An Investor's Experience with Dead Cat Bounce

GOLD investment- the complete story

GOLD is the proven, quality, long-term wealth store during a slide into deep crisis - the one which everyone else comes to in a bit of a panic.

Even if, to begin with, the early buyers are buying gold purely to protect their wealth they still tend to multiply their money, because they are subconsciously anticipating future demand. The best investments do this."

Gold's Greatest Use

People always ask 'But what’s the use of gold?' which encourages some experts to pretend gold is vital for dentistry and electronics. It isn't. The fact is that gold is hardly useful at all in industry, but that certainly does not mean it is not useful at all.

So let's explain clearly why gold has repeatedly become one of the most fundamentally useful things there is in human society, and to do that let's first recognize its main quality - its reliably rare supply.

How Much Gold Is There?

Even with modern technology gold is still incredibly difficult to find.

In total about 160,000 tonnes of gold have been taken out of the Earth.

That 160,000 tonnes is less than you might think. Formed into a single gold cube it wouldn’t quite cover a tennis court. In fact it would be 2 metres short. But that’s all the gold in the world.

Gold is being mined at about 2,600 tonnes a year, so the above ground supply is expanding at 1.6% per annum. This newly mined supply means the world's cube of gold - currently 20.2 metres across - is growing by just 11 cm per year.

All the world's gold will cover a tennis court when the above ground stock is 205,000 tonnes. This will be some time around 2025.

205,000 tonnes is approximately the sum of the current above ground stocks (approximately 160,000 tonnes) plus the aggregate un-mined known reserves of all the world's gold mining companies (approximately 45,000 tonnes).

That's all the world's gold - both above ground, and known about but still underground.

How Is That Gold Used?

Gold is not consumed in any meaningful sense. A tiny amount finds some use as false teeth because of its inertness, and some is used in electronics because of its non-corrosive nature and excellent conductivity.

But currently well over 95% of the world's gold is held as a wealth store - either in bullion vaults or as jewelry, which is generally considered a private monetary reserve (particularly in India, the world's biggest gold customer).

This stock of gold isn't disappearing, and its supply is growing at a very slow rate (1.6% pa) compared to its overall stock. This feature of a nearly fixed above ground quantity, growing slowly, has been true for about 4,000 years.

So you can now see that there exists a large, but not too large, and almost fixed quantity of gold in the world, almost all of which is held by its owners as a tangible store of wealth. That is something which is true of nothing else.

By contrast to gold's restricted supply our money systems are currently expanding out of control. Modern loose monetary policies - designed to keep the factories busy - are expanding the supply of currency, under political direction, by at least 11% per annum; and that's for the Euro, the most hawkishly managed of the modern world's major currencies.

In such circumstances gold's reliable rarity is again noticed by savers. Its great use is as a money proxy when artificial forms of money (which are far more common) are not being properly restricted in supply. In such times gold's unexpandable supply causes it to be a much more reliable store of purchasing power than currency. Nothing does this job so reliably and so well as gold, because nothing matches the unimpeachable rarity and stability of gold's above ground supply.

Better still, as people come to remember and appreciate this unique quality their demand for gold causes not just a retention of purchasing power, but a multiplication of it.

Gold - A Tool of Trade

Here's a 2,000 year old Roman explanation of a vital tool of trade.

"The origin of buying and selling began with exchange.

Anciently money was unknown, and there existed no terms by which merchandise could be precisely valued. Every one, according to the wants of the time and circumstances, exchanged things useless to him, against things which were useful; for it commonly happens that one is in need of what another has in excess.

But it seldom coincided in time that what one possessed the other wanted, or vice versa. So a device was chosen whose value remedied by its homogeneity the difficulties of barter."

Trade is right at the heart of human society, and it creates the need for this 'device' to store value for later exchange. The device needs homogeneity - constancy of form and quantity - which most governments attempt to deliver with paper money, and they are successful most of the time.

But when the going gets tough governments bend their own rules. They start to issue more and more money, and then nothing exists which matches the homogeneity of gold.

