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Friday, September 23, 2011

Is the Markets ready for a 15 Trillion Dollar Liquidity Pump.

Mr Bernanke has just started "Operation Twist" and the world is in financial crisis. Well here is a different "Twisted" view about what's really happening. Just look at the table below.

1. The first table is FED data H.3 "Aggregate Reserves of Depository Institutions and the Monetary Base"
All the Data is in Millions of USD (US Dollars) Seasonaly Adjusted, Break Adjusted.

2. The FED is looking at the Monetary Base and reporting it.
- In Jan 2007 (2007-01) the monetary base was $813 Billion
- In the peak of financial crisis Oct 2008 (2008-10) the monetary base was $1,129Billion (1.12Trillion)
- 26 months later in Jan 2010 (2010-01) the monetary base was expanded to $1,987Billion  (1.987 Trillion)
- In August 2011 the monetary base has expanded to $2,658 Billion (2.658 Trillion)

On the first look we can clearly see the FED has increased the monetary base by 235.42% (Oct 2008 to August 2011) in the past 35 months but the ground reality is that there has not been any comparable increase in economic activity.. We conclude .. US is in depression.

3. Lets look at "Reserves of Depository Institutions Required" column. A more common term used to describe "Reserves of Depository Institutions Required" is "Cash Reserve Ratio" or CRR.

As per Investopedia:
The portion (expressed as a percent) of depositors' balances banks must have on hand as cash. This is a requirement determined by the country's central bank, which in the U.S. is the Federal Reserve. The reserve ratio affects the money supply in a country. This is also referred to as the "cash reserve ratio" (CRR).

For example, if the reserve ratio in the U.S. is determined by the Fed to be 11%, this means all banks must have 11% of their depositers' money on reserve in the bank. So, if a bank has deposits of $1 billion, it is required to have $110 million on reserve. 

US CRR rate is 10% and lets look at the column titled "Reserves of Depository Institutions Required"
2008-10 (Oct 2008) Reserve Required: $48.366 Billion.
2011-08 (August 2011) Reserve Required: $83.843 Billion.

- The banks in US had deposits of $483.66 Billion in Oct 2008 (10% is $48.36 Billion)
- August 2011 the Deposits in US banking system has increased to $838.43 Billion (10% is $83.843Billion)

Reserve Required has increased by 173.35% but compared to 235.42% increase in Monetary base deposit growth is 62.06% lower. This would mean there is an increase in savings but definitely its lower than the increase in monetary base so if its a Vanilla Savings account your money would have lost value as the monetary base has increased at a higher rate.

4. This is the column titled: "Reserves of Depository Institutions non borrowed"  This column indicates the reserves held by Banks with the FED and its their "own money" "NON Borrowed (from FED)".
Before 2008 The FED paid Zero interest on the "Reserves of depository Institutions"  and from 2008 FED has started paying interest of 0.25% (25 basis points) on the "Reserves of Depository Institutions"

  a. in Jan 2007 (2007-01)
Reserves of Depository Institutions Non borrowed: $41.672 Billion
Reserves of Depository Institutions Required: $41.338 Billion
The numbers were matching .. so the banks maintained a reserve level with the FED just equal to the minimum required levels. (as there was no interest payments of 0.25% )

  b. In Oct 2008 (2008-10) just as the financial crisis imploded.
Reserves of Depository Institutions Total: $315.522 Billion
Reserves of Depository Institutions Non borrowed: -ve $332.798 Billion
Reserves of Depository Institutions Required: $48.366Billion
Monetary Base: $1,129.938 Billion ($1.129 Trillion)

The banks were really facing a liquidity crisis.. and also a crisis of confidence. 
-Reserves were higher ($315.522 Billion) than Minimum Required levels of $48.366 Billion (which indicates a crisis of confidence)
-All of the reserves was borrowed money (from the FED) which indicates a liquidity crisis.

  c. In Aug 2011 (2011-08) what is really happening.
- Reserves of Depository Institutions Non Borrowed: $1,655.535 Billion ($1.65 Trillion)
- Reserves of Depository Institutions Required: $83.843 Billion
- Monetary Base: $2,658.972 Billion ($2.658Trillion)

The banks are flush with Cash and the banks are storing it with FED as Reserves. The Scenario has completely changed from Oct 2008 where the banks had no money and were borrowing from the FED. 
Now the banks have large amount of money and are not willing to lend and are holding it with the "FED as Reserves" 

I have done some calculations and it looks like this:

1. Money in the system:
Money in the system = Monetary Base - Reserves of Depository Institutions Non borrowed.
Jan 2007  (2007-01) Money in the system: $771.434 Billion
Oct 2008 (2008-10) Money in the system: $1,462.736 Billion (1.462 Trillion)
Aug 2011 (2011-08) Money in the system: $1,003.437 Billion ( 1.003 Trillion)

On Oct 2008 the banking system had cash deficit and had borrowed from the FED $332.798 Billion so Money in the system was more than the Monetary base of $1,129.938 Billion. Money in the system was $1,462.736 Billion

2. As we can see in Aug 2011  the Monetary base is 1,003.437 Billion which is less than what was in Oct 2008 ( $1462.736 Billion start of Financial turmoil)
So even after an expansion of 235.4% in monetary base  the actual "Money in the System" is less than what it was in Oct 2008. All the money has been deposited with the FED as "Reserves" by the big banks. So a recession scenario has been created by "Tight Liquidity" by reducing the actual "Money in the system"

Conclusion: The FED has done a lot of liquidity infusion into the system. unfortunately it has never reached the  financial system. The gatekeepers "The big banks" have deposited all of it about $1.57 Trillion dollars back with the FED as "Excess Reserve holdings" This money could have been deployed in the Bond market but that has also not been done at the expense of profits and also with the intention of curbing liquidity (I think) 

Since Cash Reserve Ratio is 10% so $1.57 Trillion in reserves would translate at M3 levels $15.7 Trillion.
What has happened is .. in the past 3 yrs the liquidity infusion by the FED and the banks keeping the liquidity out of the system by depositing it with the FED as reserves .. the control (flow of liquidity) has moved from the FED into the hands of banks. 

If and when this money enters the financial system..
- Dollar should get devalued.
- Inflation in US will rise.
- Exports should become cheaper for US Exporters.
- Gold in Dollar terms could rise further while in Indian Rupee terms.. Gold could be worth  much less.
- A lot of this excess cash will look for attractive destinations and Indian Stock market should "Break away from the developed markets" Also other BRIIC markets which are driven by internal consumption could see increased valuations.

The current strengthening of the US dollar is temporary in nature. It is advisable for American Investors to move out of dollar into other stock markets and buy into good stable companies. Indian Bond market with 10% interest rates is also very attractive..Export based companies in US should also do well. US also has large natural resources and these resource based companies would also do well.
Indian Investors should remain invested in Indian companies. Exporters need to worry about Dollar devaluation and its advisable to shift to non US Dollar denominated currencies for export or Indian Rupee. 

Keeping "Peak oil" in view it is advisable to invest in basic consumption oriented ideas and Hydro power companies (NHPC). Energy "Peak oil" will make everything expensive so large value one time expenses can be front loaded. It is advisable to buy NIFTY Call Options 1 year down the line if available at attractive valuations. Best Value buy stocks are: GAEL, Jayant Agro, NHPC and Tata Communications.

PN: these are my personal views/understanding about publicly available information. Please do your own deep dive before investing.

FED H3. Data (link)
FED H4.1 Factors affecting Reserve Balances (Link)


Anonymous said...

WHATSuP,Do you tracking surya roshni? what is your view? Company done open offer at 111 level few months back .Now available at 50% discount!! Is it worth buy ?? pls share your fundamental view

What'sUp Prahalad said...


Surya Roshni was one of my first buys 5-6 yrs back..
Prakash Industries is also from the same family..
Surya Roshni has the largest GLS lamp factory and its fully integrated..

unfortunately GLS Lamp is the incandescent lamp which nobody uses as it is highly inefficient.

Also the HBT(Hydrogen Based Technology) Flourescent tubes.. (tubelights..) take forever to start .. though they are a few rupees cheaper. .. but I have one in my house.. And I dont use it .. DONT.. cause it takes 3 times longer to start and by that time it lights up.. its time to leave the room..

Also I had checked their product Star ratings And it was 3Star (CFL lamps) in US ..

I did hold a ton of shares.. but sold it for 70-90 bucks and never looked back..

Same with Prakash Industries.. (though I think Prakash is managed by elder brother..) shows tonnes of profit .. Zero taxes and Zero dividends.. Huge equity dilutions

I think we can AVOID Surya roshni..
Also the annual report for march 2011 says equity as:
March 2011 Equity: 61.46Cr
March 2010 Equity: 37Cr
March 2009 Equity: 28.43Cr

Its an Avoid.. for sure.

=happy investing

km said...

