Global Events, Global Markets, Global Turmoil

Events like The World Wars, Great Depression, Lehmann Crisis, get etched in our minds by the sheer uniqueness or the magnitude of their occurrence.

Also, by virtue of the huge advances made in technology over the years, information (rumours, lies and truths) get disseminated ever so quickly.

Fortunately or unfortunately, in this ever increasingly connected world, making decisions for our investments becomes much more harder.

Today, among many other events, the global markets crashed. Over the last few months, every government, central banks, financial markets, commodity markets are clueless about the real problem, a probable solution, effectiveness of the solution and time period within which the solution will take effect.

Some countries are fighting high inflation, others are focusing on improving growth of their economies, some others fixing their debt crisis and a few are recovering from natural calamities . Since, all countries are not facing similar issues (pretty much expected at any given time), ‘One Size Fits All’ solution does not work.

Surprisingly, despite the varied issues countries are facing today, at the time of writing, stock markets across the world have fallen anywhere between 2% and 6%. Currencies have fallen between 2% to 7% against the dollar. Crude oil has fallen 3% to 5%, gold has fallen by 4%, silver by 10% ALL IN A SINGLE DAY.

Few of the key reasons for the current chaos (and at all other times :-)) and the root for the ‘negative perception of risk’

• Fear

• ‘Following the Herd’

• Greed

• Knowledge is power, ignorance is bliss – little of both is a recipe for disaster

If we can control the above reasons and ‘react’ better with our behaviour, global events will become less unique and smaller in magnitude.

Risks and the Stock Markets - Part 3 of 7

In the last part, my closing view was that money under our pillows / beds / piggy banks were the safest places :-).

Arguments I have received in response to the above are:

• Money under pillows (and other options) is not ‘investing’ as money does not grow and it still has the risk of being robbed.

• Money in a bank (savings, FD, et. al) is ‘invested’ as money does grow and the risk of the bank going bust is minimal.

We all know that ‘risk-reward ratio’ implies a higher risk is an opportunity for higher gain (and also loss :-)).

And hence, the rationale for the views from people is driven by:

• One would rather keep the money in a bank than under a pillow as the ‘risk’ (the chance of loss to burglars, IT Department) for the latter is higher.

• Banks rarely go bust

• Keep your risks as low as possible as long as the principal is safe

Here’s a fact – there have been atleast 6 banks in the last decade which have been forced by RBI to be merged or acquired by larger Indian banks as the banks went bust or were on the verge of it (E.g. Global Trust Bank was force merged into Oriental Bank of Commerce).

Indians, by virtue of our social training, have a ‘saving’ mentality and are focused on preservation of capital even at the expense of being in a low return (low risk) investment. Unfortunately, rarely do we realize that other important macro-economic factors (inflation, government administered interest rates, etc.) are reducing the purchasing power of our savings.

The incentive for investing is not the safety of the capital (though people do not realize this fact). The BIGGEST DRIVER for people to ‘invest’ money under pillows, FDs, PPFs, NSCs, (all the safe investments) is because the fluctuations of expected return is the least in all these forms. In any or all these investment forms, we know the final return for the tenure the capital is invested. This is not true for any investment form linked to the stock market.

If an FD gives you a 10% pa return on your capital, and if a stock can give you 3% return in a quarter (approx. 12% pa) then given a choice, where will you invest your money?

Food for Thought: If we know what return we want / are expecting from an investment class / form for a given tenure, then why not use the same tenet in the stock market.

Risks and the Stock Markets - Part 2 of 7

I’ll like to keep emphasizing through these series that one needs to look at ‘risk’ as the measure of gain / opportunity.

We all by training are conditioned to risk in almost everything we do which also includes our views about investing.

To invest (especially money) by definition is always about a profitable return. If you notice, ‘investing’ has no risk!!

Essentially, the problem lies not with investing but with the latter part of the definition, ‘profitable return’. This brings the concept of the risk-reward ratio.

From childhood, we are trained to save. The simplest form of saving was not to spend the money but to keep it aside in a ‘piggy bank’. Our parents saved in a slightly organized manner – they saved in PPFs, FDs, Savings Accounts, NSCs, etc. Fortunately, all these gave very ‘profitable returns’ and since most or all these instruments were backed by the government, there were ‘safe’.

But in our childhood did we realize that the money in our ‘piggy banks’ grew only if we saved more? By saving we only postponed our impulse to spend.

If I told you that the ‘Deposit Insurance & Credit Guarantee Corporation’ (a wholly owned subsidiary of RBI set-up in 1962) guarantees ONLY Rs. 1 lac regardless of the number of accounts (or type of accounts) held by a person in same capacity and the same right.

Essentially, if you held a savings account and / or current account and / or fixed deposit with one / more branches of the same bank, AND if the bank went bust, the MAXIMUM amount RBI will compensate will be Rs. 1 lac or the sum total of your money in all accounts whichever is LESSER.

