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Why gold prices will continue to stay high

Vivek Kaul, Economic Times 21/6/2011


Gold prices have been on a roll over the past few years. The precio US metal has given a return of about 160% in the past five years. That is, if you had invested rupee 100 in gold back then, it would be worth around rupee 260 today. Now, compare that to the investment made in the stock market during the same period. The 50-share NSE Nifty Index, which is a broad representation of the Indian stock market, has grown by around 83%, which means that rupee 100 invested in the stock market five years ago would have grown to rupee 183 by now.

The point is: return from gold has been almost double than from stocks. But that, as they say, is the past. What about the future? Will gold continue to perform as well as it has in the past? The answer is most likely yes. Gold prices will continue to rise even further in the days to come. Here are some reasons why.

CENTRAL BANKS BUYING GOLD For many years, central banks around the world have been net sellers of gold. But in 2010, after a very long period, they became buyers again. "Central banks have been net buyers of gold in 2010 for the first time in the past 21 years," says Devendra Nevgi, founder & principal partner, Delta Global Partners. In 2010, central banks bought nearly 76 tonnes of gold.

This trend further accentuated in the first quarter of 2011, when central banks were net buyers of gold to the extent of 129 tonnes. Central banks were selling gold for a while, reaching a peak sale of 674 tonnes in 2005. "The current purchases are a reversal of that trend – a case of sell low, buy high (a curious recipe for gain with public money!)," remarks Satyajit Das, a world-renowned derivatives expert, and the author of the soon-to-be-released Extreme Money: The Masters of the Universe and the Cult of Risk.

WHY THE TURNAROUND Over the years, the central banks have had a major portion of their reserves in US dollar, with a minor portion in other currencies like euro and yen. This trend is now changing. As Ritesh Jain, head of investments, Canara Robeco Asset Management, explains: "The rise in gold prices has caught the eye of various central banks who believe it is a welcome addition to their reserves given its status as ‘store of wealth’ even during periods of crisis. Thus, the central banks have indicated their preference to hold gold over a depreciating asset (read US Dollar)."

Most of the bigger economies around the world have been printing currency big time to revive their moribund economies and also to pay off the loads of debt they have accumulated. This has led to a threat of paper currencies collapsing and, hence, the flight to the "safety" of gold. "There is concern over the major reserve currencies like the dollar, euro and yen," says Das. "The only way for the over-indebted western economies to get out of the mess is to print more money," says Jain. "Since gold cannot be printed or mined that fast, the value of currencies is sinking against gold." This means the price of gold is rising.

China’s foreign exchange reserves currently stand at $3 trillion and gold as a percentage of these reserves forms only a miniscule 1.8%. But this dependence on the dollar is gradually coming down. "Countries like China who are amongst the largest holders of US dollars are, in fact, diversifying away from the dollar by selling dollar and buying gold," explains Jain of Canara Robeco.

As a recent report titled In Gold We Trust, brought out by Standard Chartered, points out: "Currently, 1.8% of China’s forex reserves is in gold; if China were to bring this percentage in line with the global average of 11%, it would have to buy another 6,000 tonnes of gold, or more than two years’ global mine production (of gold)." Imagine what that would do to the price of gold. This is also true of other major holders of foreign exchange reserves like Japan as well as India. Japan’s gold reserves stand at a miniscule 3.2% of its total foreign exchange reserves of $1.14 trillion. India’s gold reserves at 8.2% are much closer to the world average of 11%.

Over the past 20-odd years, the supply of gold has been growing at the rate of 0.7%. The main reason for this has been the decline of South Africa as a major supplier. As the Standard Chartered report says: "A very important driver of the slow production growth was the dramatic decline of South Africa (as a producer),which produced about 1,000 tonnes in 1970, but below 200 tonnes last year (ie, 2010)." The supply is likely to remain tight as very few large gold mines are expected to come up.

Over the next five years, only seven gold mines that are capable of producing more than 500koz (1 oz =31.1 grams) are expected. Also, gold mines have a high lead time and take time to set up. As the report points out: "According to a study conducted by MinEx, the average lead time for the 214 greenfield projects in 1970-2003 was about 5.4 years in Australia, Canada, and the US, and 8.3 years for other countries." Also, as explained above, central banks, which were major suppliers of gold, have now turned buyers.

This means a lot of supply of gold will come from scrap sales. As Nevgi explains: "Supply mainly comes from mines and recycled scrap; there is no central bank sale happening now. The scrap supply though tends to be more price sensitive. Since the demand-supply situation remains tight, any incre-mental new demand for investments or from China would take the prices higher." Due to these reasons, the supply of gold will be lower than the demand over the next five years. Even if the demand remains flat for the next five years, there is likely to be a supply deficit of 665 tonnes, the Standard Chartered report says. This clearly will lead to a higher price.

