7% Dollar Return? There's a Catch!| Be rich | Vinod Srinivasan | Gold | Dollars | Returns |

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[00:00:56]>> Good evening everybody. Welcome back to the channel. Welcome back. tribe. Today I wanted to run a thought experiment with you today and no charts no jarens and for the first few minutes let me explain what happens but of course before that standard disclaimer I'm not say be registered none of the content on this channel is about price targets or buying or selling anything it is purely for educational learning and to help you understand what is happening and make investment decisions along with your financial adviser whom I hope you're paying handsomely because good advice it's worth its weight in goat. Okay. So what is this thought experiment? Just two brothers and one decision is the idea behind this thought experiment. We have Ravi who lives in Singapore. He moved there 15 years ago and works in shipping. Let's assume his younger brother Kumar stayed back in Chennai and runs a family business. This happens you know property sale last year left each of them with roughly equal money. That happens too. Ravi holds about $1 million and Kumar holds the same amount in rupees. Both brothers are the same kind of investors because their father was like that very conservative. They watched their friends lose monies and future in options and they don't trust trips and they want exactly one thing.

[00:02:10]Lock the money somewhere safe for 5 years and sleep well. Simple goal. And yet by end of this video you will see how these two careful men can end up in completely different places and how the same forces the entrance side cycles treats their choice very differently. So stay with me have a little patience and we'll get through this because this thought explain explains something happening in India right now and that is why I want you to understand it. Let's start with Rabi. In June this year the Reserve Bank of India reopened a tool it last used probably in 2013. No, not probably. He did use it in 2013. A special swap window to attract dollar deposits from NAS because the rupee had been under severe pressure at that point of time. Banks responded immediately.

[00:02:55]FCNR deposits which were dollar deposits with Indian banks where the depositor takes no currency risk and pays no Indian tax on the interest and are suddenly being offered a rate of about 7% for 5 years of money. So Ravi gets a call from his relationship manager saying sir 7% in dollars fully safe Indian bank RBA backed scheme sir and then comes the second part of the pitch sir why why deposit only $1 million we will lend you another 9 million against that 1 million you deposit full 10 million in FCNR deposit earns slightly more than loan cost the small cap multiplied 10 times becomes doubledigit return in to your original $1 million sir. Risk-free leverage, sir. Ravi is very conservative, but 7% in dollars sounds very conservative. Of course, the bank is the household name. He is very much tempted. Now, let's move to Kumar in Chennai. Nobody is calling Kumar with a structured product because Kumar is in India. Kumar does what his father did and his grandfather did and probably Ravi would have done if he was in India.

[00:04:05]When they are worried about the world, they look at gold. And gold has been screaming at him because it had a massive correction recently, didn't it?

[00:04:12]It has been more than double in rupee terms in the last few years. Touched about 1 lakh 53,000 per 10 gram in April. And even after cooling off 6% sits nearly at 1 lak 43,000 today. Every wedding he attends, every news bulletin he watches confirms this instinct. It's an instinct. Good instinct a lot of Indians have. The rupee is weakening.

[00:04:32]The world is uncertain. Gold is what protects the family like his for generations. His grandfather did, his father did. Why shouldn't he? He's ready to put a large chunk of his money into it and forget about it for 5 years. So, two brothers, two safe choices. Now, let me introduce you the character neither of them are thinking about. It is known as the rate cycle. The interest rates around the world move in long waves. We have spoken about this. I highly recommended Howard Mark's book called Mastering Market Cycles and getting the odds on your side. So that's a fantastic book and that will explain what's happening here. But anyway, getting back to uh to experiment, the rate cycle, interest rates around the world long waves. Central banks raise rates to fight inflation and hold uh them and then cut them when growth slows. And that wave keeps repeating. Right now in the US Treasury yields it's around 4.5% and nobody not the Fed reserve itself knows what confidence when the rates will be 3 years from now or even 5 years locked in which is makes sense because you don't want to break yourself in or lock yourself in a position. You want to keep flexibility. So the Fed will of course not say what will happen in 3 or 5 years. So the honest way to test a fiveyear decision is not to predict a cycle. It is asked how each choice behaves in each every version of it. And let's do that. Take leverage deposit first. Notice something about the structure. His asset, the $10 million FCNR deposit earns a fixed rate of uh for the 5 years. His liability, the $9 million loan may not be fixed at all. It may of these structures the loan reprices with market rates moving. It's called floating rate. A lot of us have known about it. And if you don't know about it, now you do. So before anything else, Ravi must ask his bank one question. Is my loan rate locked in for 5 years or does it float? Because the answer changes how he actually owns what he owns. If the loan floats, the rate cycle turns up. His borrowing cost rises. When his deposit income stays frozen, that gap between them, which was only half a percent to begin with, shrinks, hits zero, then becomes negative. At that point, Ravi is paying money every year to hold the position 10 times his net worth in a trade that he cannot exit cleanly because breaking an FCNR deposit early means penalties.

