Vijay Kumar Gaba

The weather in India these days is as diverse as the country itself. There are severe floods (usually not seen in pre monsoon period) in North East; cyclonic storms in East and South East, torrential rains in South; drought in North and scorching heat in North and West. Power supplies are challenges; wheat has ripened early; sugar cane is drier; seasonal vegetable crops have been damaged.

 In the decade of 2000s (2001 to 2010), gold gave superlative returns. The prices of yellow metal increased 3.8x (in USD terms) for the decade. This return had however come on the back of the negative returns for two successive decades (1981-1990 and 1991-2000). In the last decade (2011-2020) the precious metal yielded a return of 39%.

Traditionally it was believed that during periods of high inflation, geopolitical uncertainties, war, money debasement (due to quantitative easing or hyperinflation) etc. gold is a preferred refuge. However, this safe haven status of gold appears to have diminished in the latest episode of high global inflation, unprecedented quantitative easing, and geopolitical uncertainties.

The shortages of goods and skilled workers are troubling the global economy. Unprecedented borrowing and printing of currencies by the US Federal Reserve, Bank of Japan, and European Central Bank has eroded peoples’ trust in official currencies to some extent. As per the conventional wisdom, the situation is quite ripe for a super bull market in Gold. However, so far gold has not witnessed any extraordinary interest. Rather, independent digital assets (popularly known as cryptocurrencies and NFTs) have mushroomed world over to fill the trust vacuum. The new age investors have even preferred equities to hedge against debt and inflation rather than gold.

So far, the movement in gold appears to be driven more by technical trade rather than any fear psychosis, refuge seeking or hedging against risk of large scale war, hyperinflation, or money debasement due to excessive and/or unsustainable debt.

Despite the massive volatility in the exchange rate of Russian Ruble, Shutdown of Russian markets, sanctions on many large Russian global energy corporations, and freezing of billions of dollars in Russian foreign assets, the gold is higher by -11% YTD 2022 in international markets. This is in sharp contrast to the crisis in peripheral Europe (Greece, Iceland, Portugal) in 2011. The prospective default of Greece was less than US$50bn, but gold had spiked more than 30% higher in 2011.

The opinion of market participants is vertically divided on the prospects of an imminent gold bull market similar to the 1970s and 2000s. But I would like to draw attention of the readers to following points:

·         Gold traditionally been a refuge in the periods of crisis, but in recent years the preference for gold has been diminishing.

·         During the decade of 1970s (1971-1980), significant turmoil was witnessed in the global economy. That was perhaps the best decade ever for gold prices. The gold prices recorded an increase of 9x in that decade. But most of that increase came in the last two years of the decade when global crude prices witnessed a sharp increase. In the following two years (1981-1982) the gold gave up 2/3^rd of these gains.

·         During the decade of 2000s (2001-2010) the gold prices increased 3.8x as the world struggled with an unprecedented financial crisis. But most of the gains came in last two years of the decade (2009-2010); and almost the entire crisis time gains were given up in the next five years. Again the rise in gold prices coincided with the sharp spurt in oil prices.

·         Gold has gained about 39% in the decade of 2010s (2011-2020). But ~75% of the gains have come in just 9 months of 2020 when the world was shut down due to the pandemic.

·         The Gold has lost ~11% in the current decade.

·         The gold has shown strong correlation with the oil prices; though correlation with USD and Copper has weakened in recent years. Given the global trend towards clean energy, it is possible that the relevance of gold as a safe haven also diminishes with the use of fossil fuels.

Thus, it could be reasonably assumed that gold continues to be one of the safe havens but much less volatility. The risk reward profile of gold is definitely worsening with the time.

I continue to maintain my stance on Gold. In my view, a new global order will definitely emerge out of the pandemic and subsequent geopolitical events. The new order will address sustainability and equity issues. Gold will not be a key component of the new order. USD may retain its dominance but it shall face serious challenges from other currencies, including the digital currencies.

You may read in detail here:

Gold is not the end game

Bretton Wood is not about Gold

 Historically, at some point in time copper, gold and/or silver coins had been legal tender in India; and in many other economies as well. Traditionally in Indian society, these metals have enjoyed acceptance as ‘sacred metals’ having religious, medicinal and economic importance.

With the rise in its industrial usage, copper may have lost its ‘precious’ status, but gold and silver still continue to enjoy ‘precious’ status, even though these are no longer legal tenders in India; and most other jurisdictions. With advancement of technology and globalization of Indian socio-economic milieu, the ‘sacred metal’ aspect of gold and silver is also diminishing gradually.

In past few years, the government of India has made significant efforts to encourage people to own gold in non-physical form, through sovereign gold bonds (SGB). These bonds offer interest income at the rate of 2.5 percent annually, beside capital gains benefits to the holders. In recent years, the digital gold has also been gaining popularity due to ease of transaction and holding. This comes after many decades of discouraging the gold for investment and consumption.

