Money Basics: gold is not just Gold But it is GOLD

We are a race of Rose Lovers. We give roses when we want to express some positive emotion and this association has made roses valuable. We use grass for feeding our pets which we consider inferiors and so grass is less valuable. But leave us, the humans, and nothing is more valuable than the other. Things are JUST IS….Life is infact isness and we learn the first truth of our life that we make the things valuable as per our associations of those with our life. Individually everything exists on its own. So Roses are Red only for us. Hence this valuation is not linked with the individuality of a thing but to relevancy of that thing to us.

First humans feared fire…it was a sign of destruction for them. But one day they realized that they could cook with it….it could light….and at once Fire was being worshipped…it became valuable for us. We are still confused about the value of God/Religion in our life; whether it is for bringing happiness and worldly comforts or it is about Someone/Something which knows about my origin, my purpose of existence…and our fights over these make the value concept more complex.

But it is not just Religion where value concept is complex. There are many other things which are valuable but we are confused about the nature of valuation. Just like our Gold. We are mad for this and it sits atop among the most valuables of our life. But ask anybody about the reason of its valuation and we will hear nothing concrete. 

It is called the store of wealth….it can store value…so it is an investment vehicle. The purporters of this view take Gold as an investment option where people can park their money and safeguard the same. They don’t see any other significant function of Gold. Here demand for Gold is because of something like Networking effects (I have explained the Networking effects in the post related to ecommerce business valuation, click Here ) where people value Gold highly because it is valued so highly by others. I am after it as whole world is after it. Then there are others who see Gold as worthy of satisfying our needs like luxury, jewelry and industrial. But again why we take Gold as worthy of parking our savings? What is making it so valuable? Networking effects!!

So Gold is faced with two faced anomaly…Whether Gold is an Investment vehicle or whether it behaves like a commodity?? Commodity is something which can satisfy some needs of ours like Clothes, food, fuel etc. Whether Luxury/Jewelry are those needs? But these functions are derived due to associated high value of Gold which makes it desirable. So question about high value of Gold still shines.

Money is a great Commodity created by Humans

To answer this, we need to walk along with first humans…our origin. Humans in those times were just living for foods…so I was just wandering whole day in the thick forests for food…there was nothing else in our life. But one day, I met a person in forest who was peeling a coconut with a stone tool and at once that humble stone became valuable for me. To get the stone, I offered him 10 apples…but he declined my offer. I revised my offer to 10 fish (as fish are much difficult to catch, hence more valuable) and stone was in my hand. So there we were, first trade of human history happened. Humans then realized that they could exchange things among them and live a much richer life. We call this system Barter. It is still present in so many of tribes. 

But as our population and number of products grow…this trade via Barter became increasingly difficult. I am having Eggs which is not required by X who is having shoe. Shoe is required by Y who is having Wheat which is required by me. But unless we three meet at one place, this cross trade will not happen. Also there were times when quantities of exchangeable goods are not comparable like trading a wooden bed for Milk. Like a teacher, for him to get milk he needs to find a milkman who is ready for exchanging milk for some teaching lessons!! Very difficult indeed. 

So humans were looking for some neutral commodity which was required by everybody and could act as a clearing vehicle. So they tried so many things as mean of exchange like Salt, Black pepper, Rice, Sugar, Butter etc. Like Butter, it is demanded by everybody so it is more marketable. So if there is something about which everybody is sure that it will be more readily sold…then there will be greater demand for the same as it can act as medium of exchange. But these things suffered from some limitations which made them to look out for something better…..and then they found GOLD. Gold solved the search for Money. 

Money is the most important invention of the humanity as only due to this that large scale trade was made possible which promoted the production of new things and humanity grew along with. Money was a Commodity the function of which was to facilitate exchange of things. Other commodities could be expressed in terms of money and so could be traded easily. This Money commodity was the creation of Humans unlike other natural commodities which were either a part of earth or derived from other commodities. I think this invention of Money should stand among the most valuable inventions of humanity like Fire, wheel etc. Money was the single most thing which transformed the humanity from barter to easy trade. So money is a commodity which satisfies our needs of facilitation of exchange and trade. It is not a store of wealth but something which can be used for trade of wealth.

