is it likely to take for the interest rates to come down? The interest rate cycle has peaked out. I don’t think we are going to see any hikes for a long time to come. And we should see aggressive cuts in the repo rate this year. Another 150 basis points, I would not rule out. Manmohan Singh might have just put in the ears of Subbarao that it’s about time that you woke up and smelt the coffee. You have no control over inflation. But you have control over growth, at least peripherally. At least do what you can do, instead of chasing after what you can’t do. Manmohan Singh in his role as a finance minister is being advised by C Rangarajan, Montek Singh Ahulwalia and Kaushik Basu. How do you see that going? I find that economists don’t do basic maths or basic financial analysis of macro data. Again, to give you the example of the fiscal deficit and I am no economist. All I kept hearing was fiscal deficit, fiscal deficit, fiscal deficit. I asked my economist: screw this number and show me how the debt situation in India has panned out. And when I saw that number, I said: what are people talking about? If your debt to GDP is down by a third, why are people focused on the intermediate number? But none of these economists I ever heard them say that India’s debt to GDP ratio is down. I wrote to all of them, please, for God’s sake, start talking about it. Then I heard Kaushik Basu talk about it. If a fool like me can figure this out, you are doing this macro stuff 24×7. You should have had this as a headline all the time. But did you ever hear of this? Hence I am not really impressed who come from abroad and try to advise us. But be that as it may it is better to have them than an IAS officer doing it. I will take this. You talked about equity being a short-term investment class. So which stocks should an Indian investor be betting his money right now? I am optimistic about India within the context of a very troubled global situation. And I do believe that it’s not just about equity markets but as a nation we are destined for greatness. You can shut down the equity markets and India would still be doing what it is supposed to do. But coming from you I find it a little strange… I have always believed that equity markets are good for intermediaries like us. And I am not cribbing. It’s been good to me. But I have to be honest. I have made a lot of money in this business doesn’t mean all investors have made a lot of money. At least we can be honest about it. But that said, I am optimistic about Indian equities this year. We will do well in a very, very tough year. At the beginning of the year, I thought we will go to an all-time high. I still see the market going up 10-15% from the current levels. So basically you see the Sensex at around 19,000? At the beginning of the year, you would have taken it when the Sensex was at 15,000 levels. Again, we have to adjust our sights downwards. A drought angle has come up which I think is a very troublesome situation. And that’s very recent. In light of that I do think we will still do okay, it will definitely not be at the new high situation. What stocks are you bullish on? We had been bearish on infrastructure for a very long time, from the top of the market in 2007 till the bottom in December last year. We changed our view in December and January on stocks like L&T, Jaiprakash Industries and IVRCL. Even though the businesses are not, by and large, of good quality — I am not a big believer in buying quality businesses. I don’t believe that any business can remain a quality business for a very long period of time. Everything has a shelf life. Every business looks quality at a given point of time and then people come and arbitrage away the returns. So there are no permanent themes. And we continue to like these stocks. We have liked PSU banks a lot this year, because we see bond yields falling sharply this year. Aren’t bad loans a huge concern with these banks? There is a company in Delhi — I won’t name it. This company has been through 3-4 four corporate debt restructurings. It is going to return the loans in the next year or two. If this company can pay back, there is no problem of NPAs, boss. The loans are not bogus loans without any asset backing. There are a lot of assets. At the end of every large project there is something called real estate. All those projects were set up with Rs 5 lakh per acre kind of pricing for land. Prices are now Rs 50 lakh per acre or Rs 1 crore or Rs 1.5 crore per acre. If nothing else, dismantle the damn plant, you will get enough money from the real estate to repay the loans of the public sector banks. So I am not at all concerned on the debt part. If the promoter finds that is going to happen, he will find some money to pay the bank and keep the real estate. On the same note, do you see Vijay Mallya surviving? 100% he will survive. And Kingfisher must survive, because you can’t only have crap airlines like Jet and British Airways. If God ever wanted to fly on earth, he would have flown Kingfisher. So he will find the money? Of course! At worst, if United Spirits gets sold, that’s a stock that can double or triple from here. I am very optimistic about United Spirits. Be it the business or just on the technical factor that if Mallya is unable to repay and his stake is put up for sale, you will find bidders from all over the world converging. So you are talking about the stock and not Mallya? Haan to Mallya will find a way to survive. Indian promoters are great survivors. We as a nation are great survivors. How do you see gold? I don’t have a strong view on gold. I don’t understand it well enough to make big call on gold, even though I am an Indian. One thing I do know is