Cryptocurrencies (e.g., Bitcoin) are relatively new phenomenon in the global financial ecosystem. Unlike their nomenclature, these are not exactly currencies so far. Only El Salvador has declared Bitcoins as legal tender; whereas there are some jurisdiction (e.g., China, Indonesia, etc.) that have put a total ban on use of all cryptocurrencies as medium of exchange.

Crypto NOT currency as yet

To achieve ‘currency’ status, cryptocurrencies would need to gain much wider and deeper acceptance; which usually comes with time and awareness. Gold took centuries to gain wide acceptance as medium of exchange and ‘valuable asset’ status. Few cryptoes may gain this status in next few decades, simply because modern technology has made things much faster.

In India, the cryptocurrencies have gained tremendous popularity in past five years. It is estimated that there are over 100 million people in India owning one or more cryptocurrencies; the largest number for any country in the world. This number is materially higher than the number of people owning publically listed shares in India. The value of cryptocurrencies owned by Indian citizens is estimated to be close to US$900bn.

Regulating cryptocurrencies

The government has proposed to introduce a Bill in the forthcoming session of the parliament to regulate cryptocurrencies. The Bill titled ‘The Cryptocurrency and Regulation of Official Digital Currency Bill 2021’, aims to “create a facilitative framework for creation of the official digital currency to be issued by the Reserve Bank of India” and prohibit all private cryptocurrencies in India, with certain exceptions to promote the underlying technology and its uses."

Earlier, a high level inter-ministerial committee had suggested ban on private cryptocurrencies in India, except any virtual currencies issued by state. However, the government refrained from pushing the legislation in the Budget session. It was felt that a balanced approach is required in the matter, for which wider consultation with all stakeholders is important.

The Standing Committee on Finance recently highlighted many serious concerns over the obscurity of cryptocurrencies, operations of crypto exchanges and impact on the economy.

The stakeholders like RBI, Finance Ministry, Home Ministry, Blockchain and Crypto Assets Council (BACC) and industry and commerce bodies, the CII and ASSOCHAM, etc. made detailed presentation to the prime minister regarding opportunities and threats posed by cryptocurrencies and the need for appropriate regulatory framework.

Most significantly, the BACC represented that crypto assets could be treated as “utility”, “security”, “property tokens”, “intangible commodities”, or “virtual assets” that would ensure that the usage of tokens was governed appropriately and they were not confused with legal tender.

From the indications available so far, it appears that the government is totally against the use of cryptocurrencies as a medium of exchange (legal tender), but it supports the development and use of blockchain technology. It is therefore likely that a regulatory framework may be provided for ownership, transfer, sale and taxation of (select or all) cryptocurrencies. In that case the permitted cryptocurrencies may be treated as “capital assets” under the taxation laws.

It is also likely that the proposed legislation may permit a digital currency based on blockchain technology, to be developed by RBI or any other public agency. Obviously, such currency will not have the traits like Bitcoin, which is a decentralized and distributed digital token with finite supply. RBI’s digital currency will most likely be a centralized currency with infinite supply, just like fiat currency. In simple terms, RBI’s digital currency may be a dematerialized currency note that is delivered as a book entry in the receivers’ account.

Therefore, a fiat digital currency should not be confused with a decentralized and distributed cryptocurrency.

An idea whose time has come

In every democracy, especially the socialist ones, the governments have the natural tendency to regulate every innovation; simply because most new innovations make few people richer than the rest. With every new innovation, the fear of rise in inequalities also rises. The tendency to overregulate the innovations is therefore usually driven by the concerns to assure the majority of population that stays at the bottom of the pyramid.

A classic example of this was the attempt of British government to ban the use of cars on public roads in early years of automobiles. The argument was that this may have negative implications for the employment of poor people running horse carts on streets of London.

The good thing is that there is no historical evidence of a government regulation killing an innovative idea which was ready for adoption by the wider sections of public. Expansion of organized retail is a classic example in recent Indian context.

The dematerialization of securities is inarguably the single most important reform in the history of Indian capital markets. The idea was initially opposed by the market participants and bureaucrats. Computerization of banks and stock trading were other ideas that were not accepted easily by various stakeholders.

Failure to self-regulate is also a major catalyst for the overregulation. Securities’ market in India was mostly self-regulated for first 100 years. It was the colossal failure of self-regulation during late 1980s and early 1990s that pushed the government to intervene. BSE, a self-regulatory organization (SRO), that enjoyed more than 50% market share in a 29 players market till mid-1990s, is now contended with less than 10% market share in 2 player market.

“Most of the cryptocurrencies may not pass the test of time and fail, causing material losses to investors” is not a valid argument against cryptocurrencies. During 19^th and 20^th century, thousands of banks and insurance companies failed causing instability in markets and material losses to investors and depositors. More recently, many private airlines, telecom companies, infrastructure builders, private & cooperative banks, NBFCs, HFCs etc have failed in India causing huge losses to investors, lenders and the exchequer. Would anyone accept this failure as valid argument for banning these activities in private sector!.

