Gold and the Bubble

Diwali is just around the corner and the one thing that will be in high demand is Gold. Saying that Gold makes the Indian economy go round during the festive season won’t be too much of a stretch. Since time immemorial gold has been the choice of investment for Indians; Diwali season is just one of the biggest excuses to buy it. Unfortunately the recent economic scenario has made it impossible for everyone to afford Gold. It has risen more than Rs. 10,000/10 gm since last year. The last 10 days have seen prices of gold fluctuate between Rs. 25000+ to Rs. 27000+. In such an uncertain economy is Gold really the metal for the pallet?

Let us look at why Gold has been such a favourite among the buyers. Buyers can roughly be classified into three categories:

1)      People looking at gold as an investment – The prices of gold over a period of time generally tend to move up. Especially in a country like India where gold is bought keeping the long term perspective in mind, it becomes even more lucrative. Investment in gold can be done in two ways now – through EFT’s and similar instruments and through the old school method of buying physical gold.

2)      People looking at gold as a family heirloom – Every Indian family at one point or the other has bought gold, not because they like it or because they think it makes a good investment option, but purely because it is an heirloom that can be passed down to the coming generations

3)      Industrial Use – Due to high thermal and electrical conductivity and high resistance to corrosion gold is demanded highly in the electrical components. It is also used in medical profession as well as chemical processing, pollution control and fuel cells.

The question that begs to be asked is, will the gold prices stabilize or will it go down further before beginning its climb again, because its climb is inevitable. Let us look at some of the factors affecting prices of Gold in India:

1)      Gold Mining: The amount of gold mined in a year will directly affect its price by the simple application of supply and demand mechanics. 2008 and 2009 saw a decline in gold production and it again picked up in 2010. This was still less than the amount mined in 2006 and before. The numbers for 2011 are not yet in but the expectation is not very high with the largest mine of gold, Grasberg mine, Indonesia facing two strikes this year, the second of which is still unresolved.

2)      Currency Fluctuations – Gold is pegged to the US $ and has an inverse relationship with the $. The recent $ prices have been fluctuating as has been gold. The US has seen major turmoil in its economy and this has affected the $ adversely. It is not expected to stabilize in the near future although it looks to strengthen a little on good job numbers.

3)      Global Scenario – The current global economy is in doldrums. Europe is still clouded with uncertainty, US is still not stabilizing, China is not as strong as it was a year ago and India is also reflecting the unrest. This has led to gold acting as a safe haven.

4)      Inflation and Interest rates – With inflation on the rise and RBI hiking interest rates frequently, gold prices have become unstable. Rising inflation to increase in gold prices while rising interest rates lead to a fall in gold prices. The gold has still risen as the effect of inflation has been substantial as compared to interest rates.

5)      Weak Financial markets – Gold is inversely related to stocks, bonds and real estate. The stock market has been showing volatile behaviour and this has again reflected in gold prices. Gold is still preferred as the others are not as safe as investments as gold.

6)      Growing middle class - A factor unique to India is the growing middle class. This has also led to an increase in demand of gold thus leading to increasing gold prices.

We have looked at what are the factors affecting gold prices; another observation that can be made is that Gold seems to becoming a bubble. It has grown at a rate of approximately 17% a year for the last 10 years. Currency fluctuations, Inflation and interest rates, the global economy and weak financial markets have all contributed to ‘hot capital’ flowing in, in form of Gold purchase and Gold EFT’s. Few other factors which contribute to gold becoming a bubble is the unshakable belief that Gold will always go up and the basic premise that Gold in itself has very little or no utility hence it’s climb is not supported. We could compare the bubble with other bubbles seen in recent times, dot com crash in 2001, real estate bubble of but Gold has a unique feature. While none of the other sectors saw a marked inflation after the bubble Gold over the years has always seen a marked inflation.

