Golden Ratios

China, it seems, wants to load up on gold. There is an aggressive retail push going on in China towards precious metals. In India, on the other hand, there have been appeals to buy less gold, use our forex for better things, turn out our gold hidden in bank lockers etc. As if we Indians will ever listen to that! The buying continues unabated. This is also in keeping with popular perception that Indians (and increasingly, the Chinese now) have a voracious appetite for gold. Pivoted around this idea, I ran some numbers to figure out gold reserves for the top countries, the amount of gold reserve coverage given the GDP size of each country and finally how much gold reserves exist in a country per person of its population. The latter is an interesting metric – it says that if all the citizens of a country were to line up in front of their central bank’s vault to receive equal amounts of gold, how many grams or kilograms would they get. The results for 41 top countries (by gold reserve holding) is shown in the chart below:

  • USA, with the world’s largest gold reserves drops down to 23rd place when compared to countries on gold per Bn USD of GDP
  • India and China, at 10th and 5th places drop down to 37th and 35th places when it comes to the weight of gold per capita! Clearly, we should buy more!!
  • Lebanon and Libya are pricing in their geopolitical risk by paying rent and holding charges for all the massive horde of gold that they have given the size of their economy.
  • Germany, France and Italy are very well placed. From where did they get all their gold, I wonder.
  • Canada’s position surprised me.

Golden Countries

So is there a trading play in Indian gold? I am not a goldbug enough to know. Goldbugs don’t know anyways. Maybe there is a 5% – 10% scope in gold in rupee terms that is possible now. Constant pressure on the rupee has kept the INR gold chart very subdued as compared to the USD price of gold.

The first chart below shows the daily price chart of a local Indian gold ETF over the last 18 months – on the charts, it does not show a set-up which gets me excited. On the longer 3 year chart with weekly prices, there certainly seems room but again, the present price does not scream a buy (to me).

Gold 3Feb16 18mo DailyGold since 2008 weekly

Gold’s Identity Crisis

A very significant development took place in the US early last month which could perhaps turn out to be very bullish for gold. The OCC (Office of the Comptroller of Currency) and the FDIC (Federal Deposit Insurance Corporation) circulated a public note asking for comment on their proposal to change the risk weightage of gold from the current 50% to 100%! It’s even more pervasive – the BIS’ Basel Committee for Bank Supervision are not only contemplating  increasing the amount of regulatory capital that banks must set aside through the forthcoming Basel III rules but they are indeed contemplating giving gold a Tier I asset status (i.e. a 100% risk weight). In other words, they propose to make gold a zero risk asset. Banks have to risk weight their assets and have to set aside regulatory capital for the more riskier assets that they hold. If gold becomes zero risk weighted then this will release a lot of steam from the banks’ balance sheets. This move (as also the proposal to ask banks to put aside more regulatory capital going forward) if implemented from 1Jan’13 onwards, will effectively put gold on the same pedestal as US treasuries and it logically seems that the yellow metal will see a run to catch up with the handsome gains that US treasuries have witnessed in recent times.

To investigate myself, I studied the correlation between the gold and equity prices (Gold in $ terms vs. the DJIA). The result (blue line) is shown below. The red line shows whats happening in India by comparision – the difference, of course is due to exchange rate fluctuation. It’s clear from the charts that both gold and US equities have been moving in step since July 2011 and going by the oscillatory nature of the plot, it looks likely that this positive correlation will continue for some more months to come.

The neat divergence between the gold/equity correlations between US and India is interesting. The charts below try to show the relationship between these two sets of correlations. The picture on the left below shows all correlation pairs over the past 10 years – it’s truly inconclusive. Perhaps an indicator of India’s closed economy status and the lack of full free float in the INR? On this messy chart, I have indicated where we are today – that position is clearly on the boundary of the plot. If the law of averages holds here, then there are three possibilities for this boundary position to go away: A) the correlation between US equities and gold starts to get positive; B) gold starts behaving like a risk asset in India as well and C) both A & B happen in tandem. The chart on the right covers a much recent period (since start of CY’12). This chart zooms in to the data points pertaining to the most recent 6 months and presents another look at the hypothesis that while gold is behaving like a risky asset in the US, it is very much a safe haven in India!