that our fascination with gold has very strong economic moorings. We should credit Indians for having figured out what is a multi century asset class. Indians have figured out that equities are a fashionable thing meant for the Nariman Points of the world, but for us what has worked for the last 2000 years is what is going to work for the next 2000 years. What about the paper money system, how do you see that? I don’t think anything very drastic where the paper money system goes out of the window and we find some other ways to do business with each. Or at least I don’t think it will happen in my life time. But it’s a nice cute notion to keep dreaming about. At least all the gold bugs keep talking about the collapse of the paper money system… I know. I don’t think it’s going to happen. But I don’t think that needs to happen for gold to remain fashionable. I don’t think the two things are necessarily correlated. I think just the notion of that happening is good enough to keep gold prices high. (A slightly smaller version of the interview appeared in the Daily News and Analysis on July 31,2012. http://www.dnaindia.com/money/interview_you-can-shut-the-equity-market-india-would-still-be-doing-fine_1721939) (Interviewer Kaul is a writer and can be reached at [email protected])
Aswath Damodaran is one of the world’s premier experts in the field of equity valuation. He has written several books like Damodaran on Valuation, Investment Fables, The Dark Side of Valuation and most recently The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit, on the subject. He is a Professor of Finance at the Stern School of Business at New York University where he teaches corporate finance and equity valuation. . In this interview he speaks to Vivek Kaul. How did you get into the field of valuation? I started in finance as a general area and then I got interested in valuation when I started teaching. Valuation is a piece of almost everything you do and I was surprised how ill developed it was as a field of thought. It was almost random and not much thinking had gone into thinking about how to do it systematically. A lot of valuation is basically compound interest when you discount the expected cash flows. So how much of it is math and how much of it is art? Much of it is not the compound interest or the discount factor it is really the cashflows you have to estimate. So most of it is actually is in the numerator. It is about figuring out what business you are in. Figuring out how you make money. Figuring out what the margins are. What the competition is going to be. So numerator is where all the action is and it is actually very little to do with mathematics. It is more an understanding of business and actually getting it into numbers. Can you give us an example? So if you are trying to value Facebook getting the discount rate for Facebook is trivial. It is easy. It is about 11.5%. It is about the 80th percentile in terms of riskiness of companies. The trouble with Facebook is figuring out, first what business they are going to be in, because they haven’t figured it out themselves. How are they going to convert a billion users into revenues and income? And second, if they even manage to do it, how much those revenues will be, what will the margins etc. And those are all functions where you cannot think just Facebook standing alone. It is going to compete against Google. It is going compete against Apple. It is going to compete against other social media companies. So you have to make judgement calls of how it is all going to play out. It is numbers but the numbers come from understanding business. Understanding strategy. Understanding competition. Understanding all the things that kind of come into play. You just mentioned that the discounting rate for expected cash flows from Facebook was at 11.5%. How did you arrive at that? I have the cost of capital for by every sector in the US. So this is the cost of capital for dotcoms? This is actually the cost of capital for risky technology capitals. So basically I am saying is that I could sit there and try to finesse it and say is it 11.8% or is it 11.2%. But it doesn’t really matter. Getting the revenues and margins is more critical than getting the discount rate narrowed down. This 11.5% would be from a combination of equity and debt? For a young growth company it is almost going to be all equity. You don’t borrow money if you are that small and when you are in a high growth phase it is not worth it. It is almost all equity. I recently read a blog of yours where you said that you have sold Apple shares even though they were undervalued. Why did you do that? There are two parts to the investment process. One is the value part to the process. And the other is the pricing part to the process. To make money you need to be comfortable with both parts. You want to feel comfortable with value and you have to feel comfortable that price is going to converge on the value. In the case of Apple for 15 years I was comfortable with my estimate of value and I was comfortable that the price would converge on value. In the last year the Apple stockholder base has had a fairly dramatic change. There has been influx of a lot of institutional investors who have coming in as herd investors and momentum investors who go wherever the price is hottest. You have also got a lot of dividend investors who came in last year because they expected Apple to start paying dividends. What happened because of that? So you got this influx of new investors with very different ideas of what they expect Apple to do in the future. They are all in there. And right now they are okay for the moment because Apple is able to keep them all reasonably