The rise in the price of gold has shown an almost one-to-one correlation with the rise in incomes in China and India (as can be seen from the accompanying table). While Indians have been traditional buyers of gold, the Chinese have been fast catching up. "India and China continued to provide the bulk of the demand as they contributed to more than 1/3rd of the entire demand in the first quarter primarily on account of rising inflation," says Jain. "Another key statistic which came out was that the annual gold demand in 2010 from China crossed the 700-tonne mark for the first time."

"I can only quote JP Morgan and say ‘it will fluctuate’," says Das. Nevgi feels gold has the potential to easily rise above $1,600 per ounce (or about .`23,200 per 10 grams) or more in the medium term. Jain is more optimistic. He feels that gold prices will continue to accelerate over the next 4-5 years and will enter the last phase of bull run from 2012. "After a period of consolidation and sideways movement in the $1,400-$1,500 band, gold will break out to $1,700 per ounce (.`24,600 per 10 grams) before the end of this year. Gold prices are set to surge to $2,000 per ounce (.`28,900 per 10 grams) by 2012 and $3,000 per ounce (.`43,400 per 10 grams) by 2015," he says.


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Merger and acquisition stocks offer bargain buys

Financial Chronicle, 17/1/2011

Sanjay VijayKumar

The acquisition of Patni Compu­ters by Nasdaq-listed iGate last week followed a trend — investors dumped the stock fearing that iGate was buying a company larger than itself, besides saddling itself with huge debt. While iGate lost nearly 20 per cent shares in two days, shares of Patni too fell.

Whenever a listed company announces a big-ticket acquisition, the stock tends to fall due to concerns of stretched financials and huge debt burdens involved in funding takeovers on their balance sheets. But, this also allows smart inves-tors to go for bargain buys. So, as an investor, is it a good idea to invest in these stocks, when they fall with the expectation that they will gain later?

For big-ticket acquisitions, it is believed that it would result in a huge debt burden on balance sheets of Indian acquirers and hence, were perceived as investor-unfriendly.

FC Invest spoke to experts, who said that investors can take a bet on stocks of good companies, which would help them judge the execution strategy for a successful integration that would be beneficial in the long run.

We look at some of the mega acquisitions by Indian companies and analyse how their stocks performed.

Shares of Tata Steel took a beating after it announced a $12-billion offer to buy Anglo-Dutch steelmaker Co­rus Group in January 2007. The process of acquisition concluded only after nine rounds of bidding. After the deal, the shares ended down 9 per cent at Rs 463.95 as investors felt the company was paying too high a price and the purchase could strain the finances at least for the short term. The acquisition was funded by more debt and cash. Eventually, after the deal, the shares were under constant pressure and going into 2008, when the financial crisis and global recession took centrestage, the stock plunged to Rs 216.85 by the end of the year. As the economy improved in 2009, th­ings looked good and the stock boun­ced back and closed at Rs 617.60 by the end of 2009, up 184 per cent.

Similarly, the announcement in 2007 that Hindalco was buying Canada’s Novelis for $6 billion in 2007, resulted in the stock plunging to Rs 172-levels, after the acquisition. The stock closed at Rs 51.65 in 2008. The deal also involved a debt component of $2.4 billion. As the commodity boom returned, Hindalco shares closed at Rs 160.75, after the merger. Tata Motors had bought Jaguar Land Rover (JLR) for $2.3 billion in March 2008.

Two months before the acquisition, the company had a market capitalisation of Rs 24,000 crore. Five months after the deal, it had plunged to Rs 6,500 crore. The stock plunged from Rs 705.12 in March 2008 to Rs 344 in September 2008. Tata Motors’ market cap has now moved up to Rs 74,618.34 crore, more than 10 times its bottom in 2009. The stock hit Rs 1,381.40 in December, before slipping to Rs 1,178 on Friday.

These examples show investors who held on, or those who bought at the low price are now reaping rich dividends. “All these deals were done when the market was at its peak and so the valuation was viewed as costly. Also, the acquisitions are initially dil­utive to earnings and these were big-ticket acquisitions, which burdened the balance sheets. However, these companies have scored because of their execution strategies and a successful integration has helped them regain lost value. So, one should look at the execution skills of the company before making a ‘buy’ call on stocks, which are down after a deal is announced,” Jagannadham Thunu­gun­tla, equity head of SMC Capital, said.

Last year, Bharti Airtel agreed to buy the African assets of Zain for $9 billion in cash in the second- biggest overseas acquisition by an Indian company. In its third attempt to expand in Africa, New Delhi-based Bharti, also inherited $1.7 billion of Zain’s debt. After the deal, the company’s shares were hovering around Rs 310.95 and plunged to Rs 293.53. But slowly, investors started to see value in the deal and the stock is now trading at Rs 342.70.