The last gold bubble that was witnessed was in late 1970’s and early 1980’s. From a price of $192 an ounce in late November 1978 it closed at $850 an ounce in early Jan 1980 showing a gain of 343%. This was due to the US fed policy of controlling money supply rather than interest rate announced during 1979, fluctuating US$, high inflation due to strong oil prices, Soviet intervention in Afghanistan as well as the impact of the Iranian revolution. The fed policy meant that people dropped gold and invested in paper (stock). The above scenarios can be again put under the four categories causing gold to become a bubble. The bubble burst in Jan 1980. It lasted for nearly 2 years and burned many people as the burst came unexpectedly.  As can be seen in the first chart Gold was nearly 6 times the S&P before the bubble burst.

Fig1: Gold relative to S&P500 – 1975-2005

Fig2: Gold prices, S&P 500 and US$

The markets are again seeing inflated gold prices and as can be seen in the last numbers for the last 1 year while S&P rose by 4.96% and US$ fell by 0.96% gold rose by nearly 25%.

 With the current economic scenario gold will continue to remain a preferred investment option. For a long term investor (time period >10 years) gold is still the best bet around as gold prices will always increase in the long run. For the short term investor though a word of caution, gold seems to heading towards a bubble and thus needs to be handled with care. 

US Debt Ceiling and its impact

The recent headline grabbing everyone’s attention is US and its debt ceiling. For those not familiar with the news here is a brief overview. The US currently has a ceiling on the amount of debt it can run up to fund its expenditure and this ceiling is set at $14.3 trillion. Come 2^nd August and the US will run out of money!!! Shocking isn’t it!! Any sane person would say well raise the ceiling and borrow more. Ahh only if it were that easy. The ceiling is imposed on the government while it can only be raised by the congress. The next logical question would be so why is the congress not raising the debt – well the answer to that can be found on nearly all major news websites. Again I won’t go into the depths of it but just say that it has something to do with the power struggle between the republicans and the democrats. The bottom line is that if the ceiling is not raised by 2^nd August, 2011 US might have to default on its debts and that could trigger another recession.

Coming to the point of this article – I relayed the same headlines to two different people in two different scenarios and I got exactly opposite answers. One was a friend who is doing her CA and the other is a fellow student with me pursuing her MBA. The one pursuing CA said that this was the wake-up call that not only the USA but the world also needed.  According to her the world needed to see proof as to how unstable and unreliable the US economy had really become. While, at one time, the US economy had been more or less financially sound now that wasn’t the case.  The US, while still considered to be a world power, no longer holds the same attraction and appeal that it once did. The belief ‘we can do anything and it will be accepted’ is no longer valid. For her it was a case of - let the truth finally come out so that the world can deal with it.

The one pursuing her MBA had a reaction similar to one has when they fear they may have lost the most important thing to them. This was due to the fact that we are supposed to sit for our placements in about 4 months and the American economy going into recession is not good news for us. While the double dip or ‘W’ recession has been expected the news that it may be happening in reality and not just on paper is enough to scare the most brave hearted people out there. Where the world still hasn’t recovered fully from the first recession, talks of a second recession have made economies and the markets extremely jumpy.  The fact that the Indian economy was relatively stable in the 2008 recession is not enough to guarantee that it won’t suffer a meltdown this time around. While one can’t guess the results with absolute certainty one of the definite results would be job cuts and pay cuts which in turn would lead inflation rising and affecting the Indian economy adversely. 

So while the half the world lets their hair down and prepares for the weekend the other half waits tersely for the congress to reach a decision so that their lives can move on. Let’s see what the next 4 days have in store for the world economy!!

India-Euro Relations - A Reciprocal Way

The World’s largest democracy; a vast diversity of cultures, religions, beliefs, ideologies and values; a rich heritage

The world’s largest economy; political and economic union of 27 member states; a consortium with a view of united Europe

Two giants in an ever shrinking world – India and EU.

In this post I will try to highlight the history of India and the EU and analyse how their relations have changed in the ever evolving world economy. I will also attempt to take a look what the future holds for these two giants.