Gold is the best medium of Exchange: The Money

 The things humans tried before Gold as mean of exchange or Money had some great limitations like they were perishable. Over time Rice, sugar, Butter etc. would degrade and loose most of their identity and value and so ceased to be a commodity. There were also problems of easy availability and easy supply which can be increased at ease any time. These were not portable either like for buying something in big quantity or valuable we needed to carry a big quantity of these might be in thousands of KG’s. So we were in search for something which is best suited for use as money. How can a carpenter exchange a big bed made by him for meeting his requirements of Food, cloth and Milk? As he is having one large item to trade with a number of persons all having different items of his need. Gold was having all the necessary qualities.

1)      Not easily available: It is not easy to produce Gold and this is the quality which makes Gold as best suited for money. Money should not be easy to produce. Like one can increase the supply of Rice very easily which can raise the inflation and relative prices will vary frequently. But it is very difficult to produce Gold…requires a lot of effort and investments…even then the chances of getting the Gold are not guaranteed. The quantity of money should not be increased at will. In fact most of the easily mineable sources of Gold is already exhausted and it is getting increasingly difficult to mine more Gold every year.

2)      Durable: Almost 99% of Gold which is ever mined (around 180000 Metric tons) by Humanity is still lying above earth because Gold is one of the most durable elements which can withstand the vagaries of environment and time very well. Gold is the most non-reactive of all metals and it never reacts with oxygen which makes it corrosion free.

3)      Portable: Gold can be reduced to small sizes even up to micron levels. It makes it possible to trade it for small value items to most valuable of items. It is very easy to carry Gold for trade. It does not require any special storage. However silver was mainly used for small value exchanges and gold for much expensive trades.

4)      Some other reasons like production of Gold is not dependent upon the variables like rain, drought in case of Sugar etc. Gold is not required for human consumption so there is no dilemma whether to keep it for money or used for human consumption like sugar, butter. Also producers of Gold will not run for overproduction as more production than required will decrease the value of Gold and its exchange value.

So as we can see Gold derives its value for its being best suited as Money. As it is fulfilling its function as money so it is desired as money to use it for trade and commerce; the building blocks of our society and growth. Gold is valuable and unique because of its being capable of performing the role of money. So we know now that Gold is demanded and behaves as a commodity.

So Gold was our not first but best money. But this invention was not a sudden decision but a slow gradual process wherein humans understood the working of a market place, the difficulties faced by them in clearing of trades due to not so good Moneys. These difficulties made them aware about looking for things which could eliminate the limitations of other Moneys….and in their quest they finally found the Gold.

Gold Standard

Slowly Gold was replaced by Government backed Currency notes. These currency notes were nothing but a depositary certificate of Gold. Every note could be redeemed for a promised fixed amount of Gold. So still Gold was the real currency or money of the world (I will explain this shift from Gold to currency note in another post, I am leaving it here due to length of this post). The first truly global reserve currency was the British pound sterling. The world’s great trading nations settled their trade in gold, but they might accept pounds rather than gold, with the confidence that the Bank of England would hand over the gold at a fixed exchange rate upon presentment. But by the end of World War II, the US dollar was given this status by treaty following the Bretton Woods Agreement. As per this, 35 US dollar could be exchanged for an ounce of gold.

But later on during the Vietnam War era, USA did not honor their commitments for maintaining a fixed dollar gold ratio. USA printed big quantity of dollars to finance its wars and over consumption. USA increased the supply of Dollars much more than the increase in the production of goods and services, and along with, it consumed much more than its needs. So USA consumed too much, local and foreign goods which severely impacted its balance of trade with other countries. Actually these things are still happening as Governments all over the world have wrong economic notion regarding stimulating the economy by deficit spending and easy credit. These measures just drag the future consumption into present and severely hamper the savings in the economy which are the main building block of future growth.  

 Hence the volume of outstanding dollars exceeded the US’s store of gold at $35 per ounce. Countries around the world who were happily holding dollars in place of gold became concerned about the Fed’s ability to redeem their Dollar Gold exchange commitment. So they started redeeming their dollar reserves with Gold from USA and USA found that Gold reserves had shrunk to 8000 MT in 1970 from 20000 MT in 1958. USA did devaluation of dollar twice in that period and then finally USA scrapped the Gold standard in 1971 and Dollar was no longer backed by any sort of Gold. However Dollar is still global reserve currency and it is still preferred by global nations to settle their international trade.