Cryptocurrencies a bad omen for Gold

A well regulated market for cryptocurrency could be a bad omen for demand for the traditional “valuable assets’ like gold and silver. Arguably, the factors like popularity and spread of technology in common man's life; rising fascist and communist tendencies due to worsening socio-economic disparities; rise in electronic transactions (personal, social and commercial) thus lower risk (less travel, less physical transactions & deliveries); emergence of new articles of luxury to serve the vanity needs of the affluent; stronger and deeper social security programs; demise of monarchy and feudalism; popularity of spiritualism over rituals; dissipation of church & temples, etc., are all leading to sustainable decline in traditional demand and pre-eminence of gold. There is nothing to suggest that this trend may not continue in near future.

The following table makes it clear that gold and cryptocurrency are comparable assets in most respects. Some experts are arguing that gold has “intrinsic” value whereas cryptocurrencies have none. In my view, the intrinsic value of gold has developed over many centuries of wider acceptance by the state and religion. This intrinsic value has been on the decline for past few decades.

Insofar as the volatility is concerned, in past two centuries, gold has seen many bouts of wild volatility, correcting over 50% on many occasions. From December 1987 high of ~US$500/oz to February 2001 low of ~US$250, Gold yielded a negative return of 50% over a period of 13yrs. Falls of similar magnitude were rather quick during 1974-1976 and 1980-1982.

In past couple of weeks, some news items, and market & economic trends have attracted my attention. All these news items & trends somehow reflect on the reflation trade that has dominated the global markets for past few months.

The rise in commodity prices in past one year is seen mostly a function of a combination of demand and supply side factors. Post global financial crisis (GFC 2008) the investment in new capacities had slowed down considerably. The economic lockdown due to outbreak of pandemic further curtailed the supply of many industrial commodities. The logjam at Suez Canal further impacted the supply chain. The supply of commodities obviously could not match the recovery in economic activity as the economies began to open up.

The trillions of dollars in pandemic related stimulus further boosted the demand, as all three activities, viz., consumption, capex and trading got boost from worldwide stimulus. The US government’s plan to invest US$1trn in building nation’s deteriorating roads and bridges and fund new climate resilience and broadband initiatives is also expected to lead the further rise in demand for industrial commodities like steel and copper.

1.    A newspaper reported that HDFC Bank has received Rs300bn in prepayments in the quarter ended June 2021. These prepayments were reportedly made primarily by the companies in commodities and infrastructure sectors.

2.    A famous Kolkata based investment manager publically made a very persuasive case for investment in a public sector steel company, implying that in the given circumstances the share price of the company could potentially see a 3 fold rise in next one year. He also claimed that their portfolio schemes are presently invested in all metal stocks.

4.    The analysts at Phoenix Capital Research noted that “One of the key drivers of stocks prices since the March 2020 bottom has been the Fed’s interventions. The Fed spent a total of $3 trillion between March and June 2020. It briefly dipped between June and July 2020 but has since increased at a steady pace courtesy of the Fed’s $120 billion per month Quantitative Easing (QE) program.

However, all signs point to the Fed reducing these interventions going forward. With jobs numbers like those from July (900K+ jobs were created), the unemployment rate down to 5.4% again, and inflation roaring (CPI is clocking in over 5%), the Fed is effectively out of reasons to continue its month interventions at the current pace. Add to this the fact that numerous Fed officials are calling for a taper to QE and even rate hikes, and it’s clear the Fed is on the verge of announcing that it will be reducing its money printing very soon.”

It is pertinent to note that the GDP estimates for another large economy (India) have also been revised downward at least twice in past 4months, by almost all global agencies.Obviously, this cannot be good news for the traders staking their money on continuing reflationary trade.

The International Energy Agency (IEA) cut forecasts for global oil demand “sharply” for the rest of this year as the resurgent pandemic hits major consumers, and predicted a new surplus in 2022.

The announcement led to sharp correction in crude oil prices to the three months prior levels.

7.    The last move of about half of emerging market central bankers was hike in policy rates or policy tightening. Obviously, the days of monetary easing are behind. This shall definitely check the runaway inflationary expectations and therefore impact the reflation trade. 

8.    A BollombergQuint report highlighted that “Indian companies are running out of room to absorb rising raw material costs, which could force the central bank to unwind stimulus faster-than-expected and threaten a stock market rally that has earned billions for investors. Companies from the Indian unit of Unilever Plc to Tata Motors Ltd., the owner of the iconic Jaguar Land Rover, are increasingly complaining about pricier inputs and are frustrated at not being able to fully pass on costs to consumers reeling from the pandemic-induced economic shock. But it is only a matter of time before the pass- through happens, warn economists.

While its a tough balancing act, companies are mindful that something will have to give in eventually. In this case, it could mean higher prices being passed to consumers gradually as a recovery gets stronger in Asia’s third-largest economy.”