[00:06:55]Losing the contracted rate while the loan remains fully payable. A fixed asset fund by floating borrowing is not a conservative structure. It's exactly the mismatch that sunk Silicon Valley Bank in 2023. a bank that held safe assets and still collapsed because its funding cost moved and its asset income could not. Ravi would be running a miniature version of the same on his balance sheet. So suppose a loan is fixed. You know sometimes banks do offer that if the individual is creditw worthy and they're desperate for the business.

[00:07:29]So the spread is locked. Ravi is still not done because a clause is waiting for him in the loan document which he may have not read because he was in his eagerness. Hopefully, he did being a conservative investor. The Economic Times reported this month that the NRIs in Singapore and the US are discovering withholding tax on interest they pay on these very loans. Borrow from GIF City branch on an Indian bank and Singapore treats that interest as taxable. 15% withholding reduced to 10% if the treaty conditions are met. Borrow from a Singapore branch of the same bank no such tax applies. So you could borrow from HTFC in GIF city for example and you have to pay the tax. The same HTFC branch sitting in Singapore you borrow there is no such tax applied. Same branch different branches different taxes. Now the arithmetic of this whole thing mathematics is very important. You see if a loan costs 6% and a 10% withholding tax applies the effective cost becomes 6.6%.

[00:08:34]That is 60 basis points of extra cost on a trade whose entire spread was 50 to 80 basis points to start with. The tax does not reduce Ravi's return. It wipes it out. It erases it. If Ravi were in the US instead, it gets heavier still.

[00:08:51]Three-fold withholding there is 30%, treaty pay work to reduce it is something most Indian banks cannot provide. The FCNR interest that is taxfree in India is fully taxable in the United States and forms like the FBA and the 8938 await him every single year. Several banks have seen and even added a clause stating that withholding tax burden sits on the borrower. Meaning Mr. Ravi, it's on you. The brochure says enhance return. The document says the tax is Ravi's problem. Understandable because it doesn't sell if you're honest, does it? Now put Kumar's gold through the same rate cycle test. Gold pays nothing.

[00:09:40]That is the weakness and it's the honesty of gold. When rates are high, gold suffers from the comparison because every rupee in gold, a rupee is not earned 7% somewhere. So when rates fall, comparison disappears. The gold historically does well. So if the cycle turns down for the next 5 years, Kumar is likely does doing very fine with his gold. If rates stay high, his gold may stagnate. And his real risk is if interest rates stay high his goal stays may stay stagnant and his real risk is his entry price because if the buying after a run of more than 100% and the safety is at its peak price is expensive safety. So I will also be honest about the limits of this rule. The last 3 years broke the textbook because gold rose even when rates were high driven by central banks buying in and driven by fear. So the rate logic tendency is not a law. It's only something may work. It is what usually happens but it's not something that is black and white. But notice what Kumar never faces in any scenario. No margin, no repricing loan, no clause on page 14, no penalty for changing his mind because gold has no lock in at all. His fire commitment is a promise he made to himself, not a contract to a bank. It would not change in 2 years. He can still sell it in in the afternoon, but Ravi cannot. Rai cannot exit because it's a contract. So, here's a framework I want you to take away from these two brothers. And it's one question. A conservative investment is not one with the highest safety or safe looking at returns. It is the one that survives a scenario you could not predict. Run each choice through that filter. A plain unleveraged FCNR deposit at 7% survives every rate scenario because Ravi's worst case is that he merely earned 7% in dollars while the rates went higher. Gold is reasonable portion survives in every scenario too because Kumar's worst case is dead money for some years but the leverage FC now fails those test because it returns is fake but because it's an outcome depends on which way the cycle turns on the tax clause most buyers never bother reading.

[00:11:57]The moment your safe uh investment needs the Federal Reserve to cooperate and the treaty document your bank cannot produce it stops being safe. It becomes a bet wearing a depositor's clothes. Charlie Manga called this the simplicity filter.

[00:12:12]If the thesis is convoluted, please pass it. Kumar's thesis fits in one sentence and it's not complicated. It's simple.

[00:12:21]So it passes filter. Ravi's leverage version needs three tax opinions and a rate forecast. So it's becoming convoluted. So I would say you have to pass. If you remember nothing else, remember this. The rate cycle is coming for both the brothers over the next five years. It's merely the test Kumar can bear or not bear. It can break Ravi which is worse. The pitch Ravi received is the statement. The clause is his loan document. The repricing of his loan and the price Kumar is paying for per 10 grams. Those are the facts. So I would say watch the facts and not the statements. And if you do have time, like I said, read Howard Mark's book about market cycles and you'll begin to understand how all this works much better. Thank you for being with me on Bri and see you again