Dear Prahalad,

The following link estimates GAEL in a different fashion and suggests its not a sound investment.


Can you pls share your thoughts after reading the contents from the link.


What'sUp Prahalad said...


I did visit the link.. and I guess everyone has their own view..

As Mr Devdutt Pattanaik said..
- "Truth is always relative"

I would add:
- "Beauty is in the eye of the beholder"

As far as Poor showing in Q1 2012 is considered (June 2011) and GAEL not able to keep up the margins for year end. .. (extrapolating june numbers..)Well it is a well known fact that Agro Processing is seasonal..Q1-Q2 are always lean seasons and Q3 & Q4 are where the maximum money is made.. (This was mentioned in an interview by Mr Gupta and can be seen if we look at Q1-Q4 data of year ending march 2011 .. it also shows how we need to dig deep.. and a superficial glance does not reveal everything..and every ratio or analysis will not be matching for all sectors.. consumer goods and pharma have consistent margins every quarter.. not agro commodities.)

There is mention of how Cash flow should be net of investment.. and how GAEL has not been reporting +ve cash flows for past 2 years..

- Well "Debt/Equity has not increased"?
- 70Cr of investments in stocks and bonds has not been mentioned.
- Credit rating is impeccable. from CRISIL
- Capacity expansion is being done with internal accruals..
- Maize derivatives plant setup in uttarakhand was setup with internal accruals.. and now more than 50% of profits are from maize derivatives..

I think the question is do you say.
- Glass is half full or
- Glass is half empty.

Looking at the data in the blog I wonder which companies qualify? most likely Pharma, Consumer Goods but all with high PE .. market cap to sales ratio higher than 1.2

If there are no issues with the new karnataka Maize derivatives plant we should see GAEL report 100Cr+ net profit this year end (March 2012)

.. GAEL management seems to be conservative and not interested in
courting with Dalal street .. that I think is the real problem.. (from stock price performance perspective)

having said that GAEL dividend payout percentage for last 9 years is 13.32% while for March 2011 it was 10.28% so a 30% higher dividend should be the norm.. (based on 9 yrs history..)
I would say we should expect 80 paisa dividend for march 2012

Again hopefully there are no negative developments in the setup of new maize derivatives plant.

For me its "Hold,Hold,Hold"
Yes .. GAEL is testing our patience but.. till now it has done nothing wrong.. the value equations are getting better with every passing day.. (can we complain if profits increase from 60 to 94Cr with no increased debt or dilutions and management buying stocks from the market whenever it falls? )

=happy investing

km said...

Thanks Prahalad, for your response. Stock market is a place where diametrically opposite views both hold good between two experts. We need to wait very long before we get to know the verdict of the market.


What'sUp Prahalad said...


yes the wait .. I dont remember but someone did mention that should'nt we have a 3yrs timeframe for investment when I had given a target for 12-24 months.. now at hind sight Its better to be conservative...

=happy investing

Anonymous said...

Dear Whatsup...
How are you doing?
Present Maize crushing capacity of Riddhi Siddi is about 1500MT per day. For GAEL its 1000MT per day. It will be adding another 750MT per day by March 2012. And it also plans to expand to another 750..So in total will become 2500(approx) by 2013..(hopefully)...Where do u see the stock price by then??will it become another Venky'sie., 10x from here???...Im holding 10k shares...Thanks and regards
Just see this link

What'sUp Prahalad said...


Dont get me wrong.. I really like GAEL.. what I was trying to say was that the investment horizon in GAEL instead of being 12-24 months should have been 36months or more ..

+36 months is a more realistic time period .. ie in hindsight.

=happy investing

Anonymous said...

Dear Whatsup,

I didnt mention that u were wrong. Actually I read the above post after only after posting mine..I just wanted to know, when the Maize crushing capacity of GAEL exceeds of that of Riddi siddi, then can we see the price sky rocket to the present levels of Riddi siddi??Meaning a real multi multi bagger??I too bought and holding the stock after reading your blog...Take care, regards.

What'sUp Prahalad said...


Riddhi Siddhi was sold for 1.4 times its Sales (Riddhi has only corn starch business..) GAEL current Corn derivatives capacity 1000 MT and future capacity 2500MT
Current corn starch business sales is 406Cr so future sales number will be approximately 1015Cr and its Corn business "SALE" value would be: 1421Cr

SALE price is higher than general valuation.. but all said and done GAEL true/fair value is easily 100+ per share.. which would be my target price..

=happy investing

Anonymous said...

Thanks for the reply....