10.  Earlier this week, the US Senate gave bipartisan approval to a US$1 trillion infrastructure bill to rebuild the nation’s deteriorating roads and bridges and fund new climate resilience and broadband initiatives.

The plan reportedly includes, US$550 billion in new federal spending, to expand high-speed internet access (US$65bn); build/rebuild roads, bridges, etc (US$110 billion); airports (US$25 billion); and the most funding for Amtrak since the passenger rail service was founded in 1971. It would also renew and revamp existing infrastructure and transportation programs set to expire at the end of September.

11.  Back home, financials have are sharply outperforming the commodities since past three weeks. The market is telling that metals, sugars etc. have reached their peak margin and peak valuations. Using the strong price cycle, many large commodity companies have repaired their balance sheets. Consolidation by way of IBC process has also helped the larger companies. It is time that these companies may be thinking about the next capex cycle. Sugar companies have already embarked on a major capex cycle to set up new ethanol capacities. Steel companies are already planning major capacity additions. As per media reports SAIL is looking to expand capacities by 12-14 mt at its steel plants at Bokaro and Rourkela.

The popular inflation hedge trade (gold and silver) has done much worse than the overall commodity universe; whereas Bitcoin (perceived to be one of the most riskiest and volatile asset presently) has done very well.

Conclusion

These are still early days to conclude anything from the above cited news items and trends. Nonetheless, in my view, the following deductions from viewpoint of investment strategy may be considered reasonable:

·         The sharp run up in commodity prices is factor of supply constraints and demand stimulus. There are indications that supply constraints may ease as economies open up further; demand may cool down as monetary stimulus are gradually withdrawn and pent up demand subsides.

·         The commodity price inflation is now testing the limits of the industrial consumers (manufacturers). Any further rise from here shall be passed on to the last consumers, who would have much lower absorption capacity in absence of further stimulus checks. It is reasonable to assume that normal demand supply equilibrium will settle at a lower level only.

·         The balance sheets of commodity and infrastructure companies have seen substantial improvement in past one year. These two sectors accounted for more than half of the stress in the banking system. Besides, the credit growth is likely to pick up as companies rush to augment capacities to meet the increased demand and avail new government incentives for manufacturing sectors.

·         The conventional wisdom suggests that now it’s the turn of financials and capital goods manufacturers to do well. Commodities can wait for FY24 to have their turn again.

 “The afternoon knows what the morning never suspected.”―Robert Frost

In past few years, cryptocurrencies (especially Bitcoin) have gained material importance in the global financial system. Though the character of Bitcoin (or cryptocurrencies for that matter) is still evolving and it is not certain if it will assume the character of a currency; end up just being a collectible asset like Art, wine, vintage vehicles, old coins, etc.; or just end like a bad dream. But as of now, the debate over its relevance, sustainability, desirability, etc., is intense and wide.

In my view, it is a debate that will continue for many more years and no one will remain unaffected by it. Almost everyone who transacts in money or is part of the global economic system will need to deal with at some point in time.

Majority of experts still skeptical

A large number of prominent personalities in the field of finance, technology and economics, like Warren Buffet, Jamie Dimon, Peter Schiff, Paul Krugman, Bill Gates, et.al., have publically criticized the popularity of Bitcoins. In their wisdom they have chosen the terms like “fraud”, “rat poison”, “scam” etc. to describe Bitcoin. In India, the legendary investor Rakesh Jhunjhunwala publically vowed never to own Bitcoin.

The following statements of the legendry investor Warren Buffet represent the sentiments of the people who are skeptical about the sustainability of cryptocurrencies as a viable currency or asset class”

"It's not a currency. It does not meet the test of a currency. I wouldn't be surprised if it's not around in 10 or 20 years. It is not a durable means of exchange, it's not a store of value. It's been a very speculative kind of Buck Rogers-type thing and people buy and sell them because they hope they go up or down just like they did with tulip bulbs a long time ago." (2014)

"In terms of cryptocurrencies generally, I can say almost with certainty that they will come to a bad ending. If I could buy a five-year put on every one of the cryptocurrencies, I'd be glad to do it, but I would never short a dime's worth." (2018)

It is “probably rat poison squared”. (2018)

“I think the whole damn development is disgusting and contrary to the interests of civilization. Of course, I hate the bitcoin success… I don’t welcome a currency that is so useful to kidnappers and extortionists”. (2020)

 "Cryptocurrencies basically have no value and they don't produce anything. They don't reproduce, they can't mail you a check, they can't do anything, and what you hope is that somebody else comes along and pays you more money for them later on, but then that person's got the problem. In terms of value: zero." (2020)

Later, however, JP Morgan, disregarding the earlier comments of CEO Jamie Dimon, “admitted its mistake” rejecting Bitcoin as a scam and has shown inclination to accept the cryptocurrency as an attractive asset.