I think what is happening today is that everything is moving in tandem based on “news”: Fed/ECB announce more printing of their respective curriences – everything rallies; jobs report comes out in the US – everything falls, etc etc. Is it that the markets believe that no further QEs will get done? I guess gold better decide what it really wants to be and my hunch is that the day gold’s identity crisis will be resolved will be the day that’ll mark a clear trend for the markets. On the flip side though, I guess the weirdest story would be in the eventuality that gold does get classified as a tier 1 asset, rises in price and somehow equities rise further up as well – in which case would you still dub it riskless?

Is the Golden Age Over?

Finally Pranab Mukherjee said it. He is trying to discourage ‘educated middle class’ investors in India from buying this ‘dead asset’ considering that collectively, Indians now throw $60-62 bn worth of good money on the yellow metal!

While nothing has abated about the nervousness we read in financial journals the world over, I do think that the entry point in Gold for handsome returns has certainly passed us many years back. Yes, in the short term there might be volatility and the metal may climb up even more (as this article from The Economic Times points out) but a parabola is a parabola. To sustain Y = A .X^2 kind of a move, continuous energy needs to be supplied – it does snap one day or the other.


If this is Greece, what lies beneath? WYSINWYG. The one piece of ice that’s been drifting around very closely to this beast is Turkey. They should have included it in the Euro zone when things were good. Now, I doubt if the Turks will ever swim close to this thing. Cold Turkey, really. Incidentally, which is the country with the highest per capita holdings of gold? China? India? Greece? Its Turkey. China & India’s consumption may be high but Turkey’s growth in consumption is staggering – according to the World Gold Council, demand rose by 32.6% in 2011 compared to the previous year. Both their government as well as the people there are worried about the future. So while many emerging counties’ central banks are loading on gold as a hedge against inflation that the US Fed exports out to them, India seems to be a little bit too big to do that. Lots of money will be needed to buy more and more of the expensive gold and that would mean printing INR that’s getting cheaper in value (and therefore more costly to print) by the day. Considering that inflation will not be allowed to rise up any more than what it has in the past given we are soon going to be entering into the election year it looks like a catch 22 to me. Is my logic correct?

Lets Buy Oil, Not Gold

What is the difference between the professions of the Shahrukh Khan version of Don vs. the earlier one essayed by Amitabh Bachchan? The original Don was a gold smuggler while the new one pushes drugs – quite a subtle generational shift this and very much attributable to the lifting of the import duties on gold in 1992. The yellow metal had flowed in freely once the shackles were removed. The differential between the Indian price of gold vs. the UAE one reduced to a level so as to make the risk weighted returns of smuggling very low indeed. Ergo, the villians in Hindi films underwent an apt metamorphosis. Even ertswhile smugglers gave up their shady coves and wharfs and took to politics. But the smuggling never really died down – it continues to this day and the recent budgetary proposal to increase the basic customs duty on gold imported into India will certainly do its bit to not only revive this old cottage industry but also bring the old Bollywood villian out of his holster. Even godmen have dipped their toe in the pool – Swami Nityanand’s name has been doing the rounds it is said.

It’s a good thought, according to what I have read and understood provided that the authorities (read customs, BSF, RAW, etc) can lift up their game to apprehend all worth appprehending – it could turn out to be good for the economy in the longer run. They are saying that China looks all set to overtake India as the world’s largest consumer of gold – if the logic of the customs duty hike is bona fide, then this is one race which we’d be better off letting China win. As such China beats India nearly everywhere anyways. The chart alongside (via World Gold Council) hints at this. From the country’s viewpoint, gold holdings, are no different from foreign exchange reserves really – despite the fact that a huge chunk of India’s gold is in private hands and therefore cannot be mobilised easily if required to serve for national duty. Which is why the move to curb gold consumption (and therefore gold imports) by raising customs duty makes sense. We consumed 1,000 tonnes of the yellow metal in 2010 and another 933 tonnes of it during the next year! While it is clear that the current risk aversion trade and low tariffs have been responsible for this influx, the taps have been flowing all through the 70s and 80s – via the surreptitious route. Today, gold is now officially the most smuggled item to India having pipped television sets to the post. Which is why the government came out with a couple of gold mobilization drives to shore up the foreign exchange reserves. If this is the method that the planners of the economy are betting on to control the trade deficit, then I am guessing that sometime in the future we will see another issue of these gold swapped bonds/gold mop-up drives. Lets see. Remember, RBI had bought 200 tonnes of gold from the IMF sometime in late 2009. I guess they won’t be needing to do that anymore. The notion that the national stock of gold can indeed be considered as a proxy reserve of foreign exchange currency reserves is buttressed by the fact that India recently purchased oil from Iran using gold. Did you know that nearly a third of our current trade deficit is due to our purchases of gold.