Although many claim a recent history, relations between India and some member states of the EU date back centuries. The relations have existed since the time of Alexander or even before. Through the passage of time their ties underwent a lot of highs and lows. After formation of the EU, in 1957, India was the first country to have relations with it. The relations were firmed up in 1994 with the signing of the 1994 Cooperation agreement. The next 6 years witnessed a slow growth with mutual disdain on both sides. The base which had already been laid to discuss political issues with the 1994 agreement was further widened to include social, economic, global and developmental issues with the decision to hold annual summits 2000 onwards. 2004 saw international issues being added to that list with the signing of the EU-India strategic partnership. To underpin the strategic partnership, the EU-India Joint Action Plan (JAP) was defined in 2005 which defined common objectives and proposed a wide range of supporting activities in the areas of political, economic, and development cooperation.

While these developments were happening the terrorist attack in US in 2001 and the subsequent attacks in UK forced the EU to sit up and take notice of the terror threats seriously. It also brought India into the limelight as India also underwent terrorist attacks. Iran and Afghanistan were the two countries that were focused on initially. Over the years peace and security have become important policy grounds between India and the EU. It also figured on the list of the four important issues that were discussed in the 2008 annual summit. Around the same time talks also brewed regarding a nuclear pact. India formally started its participation in International Thermonuclear Experimental Research (ITER) in 2009. The agreement laid the base for a long partnership in the area of fusion research. A civil nuclear energy (fission) research agreement, with the European Commission, is also in the pipelines. Apart from this a closer cooperation is envisaged on cyber-security, exchange of strategic information and law enforcement. To cement the security relations between India and the EU a cooperation agreement was done between Europol and Indian security agencies.

Another area of interest between these parties is the advancements and partnership in Sustainable Development and Research & Technology. The mid-1980s saw the birth of research relations between the EU and India. The first EU-India Science and Technology (S&T) agreement was signed in 2001 and was extended in 2008.  The 7^th (2007-2013) EU Framework Program for Science & Technology development (FP7) has made India the 4^th largest International partner for EU. The research areas are vast and range from ICT to health and environment. Joint Working Groups have also been formed to facilitate exchanges on subjects such as Agriculture, Telecommunication and Information Technology, Pharmaceuticals and Biotechnology, Food Processing and Environment.

Migration is becoming an increasingly important subject for India and the EU. Migration includes the knowledge exchange, namely students, as well as workers migrating for work opportunities. While the US has always been a favourite hotspot for students recent years have witnessed a new trend emerging – attraction to universities in Europe. While knowledge and information about universities in both India and Europe is still limited to the few well known universities – Oxford, Cambridge, LSE  in Europe and IIT’s and Delhi University             in India- the awareness is slowly but steadily increasing. Setting up of programmes like Erasmus Mundus Scheme, UKERI and few others which have been established for encouraging student exchange programmes are helping the cause. Another factor which has to be taken into account is the number of people settling in a country as most of the awareness comes from extended families living outside the home country. This number has only increased with time. The last decade has seen a rise in the number of migrants. There was a time when travel and living in the UK inspired fear rather than awe. The sentiments and confidence has surely changed with the changing of relations between India and the EU.

Discussion about India and The EU relations would be incomplete without talking about their Trade relations. The EU is India’s most important trading partner. It accounts for 21% of India’s total exports and 14% of India’s total imports. On the other hand, India accounts for only 2.5% of total exports and 2.1% of total imports of the EU. The EU has also been the largest investor in India with a cumulative volume of over € 20.0 billion since 2000. This accounts for only 0.3% of EU’s FDI, which implies there is a lot of scope for expansion in trade relations. Trade has more than doubled in the last 8 years, from 25.6 billion euro in 2000 to 55.6 billion euro in 2007. This is further expected to improve with promises from both the parties to achieve an annual bilateral trade turnover of over 100 billion euro by 2013. The Free Trade Agreement (FTA), which is expected to be signed by 2013, is another step in the alliance among the two parties. Although there are certain points, like pharmaceuticals, which are under dispute, the agreement in itself shows the commitment and faith that the EU and India share. The agreement is a strategic move which will go a long way in strengthening the relation between India and the EU.