happy. But I think this is a game where I have lost control of the pricing process because those investors turn on a dot. Like they did, when the stock went from $640 to $530 for no reason at all. You look at any news that came out. Nothing came out. So why is the stock worth $640 and eight weeks later $530? But that’s the nature of momentums stocks. It is not news that drives the price anymore, it’s the herd. Basically if it moves in one direction, prices are going to go up $20. If it moves in the other direction, it is going to go down $30. And I looked at the pricing process and said I have lost control of this part of the process. I am comfortable with the value still. But I am leaving not forever. If these guys keep pushing it down, sooner or later they are going to push it to a point where these guys leave and then I can step in buy the stock. So it’s not permanent but I think at the moment it has become a momentum stock. You have talked about the danger of purely relying on stories while investing. But that’s how most investors invest. What are the problems with that? Even momentum investors want a crutch. Basically stories give them a crutch. You have decided to buy the stock anyway because everyone else is doing it. You don’t want to tell people because that doesn’t sound good so you look for a story to convince yourself that you area really doing this for a good reason. The power of the story is very strong, I am not denying it. But I am saying that if there is a story my job is to bring it into the numbers and see if that story holds up to scrutiny. Any example? You can talk about user base. Facebook the story is that they have lots of users. My job is to take those billion users and talk about what that might mean in revenues and margins and operating income and cash flows. And not just say that there are lot of users therefore the company must be worth a lot. If a Chinese company says we are going to be valued. There are a billion Chinese. Okay. What does that mean? You have a billion Chinese but how much will be you able to sell? How much will they buy your product? So I think you need to get past the macro big story telling because it is easy to fall into saying that hey this company is worth a lot. Can smaller investors make money by piggybacking on investment decisions of big investors? If you look at institutional investors they do things so badly why do you want to piggyback on them. Someone like a Warren Buffett and Rakesh Jhunjhunwala in the Indian context? You could but I think by the time you get the information it is usually too late. It is not like you are the only one who finds out that Warren Buffett has bought a stock. Half the world has found out. So when you get to lineup to buy the stock, everyone else is buying the stock and price has already moved up. George Soros once said that most money is made by entering a bubble early. What are your views on that? Everybody is guilty of hyperbole when it comes to bubbles and Soros is no exception. Soros has never been a great micro investor. He has made his money on macro bets. He has always been. He has never been a great stock picker. For him it is got to be massive macro bubbles, an asset class that gets overpriced or underpriced. You’re right if you can call macro bubbles you can make a lot of money. John Paulson called the housing bubble made a few billion dollars. So he is right and he is wrong. He is right because if you can call a macro bubble you can make a lot of money. He is wrong because if you make your investment philosophy calling macro bubbles, you better get lucky, because everybody is calling macro bubbles and most of them are going to be wrong. You have talked about buying the 35worst stocks in the market and holding that investment and making money on it. How does that work? It’s called the classic contrarian investment strategy where you buy the biggest holders and you hold them for a long period. There is evidence that if you hold them for a long period that they tend to be the best investments. But it comes with caveats. One is that if you buy the 35 biggest losers they often tend to be low priced stocks because they have gone down so much which increases the transaction cost of your trading. The other is that it is very dependant on your time horizon. It turns out that if you buy the lowest price stocks for the first 18 months they actually underperform. It is only after that they turnaround. This means that if you buy these stocks you are going to get about 18 months of heart burn and stomach aches. And for many people they don’t have the patience to stay in. So they often buy the worst stocks after reading these studies. About 12 months in they lose patience they sell it. It is very dependant on both those pieces of puzzle falling in. How much role does media play in influencing investment decisions of people? Media and analysts are followers. None of the media told us last week that Facebook was going to collapse. Now of course everybody is talking about it. So basically when I see in the media news stories I see a reflection of what has already happened. It is a lagging indicator. It is not a leading indicator. I have never ever found a good investment by reading a news story. But I have heard about why an investment was good in hindsight by reading a news story about it. I am not a great believer that I can find good investments in the media. That’s not their job anyway. (The interview was originally published in the Daily News and Analysis(DNA) on June 2,2012. http://www.dnaindia.com/money/interview_ive-never-found-a-good-pick-by-reading-a-news-story_1696935) (Vivek Kaul is a writer and can be reached at [email protected])