Eric Peters, CIO of Hedge Fund One River Asset Management, proclaimed (about Bitcoin) that "There Is A Vague Sense That Something Powerful, Apolitical, Transnational, Is Emerging".

In the meantime, Rakesh Jhunjhunwala, the legendary Indian investors who is often referred as Warren Buffet of India, was heard saying in a TV interview, "I won't buy it for even $5. Only the sovereign has the right to create currency in the world. Tomorrow people will produce 5 lakh bitcoins, then which currency will go? Something which fluctuates 5-10% a day, can it be considered as currency?"

Regardless of the extremely negative expert commentary, Bitcoin has not been termed illegal in any of the major economies in the world; even though some countries like China have imposed severe restrictions on transacting in Bitcoins. El Salvador has become first country in the world to accept Bitcoin as the legal tender.

Despite being most volatile, Bitcoin has remained one of the best performing “assets” in past couple of years.

The historical context

The work on developing as crypto currency started in early 1980s. The idea was to create a medium of exchange that is independent of any central authority, is based on trust and is accepted by distributed consensus. The process was formally commercialized in 2009 with release of Bitcoin, the first decentralized cryptocurrency. May be uncertainty over future of fiat currencies post global financial crisis (which led to printing of unprecedented amount of new money) prompted adoption of an independent currency as medium of exchange. Since then, the cryptocurrencies based on block chain technology have been gaining popularity. Presently, besides Bitcoin, over 6000 variants of crypto currencies are in vogue globally. Many central bankers have also expressed in using digital technologies to supplement the paper currency.

The present value of all cryptocurrencies in circulation is over US$1.6trn; out of which bitcoin alone accounts for about US$750bn. This compares with US$5.8trn of monetary base (M0) of USA). The average daily trading value of bitcoins alone is over US$23bn. It is clear that Bitcoin is emerging as a serious challenger to Gold as an alternative currency or medium for exchange of value.

Two large global corporations Tesla (again!) and Amzon have expressed the intent to accept Bitcoin as valid payment for transactions. This has further intensified the debate and softened some of the critics.

The Indian context

In Indian context, the money market regulator (The Reserve Bank of India or RBI) has taken a guarded view of cryptocurrencies. It has refrained from terming it as illegal. However, some attempts have been made to discourage the use and ownership of cryptocurrencies. The Supreme Court of India has disagreed with some of these measures, and paved the way for legal ownership of cryptocurrencies. However, the regulatory and taxation regime is still evolving and may take some time to get established.

RBI vs Supreme Court

RBI issued a circular in 2018 directing all entities regulated by it (Banks and NBFCs) not to deal virtual currencies or provide services for facilitating any person or entity in dealing with or settling those; thus virtually banning use of crypto currencies in India. The Supreme Court quashed the said RBI circular in March 2020, on the appeal of the Internet and Mobile Association of India, representing various cryptocurrency exchanges. The SC accepted the argument of the appellant that in the absence of any specific law banning cryptocurrencies, dealing in these is a “legitimate” activity; hence RBI’s circular banning these is untenable.

In August 2020 various media reports suggested that a “note” had been forwarded to the concerned ministries for inter-ministerial consultation to promulgate a legislation banning the use of crypto currencies in India. Reportedly, the inter-ministerial committee headed by the former Finance and Department of Economic Affairs (DEA) secretary, Shri Subhash Chandra Garg (who has been in news recently for criticizing the government for backtracking on reforms) had drafted the Bill of the law to ban the cryptocurrencies. In the meantime, as per various media reports, since March 2020 SC order quashing the 2018 RBI circular, the local crypto exchanges have reported as much as 20x trading volume growth and a significant increase in the number of signups.

The aggressive marketing campaigns by these ventures however are focusing on promoting Bitcoin ownership for vanity purposes, palpably as a substitute for gold.

NITI Aayog initiative on Blockchain recognizing its importance

In January 2020, NITI Aayog (the think tank of the government of India on policy matters), had released part 1 of the discussion paper on “Blockchain: The India Strategy”. The well-researched and well-presented paper unambiguously stated that the government recognizes the opportunity, importance and need for blockchain based crypto currencies.

The paper recognized that “‘Blockchain’ has emerged to become a potentially transformative force in multiple aspects of government and private sector operations. Its potential has been recognized globally, with a variety of international organizations and technology companies highlighting the benefits of its application in reducing costs of operation and compliance, as well as in improving efficiencies.”

It is admitted that “Blockchain is a frontier technology that continues to evolve. In order to ensure that India remains ahead of the learning curve, it is important to understand the opportunities it presents, steps to leverage its full potential and such necessary steps that are required to help develop the requisite ecosystem.” And “Blockchain technology has the potential to revolutionize interactions between governments, businesses and citizens in a manner that was unfathomable just a decade ago.”

The paper candidly admits that “Blockchain is seen as a technology with the potential to transform almost all industries and economies. It is estimated that blockchain could generate USD3 trillion per year in business value by 2030.”