The Romans joined a long list of civilisations which chose gold as a reliable, apolitical, monetary medium. Before them there were the great classical civilisations of the Greeks, Persians, Ionians, and the Egyptians. After them there were many more, through the Spanish, French, Ottoman, British and American empires, all of them with gold based monetary systems.

Gold's Record As Money

But every single one of those gold based currencies eventually failed - the gold stopped circulating as the money of normal transactions, as currency. So it’s best to avoid the misunderstanding of history which leads so-called “gold bugs” to regard gold as the world’s only true and permanent money, because the hard historical fact is that it has been tested - often - and it both disappears and re-appears, depending on the prevailing economic circumstances.

Yet what is different about gold and other forms of money is the way they disappear, and why. Because its natural qualities recommend it as a high quality form of money gold suffers from Gresham’s Law, a common sense law in economics which states that “bad money drives good money out of circulation”.

Think about it for a moment and you’ll see that given a choice of spending good money (gold) or bad money (inflating paper) you’d spend the paper and keep the gold as a store of value. So in an economy where economic and political considerations have combined to produce a paper currency running in parallel with gold, and where that currency is showing the early signs of being dangerously expanded in supply, then people will elect to hold on to gold and spend paper. Magnified millions of times by everyday transactions in a typical economy this eventually stops gold circulating as money.

For much the same reasons when their time is up paper currencies will pour into circulation as people look to buy hard assets, until eventually the best value you will get from the banknote is to use it as heating fuel.

This is the key difference. While paper money forms disappear permanently, and lose all their value, gold disappears temporarily, and retains its value over the very long term.

Every few years, and when circumstances are right, gold returns. It has a history of doing so which has lasted those 4,000 years.

Gold Can Multiply Your Wealth

The trick with gold is to understand the causes for these rolling phases, to recognise them, and to act appropriately. If you own gold at the right time you will own a fast appreciating asset when normal business assets, and money itself, are tumbling in value.

Owning gold in good phase is very profitable. In the 5 years after the 1929 crash gold's investment purchasing power rose 17 times.

In the decade of the 1970s gold's investment purchasing power rose 15 times.

So far in gold's current re-emergence, with the economic situation looking every bit as as hostile as the 30s and the 70s, gold's price has multiplied by about 3 times. By comparison with those previous cycles it is still nearer the bottom than the top.

And Gold Can Destroy It Too

But don't forget gold lost nearly seven eighths of its investment purchasing power between 1980 and 2000. That was during the best period for growing businesses in the twentieth century.

That price slide shows that smart investors should not grow too fond of their gold! Even though it's currently pretty grim the time will come when the outlook for business has improved, and most people either will not have realised it, or will still be too nervous to do anything about it.

Then it will be smart to sell your gold, and use its purchasing power to invest in people and businesses, and to participate once again in the dynamic creation of wealth.

The people who manage to do this will be the smartest of all gold buyers. They are not hoarding gold for its own sake. They are positioning themselves to be able to invest actively in a recovery which is a long way off. By doing this they will be both profiting themselves and serving their communities at the same time. Capital which has not been adequately protected right now will simply not be there to invest in the business opportunities of the future.

How to Predict the Price of Gold

Long-term gold investors know that gold moves inversely to the dollar, meaning if the dollar drops, gold tends to rise (and vice versa). This happens with about 80% regularity. But what many gold writers haven’t acknowledged is the leveraged movement our favorite metal has demonstrated this year to the world’s reserve currency.

The U.S. dollar index, a six-currency gauge of the greenback’s value, has dropped 7.8% so far this year (as of December 3). Meanwhile, gold is up 38.7% year-to-date. In other words, for every 1% drop in the dollar index, gold has risen 4.9%. If that approximate percentage holds over time, one can begin to estimate what the gold price might be if you know what the dollar might do.

While the dollar is likely to bounce at some point, making gold correct, the long-term fate of the dollar has already dried in cement. If the dollar were simply to return to its March 2008 low of 71.30 next year – a 4.6% drop from current levels – this would imply a rise in gold of 22.5% and a price of about $1,478 an ounce.

