Finly February 4th 2014

FINly

Finance Fortnightly Since 2011 February 4th, 2014 - Issue 34

Fragile Five

Emerging markets in turmoil!!

VIRTUAL GETS REAL A Bitcoin Primer

Finance Fortnightly

Enlighten yourself

Contents

2 In News Now

Gold commodity update

3 FRAGILE FIVE Emerging Markets in turmoil!

7 Virtual Gets Real A Primer on Bitcoins

Contributors Irina Goel Rakesh Pathak Venkatakrishnan Vaidyanathan Saurabh Prasannaraj Arpita Tripathi

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Where is the Gold going?

-By

Arpita Tripathi

Not so long ago everyone was running to buy gold. It acted as a strong hedging tool and had a stable value in the market. Mining companies were raising their production, opening new mines and employing more labor due to high demand. Yet since the last year, trend has reversed, the prices are continuously dipping. Many mines have been shut or focusing on cost reduction. The question is Whether Indians should hold on to their gold or let go??

According to Moody’s the current gold price is $1250/ounce and the average price is $1100 resulting in lower or even negative returns. Despite this scenario, consumer demand has risen 5% making it 496 tonnes.

Experts feel that the gold price is expected to remain range bound. Production cuts will not have an immediate effect on the underlying gold price; nevertheless it can help to stabilize the prices in the long run. The Indian government wants to reduce the gold consumption from 845 tonnes to 840 tonnes and has raised import duties for the same. The consumption has fallen but the domestic prices are still high owing to the falling rupee. It is around Rs 30,200/10g Now experts assume that it is not a good idea if gold comprises more than 7-8% of your portfolio. The ideal holding should be about 2-3% and fresh investment in gold should not be risked at present. There is no rebound expected any time soon. Having said that, the customers should be very careful in selling of their gold as despite the plummeting prices the global gold production reached a record in 2013. Total gold mine supply reached 2,982 tonnes last year, according to GFMS estimates, up 4.1% from 2012. Gold also enters into the market as scrap and through sale by bank. The production rate may decline further in future.

With lower price around $1200/oz the sellers might not be willing to sell the scraps for reduced profit.

As a result the supplies may drop considerably unless the prices rise to somewhere around $1500/oz.

Overall, investors need to be prudent in making their investments in gold.

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FRAGILE FIVE

Emerging Markets In Turmoil!

- By Venkatakrishnan Vaidyanathan

While the last decade saw the Coining of the term “BRICS”(2001)

by Goldman Sach’s ,Jim O’ Neil to represent the fastest growing emerging economies, “Fragile FIVE”-becomes the latest catchphrase to catch the attention of the Economic Analysts around the world this decade. The term was coined by a little known Currency Analyst, James Lloyd of Morgan Stanley in August of last year. The term has slowly become part of the global lexicon and recent events in the world economy have further strengthened its relevance. In this article ,we seek to understand what the term means ,what are the recent events that have strengthened the impact of this terminology and it’s corresponding effect on the emerging economies.

Who are the Fragile Five?

The Morgan Stanley report identifies the countries of Brazil, India, Turkey, South Africa and Indonesia as the Fragile Five countries.

What commonalities bind the Fragile Five together?

The Fragile Five represents Emerging economies that have become overly dependent on external foreign investment to fund their economic ambitions by placing too emphasis on stoking fast rates of Economic growth. Each of these economies have been using these foreign investments to fund their bludgeoning Current Account Deficits(CAD).

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All of them have been experiencing rising inflation and large fluctuations in their currencies and hence have been forced to increase their interest rates over the past couple of months. The recent decisions of the US Federal Reserve to taper its QE program and the slowdown of the Chinese economy have only aggravated the problem.

Further compounding the problem is that all of these countries are scheduled for elections in 2014 and hence each government is expected resort to populist measures that would further risk their CAD. Also policy action would be possible only after the new governments come into office. This would lead to a lot of uncertainty, forcing Global investors to pullback investments from these markets in the Short run.