Obviously, the government of India recognizes the potential, opportunity, need and importance of cryptocurrencies. However, it wants to tread with extreme caution. The NITI Aayog’s discussion paper notes that —

“Blockchain has been positioned as a revolutionary new technology, the much needed ‘silver bullet’ that can address all business and governance processes. While the promise and potential of blockchain is undoubtedly transformative, what hasn’t helped this technology, that is still in nascence of its evolution, has been the massive hype and the irrational exuberance promulgated by a bevy of ‘Blockchain Evangelists’.”

“Any transformative technology, in its initial stages of development, as it moves out of research / development phase to first few applications to large scale deployment, faces several challenges. Part of the problem is that such technologies are initially intended to solve a specific set of problems. Bitcoin, which has led to the popularity of decentralized trust systems and has powered the blockchain revolution, was intended to develop a peer-to-peer electronic cash system which could solve for double spending problem without being dependent on trusted intermediaries viz. banks. As Bitcoin started gaining prominence, the potential of underlying blockchain technology started getting traction. However, some of the early design features that made Bitcoin popular, primarily limited supply and pseudonymity, have become potential challenges in wide scale implementation of blockchain.”

(The NITI Aayog discussion paper “Blockchain: The India Strategy” could be read here.)

Bitcoin ticks most boxes

Given the nascent stage of evolution of block chain technology and crypto currencies based on it, the cautious approach is understandable. However, the caution must be pragmatic and should not transgress to typical dogmatic paradigm.

In my view, the real debate is whether the world needs an independent reserve currency for cross border transactions; given that the unmindful printing of fiat currency by the respective large central banks in past two decades has perhaps diminished the credibility of the popular global currencies USD and EUR.

A broad evaluation of Bitcoin (or any other widely accepted cryptocurrency for that matter) highlights that Bitcoin may meet all prerequisites of a good currency – e.g., medium of exchange, store of value and unit of measurement. As evident from the following evaluation table, the advantages of Bitcoin, as an evolved independent digital currency, outscore gold on some parameters. It also outweighs any fiat currency that is not backed by real assets.

Gold vs Bitcoin

For many centuries, Gold was the most popular currency – store of value, medium of exchange and unit of measurement. However, with evolution of paper currencies and metric system, the usage of gold as a medium of exchange and unit of measurement declined significantly.

In past couple of centuries, Gold has served as reserve currency whenever the paper currencies have lost faith of people due to a variety of reason, particularly high inflation and fiscal profligacy. It has also been used as such during transition periods in global strategic power equilibrium. However since end of Breton Wood agreement in 1971, gold has not been used as reserve currency. Post fall of Berlin Wall in 1989 the strategic supremacy of USA, and consequently USD, has remained mostly unchallenged.

The demand of gold as store of value is a deeply complex matter. In past gold had been a preferred asset to store value both during economic (especially hyperinflation) as well as political (including geo-political) crises.

In 1970s the world faced serious stagflation as the demand generated by post WWII reconstruction activities faded and Iranian revolution created a worldwide energy crisis. Gold jumped 10x in real terms during the decade of 1970-1980), to give back most of the gains in the following two decades.

Again in the decade of 2000s, as the dotcom bubble hit the global economy, interest rates crashed leading to sub-prime crisis that culminated in a major global financial crisis. The gold jumped 5x in real terms during this decade (2001-2011).

Presently, the gold prices are only marginally higher than the highs recorded in 2011. Whereas Bitcoin has risen almost 1000% since 2011. Like gold in 2001-2011, Bitcoin has risen 5x since outbreak of Covid19 pandemic, whereas gold is higher by about 5% in this period. The question is whether unconsciously markets are replacing Gold with Bitcoin.

Is Bitcoin replacing Gold

When economics fails in providing solution to a problem of livelihood and sustainability, philosophy always provides the answer.It is a natural instinct of human being to look up to the skies for guidance when all our efforts fail. (Some even do so without making any effort at all!) Religion has therefore been an inextricable part of human life since beginning of the civilization.

Most ancient cultures, China, Egypt, Mesopotamia, Indus Valley etc. have believed in continuation of life after death. Gold being an indestructible (and therefore sacred) object had always been an important part of their religion, culture, traditions and beliefs. It naturally evolved as symbol of power and prestige over time. The church & temples, kings & feudal lords hoarded and displayed gold to asset their power and status.

In past one century, especially past three decades, the factors like popularity and spread of technology in common man's life; rising fascist and communist tendencies due to worsening socio-economic disparities; rise in electronic transactions (personal, social and commercial) thus lower risk (less travel, less physical transactions & deliveries); emergence of new articles of luxury to serve the vanity needs of the affluent; stronger and deeper social security programs; demise of monarchy and feudalism; popularity of spiritualism over rituals; dissipation of church & temples, etc., have all led to sustainable decline in traditional demand and pre-eminence of gold.

In the modern context, technologically challenging things, e.g., Bitcoins, certainly find greater favour with investors as compared to gold.

