Kotak Gold securitites: Small investors should probably stay away

Those of you who have done any sort of Gold trading in India have probably heard of Kotak Securities.
http://www.kotaksecurities.com/home/index.html
My own introduction to this instrument was via my Dad. My Dad is almost addicted to Gold Trading via this instrument. So obsessed is he that he is constantly looking at the Gold/silver price and looking to sell and buy. My curiosity having been piqued, I decided to investigate this. And as was the case with UOB, I ended up with more questions than answers. The Funny thing is that my dad seems to have jumped into it without having a whole lot of information. Now my questions have begun to irritate him of late. I also bugged my mum a bit and also tried to wrangle some information from my Dad’s broker. As was the case with UOB, he did not seem to have a whole lot of information. Funny how uniform these things are around the world!

Now it is possible that because information is not readily forthcoming, some of my information may be inaccurate. In that case, please let me know via a comment and i will make the correction and update the article.

Introduction
Kotak Gold is a gold trading platform. Investors can buy and sell gold futures on leverage after brokerage charges. The length of contract is about three months. What does the length of contract mean? Today is July 13th. I buy some Gold at today’s rates (plus 3 months storage charges) for delivery three months hence, i.e. Oct 13th. On october 13th, I have the option to either take delivery or else sell it off. If the price on October 13th is higher than on July 13th, then I have made a profit (less storage and brokerage charges). This is what is meant by going long. There is an option to go short as well. in fact there are several options. I’m just sticking to longs for the purpose of this article.

Now let’s talk about leverage. The size of a Gold contract is 1Kilo. This costs around Rs 3,000,000. Of course, a small investor will typically not have the money or the balls to probably buy a whole kilo outright. So what to do? Well, he has the option to put up the money for only a part of it, i.e. 10gms or 1/100th of the contract size. So he puts up Rs 30,000. The brokerage house puts up the rest. Now let’s say the price of a Kilo of Gold goes up to 3,100,000 after three months. The profit is Rs 100,000. The trader is allowed to pocket the entire profit on the Kilo of Gold even though he put up the money for only 1/100th of it. In this case, the price of Gold only rose 3.33%, but the trader made a 333% profit. Pretty neat huh? That’s the thing about leverage and the thought of it fills a man’s heart with greed and his head with fantasies. Ofcourse, leverage applies reverse also, i.e. if the price falls 3.33%, then the investor makes a Rs 70,000 loss. But usually people think profit when they take leverage, not loss. Unless of course you are going short. But again, as i mentioned earlier, we will restrict the discussion to longs here. The same logic can be applied to shorts, but in reverse.

Finally, we come to brokerage charges. Each time you buy or sell, you need to pay the broker Rs 2300.

 

Should small investors be trading at all?
Long term investing has everything to do with fundamentals and the ability to hold for long periods of time. You know that a certain commodity is going to go up over a period of time. This could be Gold in an inflationary environment, or it could be stock that is so undervalued that the P/E ratio is 2 or 3. You know that this commodity will go up. You buy and you hold and you wait and watch. One day it goes up, you sell, book a profit, enjoy a great release of hormones and go poke your GF/BF/Wife/Husband/whatever.

1. This ain’t investing: But Kotak securities is not about investing at all. It is trading. It is speculative. You are speculating what Gold will do in the next three months. That is a question that cannot be answered by fundamentals. Sure, I can tell you that in 2017 gold will be higher than it is today. I know I can count on my friend at the US Fed Benny to make my prophecy come true. But in October 2012? Hell, I can’t tell you that. No small investor can. Sure, a market manipulator can. But I can’t. So buying gold futures for 3 month contract cannot be seen as an investment. It is a speculation.

2. The trading algorithms: It is well known that a majority of the trading at the major trading houses is done by sophisticated trading algorithms. Only a few trades are done by humans in these places. Now let me ask you this. What are the biggest advantage that a computer algorithm has over a human being? Think about it for a minute before reading on. …………………….Go on, think some more…………………… You done? okay here it is. The big advantage the computer algorithm has over you is that it can continuously monitor the price. You can’t. You have a day job to bring home the bacon. Kids to play with and help with homework. A wife/husband to pleasure. You sure as hell can’t monitor prices all day. You can at best check the prices 3-4 times a day. This is true even if you are retired. When you are retired you have Golf and bridge to play, books to read, walks to take. What sort of a retirement is spent watching a computer screen? In the intervals when you are checking prices, the good deals might have come and gone. Nope! when it comes to short term day to day trading and 2%-3% moves, you simply cannot beat a computer algorithm. And I am saying this ignoring the facts that a computer algorithm does not panic like humans are prone to and a whole lot of other emotional factors. No sir, you, the small investor cannot beat an algorithm in trading. This is how the big trading houses take the money of the little investor. The little investor takes on the big boys on their own turf.

