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Tuesday, September 13, 2011

Cost of Credit Vs Creation of Credit: Sell GOLD

I was going through some of the financial news and this is a very interesting discussion .. I would say its an  "Insight" by Mr Bill Gross of PIMCO.. A MUST Must See..

Here is what I understand.
There is "Cost of Credit" and "Creation of Credit" 

Cost of credit: is basically the rate of interest you pay when you take out a loan.

Creation of Credit: If you deposit Rs 100 in the banking system.. the bank can due to "fraction reserve lending rules" create a loan of Rs1000 with your Rs 100 deposit. thus "creating credit". But if you remove Rs 100 from the banking system you reduce the available credit in the banking system by Rs1000/= effectively "destroying credit creation" 

What Mr. Bill Gross said in Financial Times: 
 Helicopter Ben Risks destroying credit creation by flooring maturities out to two years then, and perhaps longer as a result of maturity extension policies envisioned in a forthcoming operation twist later this month, the Fed may in effect lower the cost of capital.
Monetary policy at the Zero interest rate bound introduces a new dynamic that may conflict or even reverse standard logic that lower interest rates across the sovereign yield curve are stimulative to economic growth 

My understanding is that Mr Bill Gross is saying that "Zero Interest rate binding" which is supposed to stimulate economic growth by lowering the cost of capital .. but "Zero Interest rate binding"  will cause a lot of the money to be pulled out of the banking system thus stop the "Creation of credit Cycle" which will result in actually stalling the economic growth cycle.

The example Mr Bill Gross gives is: 
The FED has done a conditional "freezing" of 2 yrs treasury rates at 0.25% So by taking a 90% cash position and 10% in 30yrs treasury bonds we can get a 2 yrs yield of 0.50%. This conditional "freezing" of 2 yrs treasury rates has resulted in 90% of cash remaining out of the banking system.. causing a "Destruction of Credit creation"   Ideally we should have 100% in 2 yrs treasury to achieve the same.. and the money stays in circulation.

This explanation is Mind Blowing!! Revelation I must confess.!!

Mr Bill Gross delves further and states.. The banks instead of rotating the money in the banking system have parked all their funds with FED as "reserves" which is paying then a 0.25% return reducing "Credit" in the banking system.

Investment in "Gold" is taking the money out of circulation from banks causing "Destruction of Credit" As per my understanding Pvt holdings of Gold in India is "18,000 Tonnes "Largest reserves in the world. Its high time we be smart and reduce investment in this asset class (when the prices are high..) cause we are going to see a fall in price of gold. 

Conclusion: I would say if you have been investing in GOLD start lightening up. every time GOLD goes up "SELL" and invest in a productive asset. For me that would be "GAEL, Jayant, NHPC and Tata Communications" (Recommended Best Buys) News like this does not just flow.. its an indication that its time to switch from non productive assets such as gold into productive assets.. There is a SBI 9.5% 2026 bond where one can invest the cash if you are looking for fixed income. GAEL has 35Cr invested in the same bonds.


Sid said...


You being a thorough value investor does Piramal healthcare look good.

I do understand there is uncertainity as to how the cash will be deployed. This definitely fits into the category of "Low risk and high uncertainty"

Thanks and Regards

What'sUp Prahalad said...


Yes Piramal looks like a good buy. Though they have sold most of their business other than CRAMS and critical care..

New Chemical Entities is a loss making proposition.. and will be helpful in deployment of funds..

The thing is promoters have sold stock but looks more like a tax planning effort..

Since most of the indian business has been sold there is no near term trigger..

stock will remain depressed for some time.. yes you can accumulate but in small packets.

if you see some consolidation (reduction in no of public shareholders) then you can start adding more aggressively.

=happy investing

Kishor Barhate said...


Do your blog has not facility to subscribe by mail, so as we can get mail as soon as you post

What'sUp Prahalad said...

Kishore Barhate:

You can just search for "Subscribe:"

no quotes and you can see the link its right below "Search this blog"

=happy investing

km said...

Thank you Prahalad .Your recent prompting on pitti lamination was great catch. I have pitti at an avg cost of 43. It started its run today and touched 50. What's the fair value of this stock in your opinion? Will help us ride the wave.


What'sUp Prahalad said...


Frankly speaking I am not too good in technical analysis.. having said that

I think real pressure is at 70 levels.. so 65 would be where we can start some amount of selling..

generally stocks always overshoot expectations (look at venky's) so lets keep our fingers crossed.

=happy investing

Babypicks said...

Sell Gold? Some people would have said so in the beginning of the year as well. See, as long as one holds a view that global economy and markets are not going to do well, and that is quite evident with the performance or its lack there of in the US and EU markets, notwithstanding the causality effects on emerging markets like India, investing in the likes of Gold makes sense.

However, investing in gold in the form of ETFs, or expecting high returns, or panic selling if it goes down to 1000$ must be avoided. Given the importance of gold in the Indian society, buying hard gold, time to time leading to about 5-10% of portfolio ex-jewelry etc. is always a good idea.

What'sUp Prahalad said...


5yrs back Gold was $300 and now its $1800.. that's 600% return.

one must remember that.

- It is a non productive asset. ie you donot get interest payments..
- Like a company stock where the underlying company is producing goods which create value. Gold is an idle investment.
- Suppose you invest the money in fixed deposit you will earn 10%
which means 1 year down the line your gold will be worth 1800 *1.1 =
- 1 yrs $1980 per ounce.
- 2 yrs $2178 per ounce.

World wide inflationary pressures are everywhere and as interest rates rise.. people will sell gold.

I'm not asking you to sell at $500 or $1000 I'm asking to sell at $1800 when you can easily get $1980 1 year down the line.

Also past 2 yrs stock's and other assets (Property) have under performed.. and even if people balance their portfolio there will be selling. if you had 15% of your portfolio in gold now it would be 25% of your portfolio..

Finally its a call you have to take

=happy investing