Jun 092015

DAILY NEWSJun 9, 2015 4:40 PM

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By: Jayat Bhandari
By: Jayat Bhandari

Many people try to find correlation between inflation and gold price, often using the U.S. dollar as their base currency. They ignore that the biggest gold consumers — in rural parts of India and China — are not driven by inflation in the U.S., if at all they can conceptualize what and where the U.S. is. They are driven by their local circumstances.

Others “calculate” the value of gold by dividing the total fiat currency in circulation by all the known-gold above ground or the gold in the vaults of the central banks. The ranges of gold values they get are wild. Some have “calculated” values as high as US$30,000 per oz., or even higher.

Those who attempt to value gold based on the amount of fiat currency seem to cherry-pick a couple of variables from what is an extremely complex world of monetary transactions. What kind of fiat-money should you consider: M1, M2, M3 or M4, and why? What velocity of currency should you use? Would you use only one currency or the total of over 100 currencies in circulation around the world? How would you account for paper gold (including futures, options, etc.), the supply of which is limitless in comparison to physical gold?

Finally, there are people who chart the price of gold over a period of time, to show that the U.S. dollar has lost around 97% of its value over the last century. While this is true, it is deceptive. To compare on a like-to-like basis, you must incorporate and compound the risk-free interest when charting the value of currency. You should also account for storage cost of gold. 

So what is the prime-driver of the value of gold?

Perhaps the answer lies in understanding the minds of the biggest buyer of gold — Indians — and why they keep a very large amount of their savings in non-yielding or even deteriorating assets?

Gold, property and cattle

A whopping two-thirds of India’s household savings get parked in properties and gold. Any middle class person worth his name buys several properties. A large number of houses sit forever empty, deteriorating away. If he rents, rental yield — before accounting for property taxes, maintenance and the huge risk of losing it to the tenant — is 2%, much lower than the bond-yield of about 8%, making Indian property market among the most expensive anywhere. In comparison, Vancouver, Hong Kong and Beijing properties start to look cheap.

The Indian stock market, the current darling of the world, is trading at close to its all-time high, given massive euphoria after Narendra Modi came to power last year. But a closer inspection of the returns tells a sobering reality. Earnings yield is about 5%, lower than bond-yield of around 8%, making Indian stock market from value-perspective among the most expensive in the world.

Returns on equity (ROEs) are rather abysmal, in big as well as small ventures. India has 280 million cattle. Factoring in costs, the average return from owning cows is negative 64%. Why would people invest in what will lose them money? At the aggregate level market forces should have removed the losses, even if rural people did not understand economics.

Indeed, despite negative yields, there are sound economic arguments behind all of the above. This also helps in understanding the recent advent of negative bond-yields in many western countries.

Intelligence behind the madness

Between 1966 and today, the Indian rupee has devalued against the dollar (which itself is a devaluing currency) from Rs. 4.76 to Rs 64, while applying heavy taxes on any nominal interest. Indians abhor this instrument and distrust the government or whatever it touches.   

If inflation were the only problem of the Indian economy, people would not have invested so heavily in non-yielding or negative-yielding instruments. At the core, the reason is that Indian economy mostly offers negative yields.

India is a very uncompetitive economy. Investment opportunities are very few and far between, with the ever existing risk of losing everything. An Indian — educated or uneducated — instinctively knows that his wealth will erode away slowly. 

I have no memory of an honest public servant in India. Corruption and bureaucracy is endemic. You must agree to being flogged, demeaned, and be treated like cattle. You almost never get what — based on rational ethics — belongs to you. Might-is-right is the overriding, pre-rational ethic.

Formal businesses get lost in a legal quagmire. The kind of people who can get into them need corrupt connections. Even if they can make money (which does not necessarily have a correlation with wealth-generation) such political hacks cannot be trusted to treat their investors with honesty and integrity.

But the state is only the tip of the iceberg. The underlying society is no different.

People do not rent their houses, for the risk of never getting them back is extremely high. Corruption and dishonesty even in private enterprise is endemic. Socially, if you can get away with occupying other people’s property, it is seen as fair game.

Workers are very badly trained, even when they carry advanced formal degrees. Absenteeism and low work-ethic is the norm. This is a result of superstitions and religion that completely dominate mindsets from an early age. With this as a foundation, even advanced education can only sit in their minds as a set of beliefs, making it of limited value for creativity. Even in manual, routine work, productivity and quality, to the utter frustration of trainers, stays at a fraction of what is expected. Such is the handicap created by pre-empting rational thinking through religious indoctrination.

Even after paying a mere $100 a month, one must ask if the productivity is worth such a “high” salary. The result is that in my city in central India, the shops are packed with Chinese goods.

The individual exists in a barbaric system, where everyone is after his money — and he is after other people’s money. In such a system, the concept of dishonesty is only seen as a legal handicap. The general conception of making money is not through wealth-creation.

I find it extremely difficult to find investment opportunities in India. Risk-adjusted returns are very uncompetitive, which is the reason why the government does not allow capital to leave the country, or it would in a heartbeat.

For the individual the thought often is not how to increase wealth, but how to lose the least.

The result is that the individual “invests” money where the least might be lost. A non-yielding asset is better than those with negative-yields.

In a barbarous system one of the major choices is the “barbarous relic”, gold. This is what explains Indians’ inclination to buy gold, not some mythical expertise they have in monetary economics.

Why gold will become increasingly important in the West

Those in the investment community in the West have found themselves surprised by the recent advent of negative bond-yields in several countries in Europe.

Increased occurrences of riots in the U.S. to protest capitalism, to ask for increased welfare payments and more regulatory controls on businesses is nothing but a marked departure from the rational ethics of the West.

There is nothing special about India. What happens in India is increasingly happening in the West, as the latter is regressing to its pre-rational past.

There is a huge welfare system and a growing sense of entitlements, which after a few generations have come to be seen as “natural rights.” Environmental and liberal arts education has indoctrinated western students to hate development. At a deeper level, this has increasingly made the societies in the west irrational and hypocritical. This harms their integrity and work ethic.

Over-taxed and over-regulated, and most importantly, with its rational underpinnings increasingly weakened, the Western world’s growth rate is falling to a meaningless number, even before you account for the huge risks that off-the-balance-sheet liabilities, and structural problems created by massive personal and public debts.

The risks on your wealth are increasing, so are regulatory controls over it. Most of what we own today is in electronic form and can be — and will be — frozen at a flip of an electronic switch.

No doubt Swiss bonds got sold at a high negative-yield, as people acclimatize, albeit unconsciously — as Indian cattle-owners do — to the new reality that losing a bit of your money to preserve the rest is “a good deal.” For the same reason, Euro-savers in search of liquidity have rushed to the over-priced US dollar.

Eventually, once the big money and technical momentum has over-priced the most liquid assets, it will start to over-flow into gold. People will then be thinking that no-yield is better than negative yields.

— Jayant Bhandari is a mining analyst and an advisor to institutional investors. He writes often on political, economic and cultural issues and runs a yearly seminar in Vancouver called Capitalism & Morality. An expanded version of this article is available in the “Sprott’s Thoughts” section of www.sprottglobal.com. For more, visit www.jayantbhandari.com.

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