The long-term scenario is more dramatic. If you believe the dollar will lose half its value from current levels, this would imply a gold price around $4,164. If you believe it will lose 75% of its value, gold would reach about $5,642. Doug Casey has called for a $5,000 gold price; if he’s right, guess what that implies for the dollar?

And think about this: these calculations ignore what else might “show up,” such as when price inflation shows up in the economy, the greater public shows up to buy gold, or the Chinese don’t show up at an auction. Could $5,000 gold be too low?

Unless you think the dollar’s problems are solved, its eventual demise is gold’s eventual glory. Prepare, and invest, accordingly.

A close look at Real Estate Returns in India

“The current market value of my flat in Mumbai is close to 1 crore , I bought it at 28 lacs in year 2000. The returns have been Mind boggling 72 lacs in 9 years, i.e 8 lacs a year approx , more than my current salary and now I am planning to invest more in real estate instead of Equity, What do you think” . A not so close friend was discussing his Real Estate portfolio with me.

He belongs to first category of common sense deprived idiots, who do not understand mathematics well. 28 lacs flat became 1 crore in Value in 9 yrs, The returns are great ,but not exceptional enough to make someone eyes pop out . Simple maths will tell you that its 15.2% CAGR return over 9 yrs . Now whats so great return about this 15.2% Return ? 15.2% return over long term is desirable and great and whats normal return from Real estate in last decade in our Country , The only thing irritating is how people make fuss about it . Even Gold has outperformed , Gold was $300 per ounce in 2001 and now its close to $1100 ounce , that’s 15.5% return , 0.3% more . On the top of that Builders are not keeping their promises of Delivering Projects on Time and with same quality Promised

Real estate investments has caught everyone’s attention in the past decade and every Tom , Dick and Harry with 5 lacs salary tries to grab a 40 lacs flat . I will try to throw some light on Average Real estate returns in past 8-9 yrs in India .

Coming back to my Friend, I told him that its been a very good return, and I appreciate his timing, Good job. But definitely he is bragging more than it deserves. A second person (his friend) suddenly comes to his rescue and challenges me . “But Manish , I bought a a flat in 2003 @20 Lacs with 3 lacs of down payment and rest a home loan. I spent total of 7 lacs till date and the flat is already quoting around 60 lacs, that 40 lacs of profit in just 3 yrs through investment of 7 lacs, that’s 78% return on annual basis” , showing off his fast calculations skills and giving me a “anything-else-you-young-financial-planner” looks his face .

These people are from another category of “common sense deprived and mathematically challenged” people . It is worse than first category . The problem with these people is that they do not understand “leveraging” .A situation of sitting on huge profits by just investing a small amount as down-payment and rest with home loan is pure example of leverage and very common in India , This gives a feel to people that they are very smart. These people never consider the case when their house value drops by a big margin like say 15 lacs and they have just invested 5 lacs from their pocket, then they are in loss of -300% (absolute). But as you know , Investors like to consider a rosy picture, they somehow believe that it cant be the case with them . As US citizens who bought Real estate in the middle of the Bubble just because credit was cheap and they could have made a lot of money by taking a Home loan and almost nil Down payment, When Real Estate broke in US , people who has put $10,000 from their pockets for a $4 million house were in losses of $1 millions , because they had to pay $4 million a loan money for something which is now costing $3 million .That’s a unrealised loss of $1 million in a short time . That’s the problem of Leverage . Investors never think about this , India is a success story and housing is scarce , that’s enough for them to take a chance. With my amazing quality of self control , i kept all this in my mind and didn’t argue with him, some times your skills of explanation is limited to blogs only .

What is RESIDEX ?