With the above new input, is money in the Bank really safe? Is the return risk-free? Shouldn’t we just keep money under our pillows / beds (like the big politicians do) or just keep it in a PIGGY BANK!!

References –

www.dicgc.org.in

www.dictionary.com

Risks and the Stock Markets - Part 1 of 7

My next multi-part series deals with ‘Risks and the Stock Markets – Part 1 of 5’ (not sure how many parts it will be :-)).

Every now and then I get a new prospect for my portfolio management services (through a reference) and the varied responses I get to my question ‘Why do you want to invest in stock market and it’s varied derived forms?’ are:

• I have burnt my money; want to recover some of it

• Get better returns than a fixed deposit / recurring deposit / savings deposit

• I have no other place to invest

• Other people have made money

• Am not sure what to buy

• No time to track what I have bought

One of the most important aspects of investing which people disregard is the concept of risk and the associated perception of risk.

Risk by definition is the ‘exposure to chance of injury or loss’. Humans attach various perspectives to risk and decide the quantum of risk one is willing to undertake. Unfortunately, the definition of risk also has a bias – it tends to be negative in thought.

When I was working with TCS and had to travel quite often by flight, my father used to be extremely nervous. Reason – if I could reduce the frequency of my flights, I reduce the risk of being hijacked / being in an air crash, etc. Many of you will cite the fact that air travel is the safest mode of transport but still for a parent the perecption of the risk is very different from my perception.

Similary, for every situation, the appetite for risk and the amount of loss which one is willing to suffer varies from our own social upbringing, our sense of security (job, personal, emotional, etc.) and mental accounting of the quantum of loss we are willing to take.

Food for thought – how difficult will it be for you to accept risk as a measure of gain / an opportunity; positive thinking :-)!!

Investment in Gold - Part 4 of 4

This is the last of the 4 part series about ‘Investment in Gold’

e-Gold

• One of the most interesting investment cum consumption method of investing in Gold and picks the best aspects of all the previous investment methods

• Buy gold in minimum units of 1 (no fractional ownership) at prevailing market price - [similar to Gold ETF]

• Demat account to hold e-Gold is different from the one use for Gold ETFs / stocks – [no hassles of holding gold in lockers]

• Gold is of 995 grade (the highest grade in gold) – [purity is guaranteed]

• Brokerage is lower or equal to the brokerage as in gold ETFs – [overall transaction costs are lower]

• Your gold is held in a warehouse managed by the National Spot Exchange (view it as the gold in a very large locker) but you hold it in demat form - [safety, from a perspective of storage, as good as Gold ETFs]

• You can either sell gold and book profits (like you sell stocks / Gold Mutual Funds / Gold ETFs) or take delivery of the gold in the form of coins or bars by paying applicable state VAT and handling charges - [ease of selling]

• Trading window is 10:00 am to 11:30 pm - [unlike Gold ETFs or Gold Mutual Funds]

• Flexibility of buying any amount of gold without the hassles of getting a locker

• Tax treatment on the profits made by buying and selling of ETFs in NOT AS tax treatment of profits on stocks / shares.

• Not all brokers who deal with equity are brokers in e-Gold

Gold Futures

• Started in India in 2004; comes under the category of commodity trading

• The most rewarding AND riskiest of all investment methods in gold

• Works like stock futures

• You trade (buy / sell) large amount (multiples of lot size) of gold in a single transaction

• Minimum lot size for a gold future contract is 1 kg

• Not all brokers who deal with equity are brokers in Gold futures

Risk Reward Ratio (in decreasing risk and return)

Gold Futures > e-Gold > Gold ETFs > Gold Mutual Funds

Please note, I do not consider gold under the consumption category for the risk-reward ratio.

Investment in Gold - Part 3 of 4

Gold Exchange Traded Funds (ETFs)

• Exchange Traded Funds are investments made by an asset management company to manage Gold as the underlying asset. They invest in physical gold.

• You buy Gold ETFs in units of 1 (no fractional units) through a broker as ETFs are traded like stocks and shares on stock exchanges.

• Price of 1 unit (approx. 1 gm) of gold ETF keeps changing similar to the price changes in a stock on a given trading day; except the price also moves in tandem to world gold prices. [Prices of a given stock changes based on the perception of the value (this in turn has its own set of variables) of the company, dynamics of demand and supply shares in the market].

• You need to pay a brokerage charge when you buy / sell the gold ETF.

• One needs a demat account (demat account for gold ETF is the same as that for shares)

• Tax treatment on the profits made by buying and selling of ETFs in NOT AS tax treatment of profits on stocks / shares.

• As the Gold ETF is management by an AMC, there's an additional expense of 1% pa.

• Physical gold is bought by the AMC and managed by authorized participants on behalf of the AMC.