3. The Human advantage: but where is it that a human has an advantage over an algorithm? in long term trading of course. In fact this is where a small investor can beat the pants of the big trading houses. The algorithm cannot predict long term trends based on fundamentals. It simply can’t. Not only that, the big guys are at a severe disadvantage compared to to the smart little guy when it comes to long term investing. Why is that? Because the big guy does not have the option to buy and hold. He must show constant yields. So he is forced to buy and sell when he must hold. The big boy may know the fundamentals, but he cannot act on them due to the special considerations of his profession. He is severely handicapped this way. So this is where, you the smart little investor must compete. This is your turf. Buy and Hold and sell later when the time is right.

 

Back to Kotak
The last section establishes that it is probably not a good idea for the little guy to use Kotak. But what if you say, “Hey, I wanna try my hand at beating the big boys anyway.” Okay, in this spirit, let us investigate Kotak some more.

1. Any backing by physical?: This is always my first question. Is there any physical metal backing all the gold that is being traded by Kotak? How can a little guy find this out for sure? The answer is he cannot know anything for sure. Remember, you are the little guy. You will forever have restricted access to information compared to the big boys. But you can make some educated guesses based on certain parameters.

2. Can we take physical delivery?: If the answer is no, it should immediately make you suspicious. There is a chance that it is still backed by physical. But I do not like odds like this. I am male. I like taking risks. But it is calculated risks I like. Not reckless ones.

3. Delivery charges: If the answer to the previous question is yes, things look encouraging. Time to plow further. What are the delivery charges over the sport price? If the charges are the same as what your local dealer offers on a comparable order size, then you can breathe a sigh of relief. These guys are probably legit. They may still be scamming you, but the risks are much diminished. If the charges are much higher, then it begs the question. Why are they much higher? If there is no good economic reason, and there usually isn’t, it generally means these boys are trying to discourage you from taking delivery. It probably means that there is really no physical behind the Gold being traded. When you ask to take delivery, they just buy it from the local dealer at 2.5% over spot and give it to you at 12.5% over spot, pocketing the 10% difference. From what information I could get, this is what Kotak does. Their delivery charges are a whopping 12.5%. The local dealer offers 2.5%.

4. Delivery on leveraged contracts: You cannot take delivery on leveraged contracts. This I believe is fair. But which little investor can put the money for an entire Kilo of Gold in one shot?

4. Holding charges: With kotak, you must either sell in three months or you must roll it forward. You may well ask, “how about using Kotak as a holding instrument kinda like we are trying to do with UOB here in SG?” Well, here is where it gets interesting. In order to hold, you must keep rolling the contract forward, i.e. after every three months you sell and buy again. It thus costs you Rs 4600 to roll forward. Over a one year period, you will pay this 4 times for a total of Rs 18400. The interesting thing with Kotak is that you cannot buy the entire 1 Kilo in a gold contract. You are forced to apply a 1:10 leverage at the very least. i.e. Rs 300,000 per contract. Thus the holding charges become 18400/300000 = 6.1% pa. This is much higher than the 1.2% p.a. offered by few storage houses in Singapore, higher than the 0.2% offered by Goldmoney, higher than the Rs 4500 (SGD 100) for a safe deposit box rented from DBS bank which can esily hold much more than a kilo of Gold. So there you have it, this is not a good instrument for holding your Gold.

Points of Doubt
While it may seem that I am trying to make Kotak look fraudulent, this is not true. What i am saying is that Kotak is not a suitable vehicle for the little guy even if they are backed by physical Gold. That being said, there are some indications that Kotak is not all that sketchy

1. A simple paper gold scam: A big scam with paper gold is that the brokerage house automatically takes the other side of any bet you make on the Gold. If you decide to go long, they automatically go short. If you go short, they automatically go long. They do nothing with the money you give them except to put it in their bank account. They figure that over a three months period, there is no definite trend in Gold. So on the whole, the little investor usually breaks even on this as does the house. But once you apply brokerage charges, the little investor loses by the exact amount of the brokerage charges. Thus the house makes money purely based on the brokerage charges. This is the same principle applied by gambling house in las Vegas when you play the roulette wheel. The the roulette case, the 2.5% probability edge is the equivalent of the brokerage charge.You have to understand that in this sort of scam, there are no other buyers.

2. Probably other buyers exist:  But with Kotak, the indication is that this is not the case. If it was so with Kotak Gold, it is probably so with Kotak platinum. But platinum on Kotak trades very infrequently. This is because in India there is not much of a market for Platinum. And this is reflected in Kotak. So this makes me feel that Kotak is probably not a scam.

In conclusion, whatever the case, the little guy is advised to stay away from Gold trading and stick to accumulating precious metals slowly on a regular basis. Now if only it were so easy to convince my dad on this.

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About masculineffort

A Man should be able to change a diaper, plan an invasion, butcher a hog, conn a ship, design a building, write a sonnet, balance accounts, build a wall, set a bone, comfort the dying, take orders, give orders, cooperate, act alone, solve equations, seduce a woman, analyze a new problem, pitch manure, program a computer, cook a tasty meal, fight efficiently, die gallantly. Specialization is for insects.
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