Price of Gold

So Gold is no longer the global currency but it’s characteristic of best suited money still contribute most to its current price. Scrapping of Gold standard by every nation resulted in huge supply of currency money created often by governments to fund their wasteful expeditions of wars or political milestones through subsidies. One can imagine the real price of gold if we divide the total gold by all printed money…it can be 20 times of the current although I haven’t made any analysis of this.

But Gold is still hold by Governments across the world as they know that it is the real money which is acceptable to all. Actually so much money has been printed and created that everybody is running on the edge of sword which can cut with a small misbalancing force. If something like that will happen than Gold will still remain the last trusted commodity to carry out the exchange function.

But Gold or money is not an investment vehicle or store of value as widely believed. People use their money or savings to buy gold as it is much more widely accepted and marketable than anything else in the world. So this store of value function is an outcome of one great function; the medium of exchange. If we limit ourselves to present times and to Gold then Gold should be accumulated only because it is the safest money not for returns. Price of Gold doesn’t increase due to improved performance like in the case of stocks where demand rises due to better show in the economic results or real estate where prices rise due to better economic growth and demand for real estate. 

So price of Gold rises because of natural demand supply function. In fact all prices are a function of demand supply equation. Price of something is a constant flow which is forced by the forces of demand and supply. Same thing is true for Gold also….its price rises when widespread fears about global economy force people to park their money in Gold. Its price falls when people are optimistic and looking for better investing avenues like stocks and so they take out the money from Gold and price falls due to low demand. 

But it should not be the case with Gold. Value of something is relative to our association and satisfaction of needs but price is not related to Value at all…it is just an outcome of Demand-Supply equation. Just like water which is valuable but priced low due to perceived demand supply interplay. But if you are trapped in a hot humid desert, you can give anything for a bottle of water….but make no mistake here again the price is related to demand supply not to inherent value. 

So Gold is just like water; very valuable as a commodity but priced very less due to demand supply forces which are taking it just as an investment vehicle. However Gold is like an insurance policy. It saves and preserves the value of our money (paper money). 

Like during great depression of 1930, People lost their life savings as the value of money plummeted due to excessive printing of paper currency by governments. The situation was such that it was easy to burn dollars for heat than buying a log of wood. Many retired persons lost their savings of life. Hyperinflation wiped out most people's savings, turning wealthy citizens into poor ones literally overnight, those who had gold experienced no loss in purchasing power. In Germany, In January 1919, one ounce of gold traded for 170 marks; by November 1923, that same ounce was worth 87 trillion marks!!!

In those times, Inflation, due to excessive printing of money and loss of faith by people in the paper currency, began to grow rapidly, and quickly became a monster. What's important to us as investors is that the price of gold grew faster than the rate of monetary inflation. The data reveal that over this five-year period, the gold price increased 1.8 times more than the inflation rate.

So I am always a believer of Gold. 

I have promised readers of this blog to post a study about currency wars. So I have written this post as a first step in that direction as the knowledge about money is the first enlightenment that will make us understand the complexities of currency wars.

This MONEY has brought great revolution in our life…we took a quantum jump towards growth and prosperity. The situation here is such that the food i am eating, the clothes I am wearing…these were not even available to Lord Krishna. My life is full of comforts. But for Lord Growth is when you don’t FEAR, when you yearn for your true self, when BRAVERY outshines the Gold, when you have tears for others. And these are the things which can never be EXCHANGED or TRADED.

 

Bharat Heavy Electricals Limited: A Wounded War Warrior.

Stock price of BHEL is out of power. It is around its multi-year lows. So many friends are asking for a view as many are at losses and some wants to invest.

I am a proud employee of BHEL. Our company is in tough weather…I am using the word weather because weather is mostly “imposed” on us; it is not the result of our actions. Power sector in india is grappled with double whammy, there is surplus capacity and still huge unmet demand. So we can see that problems are structural not commercial. Distribution losses are huge due to erratic and shabby state power distributors (I remember BSNL) whose poor health refrain them from supplying the power to the consumption points. Power plants are financed by banks which have short term focus…we should finance these with long term infrastructure bonds which are tradable. Moreover everybody jumped into building power plants; even newspaper wala was trying to make a story out of it although COAL is never suited for writing but ink. As these inexperienced players were building power plants with no expertise in running a power plant, no financial strength to withstand any variability instead they were heavily loaded with high cost debt  so they were bound to falter which they did and now they are selling their incomplete power plants for which there are not many takers.