As the world stands today on a brink of change, due to the recent recession, a reciprocal relation between India and the EU is a beneficial way forward. The current relations are not all positives and neither are all the people of one side enamoured with the other but the steps taken by both the parties and the relations built over the last decade are changing the dynamics of not only the billions of people involved but also the economies of the world.

The governments along with the people will play an important role in shaping the future of these two giants. As the quote goes “We have seen the future, and the future is ours”. We may not have seen the future but we have definitely gotten a glimpse of it in the recent past and we want more. 

Euro Crisis

A – A sick child, health ignored, is allowed to play in the cold because that is what makes the child happy

B – The sick child is confined to bed and told to take its medicine but three extremely ill dogs are adopted so as to ensure fairness.

C – The sick child is getting sicker even though the medicine has been administered.  Further dose is given and one hopes the child recovers soon

D – A teenager, rather a grown up, is recovering but being in close proximity to Child C is prone to further crippling illness if Child C doesn’t recover.

Any guesses for who these children are?? They are the PIGS or Portugal, Ireland, Greece and Spain.

A being Greece the country who refused to adopt austerity measure so that it could continue being a welfare state. B is Ireland, a country who adopted the measure but then nationalised three debt ridden banks to save them from collapsing.  C is Portugal, who seems on the brink of recovery but then so did Ireland so the fates are still uncertain. That obviously leaves us Spain as D. Spain which has close trade relations with Portugal is dependent on it partially for its successful recovery.

Years of unrestrained spending, cheap lending and failure to implement financial reforms left Greece badly exposed when the global economic downturn struck. This whisked away a curtain of partly fiddled statistics to reveal debt levels and deficits that exceeded limits set by the Euro Zone. By early 2010 it was evident that Greece would be in need of a bailout and by mid may it had received its first payment so that it didn’t default on the loan repayment due on 19^th May, 2010. The bailout plan has the following measure which Greece has been asked to follow:

·         Scrapping bonus payments for public sector workers

·         Capping annual holiday bonuses and axing them for higher earners

·         Banning increases in public sector salaries and pensions for at least three years

·         Increasing VAT from 21% to 23%

·         Raising taxes on fuel, alcohol and tobacco by 10%

·         Taxing illegal construction

The IMF further wants the Greek government to lower health spending, cut debt at state-owned companies and increase tax collection. This has led to a country wide agitation in Greece and has virtually brought the whole economy to a standstill. The turmoil in the country could very well become the biggest factor to undermine the effectiveness of the reform measures taken by the Greek Government.

While Greece faces turmoil within its society, Ireland is facing even bigger challenges. In the recently held European summit, Ratings agency, Moody, cut Irelands credit rating from Aa2 to Baa1. It further warned that subsequent downgrades could follow if Ireland was unable to stabilize its debt situation (The debt situation caused by a decade long property bubble followed by a banking crash). This comes at the heel of a massive bailout package – 85 billion euro deal- handed out to Ireland on 15^th December, 2010.

Ireland is not the only country faced with the prospect of a downgrade. Greece which had already been downgraded was put on negative watch and Spain and Belgium were given warnings. This is an indication that financial stress in any one country of EU can and is rapidly threatening the macro financial stability of EU as a whole.

Portugal even though not on the list of the rating agencies in this submit can’t relax its vigil. Even though the borrowing costs haven’t reached unaffordable level Portugal still is not out of danger. Most analysts believe that by March 2011 it will be next in line for a bailout. This could spell trouble not only for Portugal but for Spain and EU at large. Spain which is the biggest trading partner of Portugal faces the immediate consequences if Portugal defaults. As everyone takes a break for Christmas and New Year, the hope and prayer would be to salvage whatever can be salvaged of the EU economies.  So, let’s wait and watch what lies in store for not only the Euro Zone but the EU as a whole.