Dont feel amazed if I tell you that there is an Index for tracking Real Estate in India . Its called Residex and maintained by National Housing Bank in India . Its updated once every 6 months . It covers all the major cities and the sub-areas in that city . The index Value over time will tell you how is real estate prices doing in some area or city. Please understand that these prices are average real estate prices and not some general case which would negate what we discuss here today. I dont know how that is calculated but a common sense way of calculating it is to take a sample 0f real estate plots/flats in a area (for example 1000 units) and calculating the appreciation in value from last 6 months .

Lets see the RESIDEX values for 5 cities

Here is the chart of the same table

 

 

 

 

 

 

 

 

 

 

 

 

 

 

What is the mistake people do when they calculate Returns ?

The beautiful mistake which everyone does is that they calculate pure absolute returns from Real estate which is in many lacs of rupees obviously. So if a person invested 30 lacs in a flat and it becomes 60 lacs in 5 yrs. They are sitting on a 30 lacs profit. Thats a lot of money and people are excited to see that much money , but you also have to see that they invested damn 30 lacs !! for that, which is not every one’s cup of tea and the returns are normal 14-15% return/year on investment if you compare it with Gold or Equity. You could have made more returns if you had invested in Equity (SIP in mutual funds in some top funds) . If you consider the risk taken for the return people have got in Real estate , personally I am not very much excited then , Investors forget the risk taken to get some return and only concentrate on Return part .

What you have to see is how much return you got from something after adjusting the risk taken for that . So given a time frame of 1 yr .

• If you do a FD and make 9% , its amazing !!
• If you invest in Real estate and make 10%, Its ok
• If you invest in Equity and make 11% , its just fine .. not a big deal
• If you speculate in Options for one year and make your money grow by 500% , I Would be personally disappointed a lot .

Some smart (second category people) people think that they can buy Real Estate on loan and make 30-40 lacs in 4-5 yrs from house value appreciation , While that is possible and has happened to a lot of them and definitely the return would be amazing . But this exposes them to a great amount of risk which they dont understand , its pure leveraging . There are better ways of leveraging than this . This kind of Leveraging is still nothing in front of Options trading in Nifty or some Stocks . Not that I discourage people from taking a home loan and invest in real estate , but dont over do it , and understand and accept the risk involved, be ready for it . “Risk happens when you have no idea what you are doing”
. If you precalculate it and consider it , then its called Speculation , which is my favorite . Options trading is something I would recommend who have great risk appetite and dream of millions in short span of time , Better than real estate .

What is Average Real Estate Returns in India

IF we see the above chart of RESIDEX Values (for 8.5 years) , you can find out the CAGR return of Real Estate in different cities . Let me show that for 5 cities in India .

Chart f or the same data

Note : I have assigned Index value for “India” by assigning weights of 25% , 25% , 25% , 10% and 15% to all five citites in same order .

What Should you Do ?

First of all , understand that Real Estate is important and You should always invest in it for Diversification of your Portfolio (If you can afford it right now) . But that does not mean compromising with your Risk Appetite and investing just for the sake of Investing. If you want to buy home , make sure you afford it, Buy a 1 BHK which you can afford if you want to live in it . If you want more than 1 BHK , plan for it , take it later . There is no rush. Real Estate is not the last thing in the world . Don’t feel left out when you see others minting money in Real Estate , believe me they are making similar returns which you can make from Equity, just that the magnitude of profits they are making is high , not the returns on average . So Chill !! .

Note : Understand that whatever we have talked here is based on the RESIDEX index and there will be many specific cases which would make this all talk a nonsense , but we have to look at general case and not a specific case .Download More data on Residex from HERE (From 2001-2007) and after 2007 HERE . Note that you cant get all data of Residex at one place . I combined the data from NHB from 2001-2007 and combined it with data on their Website to construct all 8.5 yrs of data . There was a shift in Base year because of which I had to do so .

What do you think about the Real Estate Prices at the moment in India . I do not feel they are justified and the prices are mainly driven because of unnatural demand created by easy access to Loan . People buy it , but can not afford it , If things continue for some more years . I would be surprised to see a big bubble burst in India like we saw in 2007 . Leave your Comments and let me know you are reading this blog .

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