The government, via two customs duty hikes in quick succession, is hoping to provide an external stimulus that helps the economy to break out of the current gold – inflationary cycle. The customs duty hike works in the import stage which is circled in yellow in the picture alongside.

Gold and Monetary Thoughts

The latest RBI working paper invites public comments on the topic “Gold Prices and Financial Stability in India“. The paper notes the recent sharp rise in international old prices; examines inter-linkages between desi and international gold prices and finally brings out the emperical observation that the implication of a correction in gold prices on the Indian financial markets is likely to be muted. I also picked up this interesting chart from the paper which compares the real and nominal prices of gold right from 1971. Interesting to note that the precious metal has never “really” breached the USD800/ounce mark, though it came very close to challenging that limit, during 1979/80 and 2011. The nominal price high has been ~$1,900 which came in Nov’11.

Shiploads worth of unaccounted wealth has always kept the demand for gold very high in India, making even someone like John Maynard Keynes liken our desi fixation for it as a ‘ruinous love of a barbaric relic‘. The paper notes this pre-historic Indian yearing for gold but then it makes a point which I don’t quite follow: the authors (of the paper) measure some important macro-economic parameters and restate them in gold terms; and observe that the value of these indicators has actually fallen in gold terms and therefore they conclude that gold must not be in ‘bubble territory’. Duh. Anyways, the paper also notes the fact that the really devastating asset bubbles are the ones that take the banking sector down with it – the dot-com bust has certainly caused lesser damage than the sub-prime crisis. I read up on some literature on the internet on this notion of complicity of the banking sector in global recessions and noted the events that have lead us to today’s line of monetary thinking:

By the 1830s, in England, it was generally believed that the mere legal requirement that the liabilities of the banking system (i.e. public deposits) be convertible to gold on demand was not sufficient to prevent various economic crises. So, in 1844 they introduced the Bank Charter Act which established a currency board – based on gold – to eliminate the banking system’s ability to create fluctuations in money supply. Between prices and money supply, it was firmly believed that prices were the effect and the supply of money was the cause. However, economic crises continued to persist in England in 1847, 1853 and 1865. The prime reason cited for these crises was that the framers of economic policy had not paid much attention to the role of bank deposits in the monetary system.

So, as a result of this, by the 1870s, monetary thinking brought in the concept of the Bank of England being the ‘lender of last resort’ . Gold convertibility was never in question and though financial crises did occur in England from time to time, none involved bank failures. The British experience was well known to observers in the US, where crises involving bank failures were a regular feature of the financial landscape until 1914 – this provided an important impetus for the founding of the Federal Reserve System and there onwards to the following 4 phases:

1. Classical Gold Standard (1880 – 1914): Governments accorded the highest priority to maintaining fixed prices of their currencies in terms of gold.

2. Interwar Gold Exchange Standard (1925 – 39): The techniques developed during the era of convertibility under the gold standard proved insufficient when the need of the hour was to ensure and provide domestic macro stability – ultimately resulting in the Great Depression. Countries cared little about their ‘neighbours’ and freely debased their currencies in order to make exports more attractive in order to grab a slice of the post war economy rebuilding opportunities.

3. The Bretton Woods International Monetary System (1944 – 71): Post WWII, ex Allied nations favoured a regulated system of fixed exchage rates, indirectly disciplined by the USD, which in turn was pegged to gold. All agreed on the need for tight controls. ‘Beggar thy neighbour’ no more. 

4. Managed Float (current): The great inflation of the 70s made policy makers re-emphasize the goal of low inflation and to commit themselves to convertibility-rule like behaviour. USA broke away from the Bretton Wood fetters and freed up the USD from the gold overhang. USD thus became a fully fiat currency.