What will the impact of the recent decisions by US FED with respect to its QE tapering policy on the Fragile Five?

The US Federal Reserve continued with its QE tapering for the second consecutive month, reducing its stimulus (bond buying program) by another $10 Billion from $ 85 Billion to $ 65 Billion over the last two months. The flow of capital that had resulted from QE into the emerging markets, would now reverse as the Fed tapers its assets purchase gradually .This is expected to have a destabilizing impact on the emerging economies and the recent case of Argentina’s devaluation of its peso in response to the lowering dollar reserves is a perfect example of the fragile nature of the Economies.

What is the present status of each of the economies and its currencies?

Brazil The rollback of the Stimulus have already led to increasing inflationary pressures, increasing interest rates and weaker currencies forcing the Brazilian central bank to raise its rates seven times to 7.5% to 10.5% to clamp down on inflation South Africa The rising CAD has strongly weighed down the Rand and it is more vulnerable to the slowdown in Chinese economy resulting in rising commodity prices, strikes and unemployment. However it has kept its interest rate unchanged since mid of 2012.

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Turkey Seen as one of the most Fragile among the Five, the Turkish Central Bank was forced to raise it’s interest rates by 4.25% to 12% as against its earlier passive approach of defending is currency. This has been intended to encourage foreign investors, corporate and household savers to hold on to their Lira instead of selling them for dollars.

Indonesia The Indonesian Rupiah has been one of the worst performing currencies. This forced the Indonesian Central bank to increase interest rates by over 175 basis points sine June India While the wholesale prices have been cooling off, the consumer price index is still very high. The recent slowdown in GDP, IIP numbers and the manufacturing and services sectors have been a matter of concern. This concern has been reflected in the Governor of RBI, Raghuram Rajan’s latest interest rate hike measures to tame inflation wherein the bank rates were hiked to 9%, Repo rates to 8% and reverse rates to 7%.Infact Raghuram Rajan asked the US to consider the impact of its monetary policy on the emerging economies as we live in a truly globalized world.

Concluding Note: The impact of the US Fed‘s decision on stimulus reduction and the slowdown in Chinese economy have had a dramatic effect on the Emerging economies .But the recent slowdown and problems have been a result of their own flawed policies. Excessive dependence on Foreign investments ,unstable political and economic structures and lack of seriousness and consistency with respect to the implementation and execution of reforms have had their effects in terms of degrading market sentiments. It is now imperative upon each of these economies to Perform Or Perish under the weight of the Market forces and chart the course of their Political and economic Recovery and ultimately change their Destinies.

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VIRTUAL GETS REAL - By Rakesh Pathak

In today’s world almost everything is either digital or virtual. We spend our day with gadgets and

stay in the digital and virtual world of Facebook, Google, Whatsapp et al. If everything that surrounds us is digital, then why not the currency as well? Digital currency is an electronically created and stored medium of exchange.

What is Bitcoin?

Bitcoin is an experimental, decentralized digital currency that enables instant payments to anyone, anywhere in the world. Interestingly, unlike fiat currency, which derives value from government regulation or law, bitcoin derives value from computer processing power and that is the most fascinating feature of it. Rather than getting manipulated by a system, which is often tainted by corruption, this currency derives its value from mathematics, processing power of computers and highly complex encryption protocols.

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How to use bitcoins?

As a user, one has to simply install a bitcoin wallet on his computer or mobile phone. The owner of the wallet then holds the encrypted key and this ensures the security of the Bitcoins contained in the wallet.

This leads to generation of an address of the wallet that he/she can share with his/her contacts to enable transactions.

This entire process is very much similar to how email works. To start using bitcoins one does not need to know the technical details. Just get some bitcoins and keep them safe.

How are bitcoins generated?