Conclusion

To conclude, I would say that the ultra-loose monetary policy prevalent in most developed countries shall have to end at some point in time in foreseeable future. This suppression of savers and poor cannot continue into perpetuity. However, ending this tiger ride may not be easy and would require some innovative measures.

For example, the following is one of the scenarios that is potentially possible—

·         US Government and Fed decide to correct the fiscal and monetary indulgences of past couple of decades, by material devaluation of USD and letting USD retire as global reserve currency; settle trade and currency dispute with China agreeing to restore the global trade balance.

·         Global commodities are no longer priced predominantly in USD. The share of neutral currencies (cryptocurrencies) increases substantially in global trade.

·         Consumption pattern change materially. The consumption of fossil fuels, steel, chemicals etc. declines structurally.

·         Digital transformation leads to material rise in productivity, further adding to deflationary pressures created by aging demography of the developed world; thus alleviating the fears of hyperinflation and need to resort to gold as reserve currency.

This may sound fanciful but is not totally unlikely.

There could be many similar or different solutions to end this tiger ride of quantitative easing, negative rates, and suppression of poor (people, economies and regions). Out rightly, rejecting the need and importance an independent currency at this stage could prove to be fatal.

The question, whether Bitcoin would be emerge as the independent global currency would best be answered by time. I would though not reject the probability. Nonetheless, Bitcoin (cryptocurrencies in general) has assumed the status of a popular alternate asset and there is no reason to despise it, just because its price in USD terms is highly volatile presently.

India's trade gap widened to $13.93 billion in March of 2021 from $9.98 billion a year earlier. The trade gap was however lower than the preliminary estimates of a higher $14.11bn. The key highlights of trade data were as follows:

·         In March 2021 exports soared 60.3% to a record high of $34.5bn (up from $27.5bn in Feb’21), marginally higher than the preliminary estimate of $34bn.

·         The exports surged ~60% yoy in March, driven mainly by $6bn rise in non-petroleum products’ export.

·         Imports in March 2021 were $48.4bn ($40.5bn in Feb’21), led by non-petroleum imports of $38.5bn ($31.5bn in Feb’21). Imports surged 54% yoy

·         Overall exports contracted by ~7.2% yoy in FY21, a reasonable figure given the difficult period for trade due to global lockdowns.

·         Imports were down 17% yoy in FY21, mainly on account of 37% lower petroleum import due to lockdown and mobility restrictions.

·         Trade deficit widened in March 2021 to $13.9bn ($12.6bn in February and $9.98bn in March 2020)

·         Pharma exports maintained high growth in March, growing 49% yoy to $2.3bn, an all-time high.

·         For FY21, India recorded current account surplus equal to 1% of GDP, due to lower imports and higher FPI flows. Overall BoP surplus in FY21 was $84bn.

I usually do not like to read too much into monthly macro data, unless there is a sustainable trend that could be reasonable extrapolated to future periods. However, I find that any decision based on headline trade data might be erroneous. It is important to factor in the details. For example, consider the following:

(a)   While almost all items recorded positive growth, majority of the growth in imports and exports was driven by abnormal growth in a handful of items.

Out of ~$17bn yoy increase in exports, gold imports alone accounted for 50% delta or $8.3bn. Reportedly, gold imports touched 98.6 tons in Mar 2021 from 13 tons a year ago.

(b)   Export’s growth was led by the growth Engineering products’ export, which accounted for almost one third of the export growth. It is estimated that large stimulus spending in trade partner countries led to higher engineering product growth. However largest export growth was recorded in Iron Ore, led by sharp rise in prices.

(c)    With fresh mobility restrictions the trade momentum may slow down again. FPI flows may also taper this year reducing the CAD and BoP surplus. The consensus appears a CAD deficit of ~1% for FY22. INR may therefore

On the positive side, the advance economies are outpacing the emerging economies in growth recovery. This trend augurs well for Indian exports, especially engineering goods. A weaker INR (my view 74-74.50/USD average for FY22) might be an added advantage.

 The two thousand twentieth year of Christ is coming to an end. This year has been totally forgettable and remarkably transforming at the same time. It reminds me of the title of the autobiography of legendry poet Dr. Harivansh Rai Bachachan – “क्या भूलूँ, क्या याद करूँ”.

Notwithstanding the all-time high levels of stock market indices in most countries; the global financial system inundated with trillions of dollars in free liquidity; over US$20trn worth of bonds yielding negative return globally; the massive economic and social shock of Covid-19 pandemic has left billions of people in distress. The inequalities of income, wealth and opportunities have risen to new highs.

Significant developments have been reported on the front of vaccine development to check the spread of Covid-19 virus. Many countries have already authorized emergency use of some vaccines; and people are being administered such authorized vaccines. Nonetheless, recently a fresh wave of mutated version of Covid-19 virus has been reported from some places in Europe (especially UK), resulting in fresh set of mobility restrictions. This indicates towards the possibility that the world may not return to total normalcy in many months to come. As per various estimates, it will take 15-18months to inoculate a sizeable population to reach a stage of herd immunity against the Covid-19 virus.