“If you look at the acquisitions, most of the targets where loss-making companies operating in a troubled environment. In addition, the debt portion involved in many deals, caused a knee-jerk reaction after the deal was announced. But it tends to subside once the company gets into the integration mode and starts to realise benefit from the acquisition. In case of companies, with a proven track record, if the stock falls over 15 per cent on an acquisition announcement, it is a good time to accumulate,” Vivek Karwa of Chennai-based financial advisory firm Vridhi said.

“It all comes to the final execution in terms of big-ticket acquisitions. You see these targets meaningfully contributing to the earnings in the long term, which is also reflected in the share prices. So, the track record of the company matters when it comes to taking a ‘buy’ call,” Alex Matthew, head of research at Geojit BNP Paribas Financial Services, said.

New froth in stock market?

New bull market or new bubble?

Mint 5/8/09

Opinion seems to be evenly divided over how to describe the surge in share prices over the past few months. There are fundamental reasons why investors have rediscovered the joys of equity investing: Risk premiums have reduced, there are some signs that economies are stabilizing and corporate results in India have been surprisingly good.

Yet, none of this can justify current valuations. The Bombay Stock Exchange Sensex is currently trading at around 20.64 of historical earnings. That’s expensive, going by historical standards and the current growth prospects of the Indian economy.

This recent surge in share prices has helped the economy in two clear ways. One, lots of green on the stock ticker helped clear away the glum mood in urban India, where pessimism assumed that the economy was in worse trouble than it actually was. Two, companies have used higher share prices to raise capital, cut leverage and repair balance sheets.

But that does not take away from the fact that most of the current surge in share prices is because of the flood of global liquidity that has been released by central banks since September 2008 to prevent a full-scale meltdown of the global financial system. And a lot of this liquidity has come into asset markets, both shares as well as commodities. This is Bubble 2.0.

There are several factors that investors should take on board before euphorically jumping into the foaming waters. One, the economic downturn is bottoming out, but that does not mean that a strong recovery is necessarily around the corner. It’s impossible for an economy to keep shrinking to zero. But that does not mean it will quickly regain its previous dynamism, especially given the damage to individual and corporate balance sheets around the world.

Two, asset price inflation could eventually be followed by consumer price inflation. It is not a great danger right now. Most advanced countries are close to deflation and even countries such as India are more worried about food price rather than manufactured goods inflation. But central bankers across the world have made it clear that there will come a time when incredibly loose monetary policies will have to be discontinued.

The road ahead promises to be a rocky one, with stuttering growth, creeping inflation risks and overextended fiscal systems. Investors seem to be pricing companies as if they expect a quick return to the boom years of 2003-07. Our guess is that this is a case of unnecessary optimism.

(The views are of the author, VRIDHI may or may not subscribe to them)

Satyam likely to sack 8,000 staff from June

ToI 25/5/09

New Delhi: Satyam Computer is likely to sack most of its non-billable staff of up to 8,000 working in marketing, HR and administration wings, after Tech Mahindra takes charge of the company from June 1.

A Satyam official said there is no doubt there will be largescale sacking mostly of the support and non-billable staff (other than software engineers) once Tech Mahindra directors come on board from June 1.

The surplus staff is about 10,000-12,000 and the “least painful” ways of sacking is asking the bench, non-billable and support staff to go. The company spokesperson, when contacted, said that at the moment these are mere speculations.

Sources also said the outsourcer may opt for “virtual pool” sacking method whereby the company would ask some of the staff to take 75% of its salary and take one-year off and look for a job elsewhere with the fragile assurance that they would be recalled, if required.

Tech Mahindra CEO Vineet Nayyar, who will also come on board of Satyam in June, said last week that Satyam has about 10,000 surplus staff and “we are looking at the least painful ways to tackle the problem.” Satyam has already called back most of its onsite staff to avoid further costs and most of them may be asked to quit, said the official. About 3,000 people are on the bench and there is a surplus manpower even in the R&D and engineering units, sources said. AGENCIES

Honchos quit    BPO unit

Hyderabad: Top executives of Satyam’s outsourcing arm, Satyam BPO, have pressed the eject button. According to sources, Naresh Jhangiani, global head of HR at Satyam BPO, V Satyanandam, head of corporate services, have put in their papers.

Kulwinder Singh, head of marketing (Asia Pacific), Satyam, and earlier with Satyam BPO as global head of marketing and communication, has resigned.

Satyam’s spokesperson M V Sridhar said the three executives were not asked to leave. However, another official said that people correction is natural after business and revenue


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There’s no Breather for the New Govt.