The following ‘process’ generates Bitcoin, the brainchild of Japanese IT whiz Satoshi Nakamoto: Complex cryptographic puzzles are randomly generated by a pre-defined computer program at a fixed rate, and transmitted to a network of Bitcoin 'miners'.

Using open-source software and insanely high-speed processors, miners crunch data to solve these puzzles.

The program has been preset to generate puzzles till 2140, after which it will stop generating after producing 21 million bitcoins. The number of new bitcoins generated is halved every four years until 2140, when this number is rounded to zero. At that time, no more bitcoins will be added and to accommodate the limit, each bitcoin is subdivided down to eight decimal places forming smaller units called Satoshis, which will number 100 million per bit- coin.

Since the puzzles are insanely complex and require ultrafast processors, mining is the sole purview of IT professionals. Even the rich can mine bitcoins and then trade them online.

Who controls the Bitcoin network?

Nobody owns the Bitcoin network much like no one owns the technology behind email. Bitcoin is controlled by all Bitcoin users around the world. While developers are improving the software, they can't force a change in the Bitcoin protocol because all users are free to choose what software and version they use. In order to stay compatible with each other, all users need to use software complying with the same rules. Bitcoin can only work correctly with a complete consensus among all users. Therefore, all users and developers have a strong incentive to protect this consensus.

Bitcoin solves many problems that have plagued paper money since centuries. They can't be created by banks, individuals (by counterfeiting) or governments (by printing). They are a form of 'virtual gold', made for the Internet era.

Demand of Bitcoin: In January 2014, 1 bitcoin was equal to a whopping $1200! Currently, its value is around $850 that is Rs.53,000. Pricing, as stated by general economics is always driven by demand which has been steadily rising for bitcoin due to the following factors:

1. General perception that the world economic system is inherently unstable and headed for a collapse.

2. For the Users who want to remain anonymous, digital domain offers secrecy: Illegal arms traders, drug dealers and the likes of speculators and millennial who feel the Internet will soon take over the real world.

3. Advantage of bitcoin are that there are no financial institutions to mediate between buyers and sellers and absence of regulation by banks and governments, whose 'bad' financial sense is being seen as the main factor for the collapse of world markets.

4. Since the currency is electronically encrypted, it is impossible to counterfeit and extremely fast to transfer through Internet.

5. Fewer risks for merchants - Bitcoin transactions are secure, irreversible, and do not contain customers’ sensitive or personal information. This protects merchants from losses caused by fraud or fraudulent chargebacks, and there is no need for PCI compliance.

Merchants can easily expand to new markets where either credit cards are not available or fraud rates are unacceptably high. The net results are lower fees, larger markets, and fewer administrative costs.

Bitcoin is quickly gaining acceptance across the world as more and more online retailers start accepting digital money. Wikileaks and other major organizations across the US and Europe have started accepting Bitcoin as payment and certain companies in the US have also started paying their employees as a certain percentage of their salaries in bitcoins. Polish Web Design Company EL Passion, Finnish developer outfit called SC5, and even Kentucky police chief are paid a part of their salary in bitcoin.

As online commerce increases exponentially and the world shifts online, bitcoins are truly going to become the most common and the most preferred choice of currency.

Though introduced only in late 2009, bitcoins have quickly gained traction and the bitcoin economy is now worth more than 1.1 billion dollars. There are around 11.5 million bitcoins in circulation worldwide and more than 70,000 trades happening through it daily. It is estimated that investors trading in bitcoins generate an average daily profit of around $681,000, which is increasing steadily. In India, there are estimated 30,000 bitcoin holders and it has only 1% of around 12 million bitcoins in circulation around the world.

Bitcoin Story across the globe: The growing clout of bitcoins can be seen through some of the recent developments around the world.

In Argentina, where inflation has been increasing at highly unsustainable levels making life increasingly tough for the middle class, there has been a 30- 40% surge in the value of bitcoins. The growth of bitcoins in Argentina has zoomed with bitcoin downloads rising exponentially. In an economy where the people are slowly but surely losing faith in governmental economic measures, bitcoin is being dangled as a safe haven. A similar effect can also be seen in neighboring Uruguay where again inflation is on the rise and paper money is seen losing value.