• Gold ETFs were launched in India in 2007

• Well known Gold ETFs - BeES Gold ETF, UTI Gold ETF, Kotak Gold ETF

• Automatic SIP (Systematic Investment Plan) is not possible in Gold ETFs

Gold Mutual Funds

• The investment company (AMC) invests in either companies involved with the mining, refining, trading of gold or invests in Gold ETFs (Fund-of-Funds).

• AIG World Gold Fund and DSP BR World Gold Fund invests in companies which mine, refine gold ore

• Gold ‘Fund-of-Funds’ trend was started by Reliance in 2011 followed by Kotak Gold Savings Fund. Reliance Gold Savings mutual fund is a fund which invests money in Reliance Gold ETF. SBI's latest Gold mutual fund is again a Fund of Funds which invests in SBI’s Gold ETF.

• Any mutual fund which invests in another mutual fund gives a lower return and has higher costs.

• Reliance Gold ETF will give higher returns than Reliance Gold Mutual fund.

• No need for demat account to buy gold mutual funds

• For every amount you invest, you get units of the gold fund. Fractional units are possible when you invest through gold mutual funds

• Entry load / exit load and expense load (1.3%+ pa) as in any mutual fund is applicable

• Tax treatment on the profits made by buying and selling of ETFs in NOT AS tax treatment of profits on stocks / shares

• Automatic SIP (Systematic Investment Plan) is possible in Gold mutual funds

Investment in Gold - Part 2 of 4

Here’s Part 2 of 3 of the series 'Investment in Gold'.

Gold As Consumption

Bars & Coins:

• Typically in standard weights of 1 gm, 5 gm etc.

• Available from Banks, Jewelers, Gold Marts

• Purity is 24 carats or 22 carats

• Price is subjective to the prevalent rate of the day in the World Market indicated in dollars per troy ounce for 24 carat gold.

• Additional charges include die charges for marking and certification of purity

• 1 Troy Ounce is 31.1 gms

• Price of Gold in India for Gold is calculated by

o Value of USD in INR per Troy Ounce

o Convert the rate from previous point to get rate per gram for 24 carat gold

• Don't buy bars / coins from Banks as they charge a higher premium

• Don't buy 24 carat gold bars / coins. Jewelers prefer to buy back 22 carat gold

• Purity of gold only guaranteed by banks for coins / bars sold by them

• BIS standards exist; all purchases from a jeweler are based on trust / reputation of the jeweler

Jewelry:

• No standard weight for jewelry bought

• Costs include making charges, wastage charges and state VAT.

• Indians typically choose to buy 22 carat jewelry

• More complex the design, higher the wastage and making charges which increases your cost of acquisition

• Though BIS standards exist, all purchases from a jeweler are based on trust / reputation of the jeweler

Additional cost of keeping the above forms of gold in bank lockers. Gold sitting in lockers does not generate any intrinsic value (until price of gold increases).

In many a movies (and in real life), selling of the 'household' gold is the last resort to encash the value of gold.

In India, culturally, Gold is an asset handed over from a generation to another (mother to daughter, mother-in-law to daughter-in-law, etc). Gold is also part of tradition / custom of many castes / religions in India.

Gold is an asset which is traditionally a way of giving a girl's share in the family property.

Now NBFCs (Non Banking Financial Corporations) like Muthoot and Mannapuram offer loans against gold.

• Here the price of the gold is taken as the average of gold price over the last 90 days.

• Purity and total weight of gold are key factors to arrive at the amount of loan you can get.

• Loan sanctioned is 70% of the total value arrived based on the above 2 points

• Interest on this type of loan is between 14 – 16 % per annum

Investment in Gold - Part 1 of 4

Continuing from one of my previous mail threads about Gold, I’ll be sharing a 3 part series about investment in Gold. So here’s Part 1 of 3.

Gold prices are impacted by the following:

• Jewelry off take (pure consumption demand)

• Industrial use

• Geo-political concerns

• US dollar movement against other currencies

• Indian rupee movement against the US dollar

• Central Banks diversifying into bullion (Central Banks normally invest in bonds of other countries mostly US, Germany, France, Canada – AAA+ rating :-) )

• Central Bank Sales Slowing and Massive De-Hedging

• Gold Mine Production

• Fall in Supply

• Buying of gold can be broadly classified into 2 categories

o Consumption and

o Investment

• By world statistics, gold is mostly bought for consumption, investment and finally for industrial use

Gold for Consumption:

• Buying of gold is influenced with the intent to HOLD and NOT SELL

• Forms of buying gold is in jewelery, coins, bars

• Industrial Use

• Mostly bought my individuals and manufacturing companies in the hi-tech sector

Gold for Investment

• Buying of gold is influenced with the intent to SELL and NOT HOLD

• Forms of buying and selling of gold is Gold ETFs, Gold Mutual Funds

• Speculative buying in form or Gold Futures

• Mostly bought by investment management companies, central banks, speculators / traders and lastly by retail investors