On the positive side, the pandemic has accelerated many trends that may help the cause of sustainable faster development in the medium to long term.

There have been many events in 2020 that must be taken note of by the investors. However, as a tine investor in Indian assets, I would in particular like to remember the following eight for next many years.

1.    The Indian government imposed a total socio-economic lockdown in the country in the wake of the outbreak of pandemic from 25^th March 2020. The restrictions were relaxed gradually from June onward.

In my view, it is almost impossible to assess the utility and true impact of lockdown exercise. We would never know, what could have been the situation if a total lockdown was not imposed in March. It could have been worse in terms of economic and health shocks; or perhaps the economic loss could have been less pronounced, sans total lock down.

This episode however has further strengthened my already strong view that the incumbent government is unpredictable. It can take decisions having far reaching repercussions rather quickly; without adequate planning; and without bothering about the immediate consequences in terms of human suffering. I shall continue to incorporate this feature in my investment strategy for midterm.

2.    During the lockdown, when the human activities and mobility were restricted to a great deal globally, the nature attempted to reclaim its space. The instances of peacock dancing on city streets, deer, sheep and even lions roaming freely on public roads, air quality improving to “serene” from “severe”; visibility improving to few hundred kilometers from few meters; children learning that the color of sky is “azure” and not “pigeon blue”. However, within 15 days of unlocking, the human reclaimed the entire territory from the nature.

Notwithstanding the enthusiasm behind sharing pictures of “pure nature” on social media, it is clear that we have moved too far on the path of self-destruction.

On the other hand, “work from home” and “digital meetings” have been adopted as fait accompli by many businesses. This because it brings immediate tangible benefits to both, the employer and the employee.

This leads me to conclude that any global agreement on climate will not succeed unless it has immediate and tangible economic payoff for the parties. The Paris accord, fails on this test, just like the Kyoto protocol. I shall therefore not be looking for investment opportunities in Paris accord, unless I see tangible economic gains for Indian businesses and consumers.

3.    On 20^th April 2020, something happened in global commodities market, which was unheard of. The WTI Crude Oil Future in New York crashed to a negative US$37.63 price. This event, though rare, has added a new dimension to the risk management process; option pricing methods; and trading strategies.

4.    The benchmark crypto currency “Bitcoin” has been vogue since 2009. Even though it was accepted as a medium of exchange in many jurisdictions, it never gained wider acceptance as legitimate asset like gold or store of value like currency. In 2020, most of the reputable global investors and strategists have accepted Bitcoin as futuristic “store of value”, just like gold and USD. This acceptance has come on the back of Bitcoin’s sharp outperformance vs precious metals and USD. I believe that this marks the beginning of a new era on global monetary system. Neutral digital currencies shall continue to gain prominence in global monetary system in future. May be this prominence would diminish the dominance popularity of gold and USD as global reserve currencies.

5.    The year saw a brilliant thaw between the traditional enemies the Arabs and the Israelis. Some strategic initiatives were taken by Israel, UAE and Saudi governments to reduce tension in the region. This also saw Arabs increasing distance from Pakistan. I see this as a good omen. It may result in sustainable reduction in terror support and funding globally. However, this has pushed Pakistan closer to China. The tension at Indian northern, western and eastern borders may sustain and even increase in short term. More frequent hostilities at borders  is something we would need to incorporate in our investment strategies.

6.    Reliance Industries, led by Mr. Mukesh Ambani managed to convince global business leaders like Facebook and Amazon, and investors like KKR, Carlyle, GIC, ADIA etc to invest in its digital and retail ventures. Global petroleum majors British Petroleum and Aramco have also committed large investments in fuel business of the company. If these investments are consummated successfully in next 2-3years, we shall see many large Indian businesses gaining attention of the global business leaders and investors. I shall be reevaluating some of the large, viable but heavily indebted businesses from this viewpoint.

7.    First protests against the Citizenship Amendment Act (CAA and Shaheen Bagh) and now protests against the three acts to reform the farm sector in the country have further strengthened my belief that the mistrust between the ruling BJP and opposition parties has breached the red line. The political environment shall get further vicious, once the BJP tries to conquer the Forts of East (West Bengal and Odisha) next year. I shall not be expecting political consensus on any issue for next few years, for my investment strategy. Although with Congress weakening further, getting majority votes in Rajya Sabha may not be an issue for the government, nonetheless, the threat of reversal of contentious legislative changes shall always prevail, should a united opposition manage to dethrone BJP in 2024. (I agree that as of this morning this looks almost improbable).

8.    India recorded its first recession in past four decades in 2020. Though many analysts are terming it a technical recession due to lockdown; I would like to wait and see the trajectory of recovery to conclude if a lasting damage has been caused to the growth prospects.