So the cycle continues and gold (in real terms) has again risen to levels that it earlier saw during the runaway inflation levels of the 70s. Gold has always been central to monetary thinking – even in its divorce from monetary planning in recent times, the need for gold is as important as before – by proxy. When a currency becomes fiat – it derives its value from it’s issuer country’s regulations and policies. The modern economic policy of low inflation and mindless credit expansion has all but effectively debased these fiat currencies (USD and EURO). Therefore, the growing interest (and price increase) in gold under the hope that the current regime of managed float will end and we will move back to the era of tighter monetary regulations backed by gold. According to me, if that happens then fluctuations in the price of gold will most certainly impact prices and financial stability. The probability of occurrence of that happening anytime soon is incomprehensible to me. You need an expert to opine on that – but I’d just say that the world revolves around the USD – fiat or not.

The banking sector has very much been in the eye of the storm during the current economic crisis and therefore no one would play blind on a bet that gold may not breach the $900 psychological mark…

Gold Platinum Ratio

The gold – platinum breached unity recently for the first time in the past 30 months. I have plotted the prices of gold, platinum and the gold/platinum ratio for the past 10 years. It does look like the 70s rally in gold may just get repeated this time as well.  Last time we saw this convergence, the ratio quickly fell down and it was more a case of platinum retracing its sharp fall of 2008 and tearing away from gold. Gold rose as well but platinum rose faster. This time around, what will happen? Many folks are of the opinion that the ratio will shoot up as a result of gold continuing its upward march vis-a-vis platinum.

It seems that platinum is a cyclical asset while gold is more seen as a heat sink, attracting the risk averse wielder of capital. Since industrial demand is down and many catalytic convertors seems to be idling around, platinum appears to have lost its sheen. Platinum has indeed been a 5 bagger during the first 8 years of the past decade, so a reversal to the mean (given its cyclicality) is expected. But the question to goldbugs is – will 1.0 the new near term median level for the gold-platinum ratio? Or will this p/g ratio retrace its recent climb and get down in the region of 0.5 which seems to be its last decade’s resting level. If the latter, then gold surely has ample room to rise.

Abortive Gold Trade

Of late, the NIFTY has been climbing up while Gold has been dropping. When I looked at the short term technical charts of NIFTY and Benchmark Gold Bees Index (I am long this index on a long term basis), I had an idea – to short the NIFTY and go long on Gold. So I chewed upon this trade set-up idea this weekend and finally perished the thought. Interestingly, my gut-feel (aka intuition or 6th sense) is a biased coin. When I have relied on my inner voice and followed the thought or idea that has sprung to my mind first, I have generally found myself to have chosen wisely. But this is generally related to work related and other decisions. Now, investing is certainly not about which-turn-to-take-from-Masab Tank type of inner voice invocation. So, it is not surprising that for me, when it comes to investing gut-feel, usually my initial gut-feel reaction has always tended to be dead wrong!!! Quite a personal contrarian indicator.

The chart alongside shows the 7.45% return of the NIFTY over the trailing 12 months against the very significant 16.25% returned by the Benchmark BeES index. The first half of the trailing calendar year has generally seen gold prices moving in lock-step with equity prices. From February this year onwards, the correlation has turned mildly negative which is what seems intuitive. So, commodity prices being the primary fuel of the stock indices has ceased to be the case for now as metals and of course, oil contracts. As I read up more on the internet, I figured out logic and reasons for why my initial gut-feel spawned trade idea was bad. On Gold, with Greece passing austerity measures, there is less of a motivation to look at gold as a safe haven in the very short term. So, it is likely that the coming week will be bearish or directionless for the yellow metal. Moreover, the US markets are going to be closed on Monday (4th July) and therefore gold could continue going the “buy the rumour, sell the fact” way down. On Thursday, the ECB and the BoE will have interest rate decisions announced and Friday will see the release of non-farm payroll data in the US. Therefore, it is unlikely that traders will take a strong view before these data points are clear.

So, if you look at the above chart, my hunch is that during the coming week, the gap between the yellow line (proxy for Gold) and the NIFTY will narrow down. Even if it doesn’t, no big deal for I have done the best thing that practise has taught me re investing: ignore my otherwise extremely reliable inner voice when it comes to pulling the trigger on investment decision making. Even if my intuition is proved right, at maximum I would just be guilty of an opportunity loss. Trade idea postponed, if not entirely killed, to next week now!

Bling, Bling – But For How Long?

Gitanjali Gems Limited

The light is shattered into gold on every cloud, my darling, and it scatters gems in profusion.

Mirth spreads from leaf to leaf, my darling, and gladness without measure.