Another example is Kenya, where already mobile SIM card powered M -pesa (digital currency) is popular. But for the huge number of Kenyans who work abroad, remitting money back home is burdensome, time- consuming and costly affair. Bitcoin, with little to no extra charge and extremely fast transfer is again the savior here with more Kenyans looking to take advantage of it.

The Australians are keeping their eye on Bitcoin, and plan to tax it, so those dealing in it should keep good records. And they’ve seen Bitcoin’s dark side: “In October 2013, an Australian Bitcoin bank was hacked, resulting in the theft of over US$1 million of the currency.”

Icelandic currency expert Sveinn Valfells has an important suggestion for the Icelandic government, that Iceland should adopt bitcoins as the national currency so that people can bear with the brutal economic climate destroying Europe. Iceland is facing double-digit inflation, today, when the Cyprus banking system collapsed earlier this year, people who had invested in bitcoins became instant millionaires as the value of bitcoins surged to $265!

Bitcoin is also seen as a threat to Gold, which till now didn't have a proper competitor except the paper money. Bitcoin mimics Gold in the sense that it has limited supply but while more gold can be found, bitcoins has a predefined limit, hence enhancing its value over the long term. Also, unlike Gold, bitcoins are hard to steal and don't require armed men or vaults to guard them. Lastly, digital currency is least likely to be manipulated by the government and financial institutions since bitcoins don't have any central authority controlling them.

In India no explicit laws have been laid down yet, though its banks have warned the public about the “risks of cyber security attacks and money laundering” related to Bitcoin, and cautioned investors in December. India’s largest Bitcoin trading platform BuySellBitCo.in, suspended its operations, citing the RBI’s notice. Some of the operators have approached RBI for clarification and have requested to put in place a regulatory framework for the virtual currency.

Bitcoin does have its shortcomings, among which is its price volatility, inspired by its limited supply and investor speculation. But in an increasingly uncertain world, where fiat currencies are increasingly becoming volatile and the governments and premier financial institutions are no longer be trusted to do the 'right' thing, Bitcoins are becoming an increasingly attractive option.

Economists have had a mixed reaction to Bitcoin. Some have responded positively, including Franรงois R. Velde, a senior economist at the Federal Reserve in Chicago who described it as "an elegant solution to the problem of creating a digital currency." Others have been critical. Economists Paul Krugman and Brad DeLong have found fault with Bitcoin for numerous reasons, including that bitcoins are not a reliable store of value, and that there is no floor on the value of bitcoins.

Economist and professor John Quiggin has called Bitcoin "the final refutation of the efficient market hypothesis". The free software movement activists including Richard Stallman, an American software freedom activist, have criticized Bitcoin for its proof of knowledge and computer programmer, who called for reformed development.

Bitcoin is a decentralized, anonymous electronic currency that first came into being in 2009. It's still not clear how far Bitcoin can go in establishing itself in the mainstream economy, but there are quite a few large and small businesses accepting Bitcoin as a means to purchase goods and services. You can use the cryptocoin to buy produce at a farmers market, security services from major Internet companies, as well as drugs and weapons from your favorite online black market.

The list of Bitcoin vendors is growing every day but still, there may be a lot of reluctance to accept Bitcoins in the form of currency because of the complexity of the software required for generating and using it. Also currently, its value remains to be very volatile. PayPal President David A. Marcus calls Bitcoin a "great place to put assets" but claims it won't be a currency until price volatility is reduced.

Just like Google was not the first search engine, BitTorrent was not the first file-sharing service and Facebook was not the first social networking site, it may be possible that Bitcoin will be a pioneer in the field of virtual currencies, but will be overshadowed by an easier-to-use rival.

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