ET 20/5/09

Whoever takes charge as the finance minister will have his plate full. Stalled by the left, the outgoing government has an array of pending legislations that must be passed soon.

The financial services sector, the worst-hit by the downturn, has high expectations from the new government. The United Progressive Alliance’s (UPA) near-decisive mandate has improved the prospects of reform.

The market remembers it was the government’s disinvestment in Maruti that sparked off one of the longest bull runs in Indian capital market’s history. In some public sector units (PSUs), particularly banks, disinvestment has improved efficiency and profits.

This time around, it’s widely perceived that the government will spur foreign fund inflows by increasing the foreign direct investment (FDI) limit in insurance to 49% from 26% and also sell shares in PSUs. Public sector savings have turned negative in recent months.

But beyond these big-bang measures, there is a string of policy proposals that has been hanging fire for a long time. Moving ahead with these proposals will clear the roadblocks in the financial sector and keep the growth engine chugging. Some of them are listed below:

Insurance reforms: The increase in FDI is only part of the story. There are a whole lot of legislative changes that the government has drafted. These includes changes to the LIC Act, which will allow the corporation to increase its paid-up capital to Rs 100 crore. There is another amendment that proposes to allow foreign reinsurance companies to set up branches in India. Other amendments are aimed at removing some guidelines from existing laws and giving the regulator more powers to decide on them.

Consolidation of PSBs: P Chidambaram, the former finance minister, had proposed consolidation among public sector banks a few years ago. Unsure of political support, he had asked public sector banks to voluntarily come forward.

Indeed, RBI had even given the go-ahead for a possible merger of two Mumbai-based state-owned banks. Now, with most banks running out of room to raise capital from the market, things will soon come to a head. The committee on financial sector reforms has recommended the merger of smaller banks, having limited ability to raise capital, with stronger banks, having greater headroom to raise capital.

Amendments to Banking Regulation Act: There are several lacunae in the Banking Regulation Act. It places the onus of ensuring that maximum shareholding of single investor in a bank does not cross the stipulated 5% upon the bank (investors are not mandated to consult a bank prior to purchasing its shares). The amended law is expected to address such shortcomings. The amendments will also remove the 10% cap on voting rights of private banks.

Separate public debt office: This is another long-pending proposal. Former RBI deputy governor SS Tarapore had first suggested such an office because of the conflict of interest arising from RBI’s management of public debt as well as interest rates. The proposal was made again by the Vijay Kelkar committee on restructuring the finance ministry.

However, RBI has been opposed to this move. RBI’s outgoing deputy governor Rakesh Mohan has said that with the new legislation on fiscal responsibility, there is no conflict of interest. Also, states are more comfortable in dealing with an independent institution managing their loans rather than an arm of the finance ministry.

Development of microfinance sector & regulation: The Micro Financial Sector (Development and Regulation) Bill, 2007 was introduced in the Lok Sabha in 2007 to create an environment-friendly policy for microfinance services in the country. At present, microfinance activities are carried out by finance companies, non-government organisations and cooperative societies.

Funding these entities will become easier, as they are expected to come under the regulation as per the bill. The draft legislation also envisages the creation of a microfinance ombudsman for settling disputes between eligible clients and microfinance organisations. With most Indians living in the heartland still dependent on unofficial moneylenders, an institutionalised microfinance system will go a long way in financial inclusion. SBI Associates’ merger/amendment: The associate banks of State Bank of India (SBI) live off the brand strength of their parent. They offer the same services and depend on SBI for equity. The merger of the associate banks with the parent was recommended more than 12 years ago by management consultant McKinsey. The reasons for the merger still hold good. While the merger process was initiated, it came to a grinding halt after union protests that were buttressed by Left support. The SBI Act amendment bill has been pending with the Lok Sabha since December 2006.

Pensions bill: Although the New Pension Scheme has been opened to the general public, the government has had to work around the absence of any legislation. The Pensions Fund Regulatory & Development Authority Bill will give the PFRDA the power to give direction to all pension fund managers. The bill could also trigger a turf war between the PFRDA and Irda since it proposes to give the pension fund regulator the mandate to oversee all private pension schemes. This bill has been pending since March 2005.

Mumbai, a financial centre: This was one of the most ambitious reform ideas thrown up in recent times. The creation of a financial centre where multinationals could freely enter was an idea that faced strong opposition even two years ago, when markets were at their peak. RBI opposed it on grounds that financial sector reforms cannot lead real sector reforms. Now, after the Wall Street meltdown, there is absolutely no chance that the core suggestions of the report will be accepted. However, there are still some takeaways from the report, one of them being the launch of trading in interest rate futures. The government has promised this will be a reality soon.