The heaven’s river has drowned its banks and the flood of joy is abroad

 – from Rabindranath Tagore’s anthology of poems called Gitanjali 

I had picked up Gitanjali Gems on 29Apr’10 and have been holding it since then. The point of my purchase is shown as the green star on the chart alongside. The timing looks awesome but I don’t really care – I’ve gone through the motions quite a few number of times by now. What I am really focused on and trying to discover is a personal method that helps me to know the right time to sell. If I can reach that stage of ‘enlightenment’ by my next birthday, I would have really matured as an investor – in my opinion. Coming back to Gitanjali Gems, it has been an awesome climb, right? In all of 6 months! So is it time to say bye to bling bling? I don’t think so. Why? I like it! Reason enough? It better be!

Take a look at its website and you’d be forgiven to think that u’d landed at some Bollywood portal given that Neha Dhupia, Salman Khan, Katrina Kaif and Kareena Kapoor glitter through in huge 4” by 8.5″ sized banner frames!  At least in my browser window. As if personifying Nakshatra, D’damas, Gili and Asmi. And that’s the point – the company has been so successful in transforming these product names into integrated brands with massive recall. There’s Sangini and Vivaaha as well. Shahrukh Khan is also hidden somewhere in the inner pages of the website – try that ‘treasure hunt’ search if you have nothing else to do and are fully invested in this company.

The CMP of 285 currently discounts it’s trailing 12 month earnings 12 times. It was 5 times when I had purchased it. The company is selling for INR 2,400 crores which is about 530 million USD. Given that it has ambitions of becoming a global brand, that number does not look out of whack, especially when you consider that the mcap/sales ratio of it’s sterling competitor, Titan Industries is 3.3 as compared to 0.71 for Gitanjali. Moreover, Titan Industries’ Tanishq is more into gold as opposed to diamonds. And how does that matter? The shine of diamonds is more than the glow of gold – i.e. margins in diamond retail is more than gold jewelley. Gold has appreciated 17% (in INR terms) in the past one year while diamonds have become dearer by 25%. But since Gitanjali has stake in Tanzania’s bloody mines the raw material price spike will not hurt as much. I think going forward more and more people will start comparing Titan to Gitaljali (if they are not doing so already) and perhaps that will make some difference. The labour required to cut is more than the effort needed to goldsmith. Not high at all, I’d guess. Speaking of global ambitions, the company has recently acquired an Italian jewellery and design firm,

It spent INR 25 crores servicing its debt in 1Q11 which is approximately 2.5% of what it sold. In that sense, the big question mark is the retail foray. Why get into making malls and infrastructure when diamonds are forever? Will they add more leverage to their balance sheet? My hunch is that the Italian Job and/or the SEZ fling will increase the interest costs for the company – let’s see.

I think I will hold on given that this position of mine has perked up 144% in double quick time, so even if it corrects I’ll be cool. The technicals are shooting up full steam ahead and the share has seen a near parabolic climb recently. So some steam will definitely get let out. My investment logic was never based on such crappy observations that Indians are getting urbanized and therefore they’ll shun traditional gold ornaments and stud themselves with diamonds. The market leader in branded diamond jewellery was available at a market cap of INR 980 crores only. So while it was not some Grahamian deep discount discovery but there indeed was lot of money on the table to pick up. Now, however, it looks like a traditional and boring growth story. But even a slow and steady rise of 15% per annum will make it a 3 bagger for me in 18 months or so! The anticipated deluge of US hot money notwithstanding. If that target is reached much sooner, then I’ll jump out. But wait. Is this not a retail stock? And don’t retail companies, especially ones with a glittering track record and market leaders in their segment get high multiples? If we assume an EPS of 30 for close of next financial year, it’s forward P/E comes to 9.5 only. Plebian, male names sell at such high forward P/Es. When will India and Indians give equal opportunity to females, I wonder. Look at the table below to see what I mean. Gitanjali means an offering/anthology of songs. Would it have made any difference to its valuation if Mehul Choksi would have called his company Upanishad Jewels? ( = anthology of teachings from Vedic Hinduism) Or maybe his choosing the name Gitanjali might have been quite a prescient flash then? I don’t know what these boring boys are doing with jewels and diamonds – let’s leave them for pretty girls like Gitanjali and focus on making money instead.

And please do not ask me why I did not buy this stock when it was INR 34 (Mar 2009) if I am really as smart as I pretend to be.

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