Aggressive bidding even by some established players further aggravated the situation. Some of them even made their calculation of bidding at low per unit costs on the basis of imported Indonesian coal where they never factored for a possible rise in the cost of coal. They even left the possible fall in rupee which could even out any fall in the global coal prices. There was no plan B. But Indonesia raised the prices of exported coal which resulted in the first assault which severed the base.  And when coal prices fell globally, fall in the value of rupee even out any possible benefit out of the fall in coal prices.

This is further impacted by the not so fast growth in manufacturing in india as compared to the growth in capacities in power sector. Indian power sector also witnessed unbalanced investments with heavy investments into generation but very less in transmission and distribution. Building one megawatt of transmission and distribution capacities costs as much as of building production capacity of one megawatt. But grid capacity in india is very inadequate and unreliable. So there are situations when North india is deficient of power and there is surplus power in south and western india but it is of no use for North india as there is no transmission Grid.

So we see here our power sector inflicted by multifaceted issues. I have always felt that slowdown or recessions are mostly the results of misallocation of productive resources. To repair this misallocation, we need to bear the pain of fall of some of pillars of a royal palace as too many pillars hinder the free movement. So some pillars will eventually fall in our power sector.

This is consolidation phase in power sector where big and mighty will survive; inefficient players are going to disappear in this survival game. First margin will disappear in a last attempt to breathe. Right now we are in this margin phase as everybody is bidding low for new orders. Even the margins of BHEL are down heavily and may down even further. But after this correction, only the efficient ones will remain. In power generation, NTPC and Tata power will emerge as leaders with Reliance, Adani distant seconds. BHEL will remain the leader among power producers. It is still capturing around 70% of the orders every year even in these difficult times although at lower margins. But this is part of the game.

Recessions are always helpful in eliminating the unnecessary additions; they bring out the best in the efficient who then focus on sharpening their skills and shedding the heavy unproductive fat. BHEL is not just a power producer but is a significant player in indian defence, transmission and transport sector which account for around 20% of its turnover and these are the other areas which BHEL is going to focus on in its current resurrection.

Not many may be aware of this but BHEL is the main supplier of solar panels and Lithium ion Cell batteries for the satellites of ISRO. These require very advanced technical expertise. BHEL is doing this for ISRO in its Bangalore unit from 2002 for solar panels and from 2005 for batteries. BHEL can garner bigger share in indian defence sector due to its inherent but unused technological strength. Like BHEL is supplying naval guns to Indian Navy and now it is looking for some technology partner for making even bigger guns.  BHEL has also formed a consortium with two other PSUs, Mishra Dhatu Nigam and Hindustan Shipyard, to build submarines indigenously. They are planning for bidding for submarine order, the order value of which will be around 50000 cr. One can imagine the possible scale.

BHEL was also having big investment plans ( may be around 2000 cr) for solar business but I think they may have to shelve the same due to Chinese onslaught and lower demand for solar power but situation is changing now. As I have explained in my post on Gujarat Borosils about solar power that at present there is no solar manufacturing capacity in india, there is only low value assembly capacity and BHEL is best suited to start the solar cell and panel manufacturing in india as it is already doing it albeit at lower scale.

In railways BHEL provides electrical propulsion system and its controls and accounts for more than 40% of electric locomotives in operation by Indian Railways. As we know Railway is another face of india which needs big makeover and we will see huge investments in the sector in the near future.

BHEL is spending around 3% of its turnover on R&D which is the highest in its kind of industry in india. BHEL has around 1400 patents to its credit and has world class technology giants as its business partners.

So I don’t think that time is over for BHEL, in fact it is time for making one more relevant and efficient.  BHEL is debt free with around 10000 cr cash; it can speed up its pace and build up muscles anytime.

No doubt BHEL is wounded because its war time. So only those should invest here who like to witness a war and have the will power to withstand some wounds.  

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and not holding the stock discussed in this Post)