1. Avant Garde Wealth Management Pvt. Ltd.ContentsGold An investment case for the yellow metalBull and bear markets Where are we in the cycle?Portfolio positioning Cash position remains highStocks in the portfolio Some more gold platingPortfolio performance Satisfactory so farDear investor,Headlines have been positive in recent weeks. The government is making all the right noises. Marketpundits are increasing their targets for the stock indices and foreigners are showing their confidencein Indian equities through large FII inflows. Popular discourse is that battles are being won andvictory in the war on slowing economic growth and falling stock markets is at hand. From our pointof view not much has changed from three months ago when we last wrote to you. At the margin weare more worried about the macroeconomic environment and the stability of the global financialsystem. This leads us into our first discussion topic for this letter.Gold An investment case for the yellow metalIn the investment world gold is often disparagingly referred to as the barbarous relic, a term coinedby Keynes in 1932. None other than Warren Buffet has sought to warn investors about the risks ofinvesting in gold. In the 2011 Berkshire annual report he says, [gold is] currently a huge favorite ofinvestors who fear almost all other assets, especially paper money...[it] has two significantshortcomings, being neither of much use nor procreative...if you own one ounce of gold for aneternity, you will still own one ounce at its end...What motivates most gold purchasers is their beliefthat the ranks of the fearful will grow. Buffet goes on to state that My own preference...[is for]investment in productive assets...these investments will remain superior to nonproductive orcurrency-based assets. It is difficult to disagree with an astute investor like Buffett and his reasoningis certainly sound. However, we believe that there are times when gold deserves a place in investorportfolios and that we are currently living in such times.Any currency is supposed to be both a medium of exchange and a store of value. Gold has had animportant historical role, as a currency, and also as part of the gold standard when the majorglobal currencies were convertible into gold. The gold standard effectively ended in 1933 when U.S.President Roosevelt outlawed the private ownership of gold, which then no longer permittedcitizens to turn in their dollars for gold. There was still a semi gold standard under the subsequentBretton Woods agreement, which allowed other countries to sell their gold to the US treasury at$35/oz. However, in 1971 this agreement was ended by U.S. President Nixon, thus moving to acomplete fiat currency system.Under the gold standard the growth in money supply was effectively limited to the growth in thestock of gold. By contrast, in a fiat currency system there are no limits, theoretical or otherwise, tohow much currency can be created. The decision to create money lies with policy makers and theyhave used this power quite liberally over the last few decades. In such circumstances a currencyNote: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios

2. Avant Garde Wealth Management Pvt. Ltd.ceases to be an effective store of value. In the extreme, in cases when supply of money is so highthat there is hyper-inflation, the currency even ceases to be an effective medium of exchange.Due to its legacy and limited supply growth gold is considered to be a good store of value byinvestors and this is unlikely to change any time in the foreseeable future. So gold benefits fromhigher inflation and higher inflation expectations. Inflation, defined as increasing prices of goods andservices, has been relatively low over the past few years in developed economies. However, thisdefinition is narrow and misleading. Inflation is simply the reduction in the purchasing power of agiven quantity of money over time. Thought of in this manner increase in prices of assets is alsoinflationary. Income is either spent on consumption or saved, which is essentially deferredconsumption. Savings are parked in assets. Higher asset prices lead to lower prospective returnsfrom those assets1, which translates into a reduction in future purchasing power and is thereforeinflationary. So any increase in the quantity of money can lead to inflation either through higherprices of goods and services or through higher asset prices.As monetary authorities across the world have cranked up their printing presses, this has led to bothasset inflation and increase in prices of goods and services, albeit to differing degrees in differentcountries, contributing to the bull market in gold over the last decade. This is illustrated by the graphbelow, which highlights that the rate of expansion of central bank balance sheets picked up pacesignificantly in the post-Lehman era.Assets Total Assets for Major Central Banks (in USD billion) vs. Gold (USD/Oz)Gold18,0002,000Sep08 (Lehman)16,000 Fed Asset CAGR (in USD): ECB Asset CAGR (in EUR):1,800 Jan95 - Sep08 = 5.4% Jan99 - Oct11 = 9.8%14,000 Sep08- Oct12 = 31.8% Oct11 - Oct12 = 34.6% 1,600 (Trigger point = Lehman) (Trigger point = Mario Draghi becomes Chairman)12,0001,40010,0001,200 Asset CAGR = 14.5% 8,000 Gold CAGR = 17.5%1,000 6,000 Asset CAGR = 18.3% 800 Gold CAGR = 20.8% 4,000600 2,000400- 200 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Aug-02 Aug-03 Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12Nov-02Nov-03Nov-04Nov-05Nov-06Nov-07Nov-08Nov-09Nov-10Nov-11May-02May-03May-04May-05May-06May-07May-08May-09May-10May-11May-12Total Assets GoldNote: Major central banks include Fed, ECB, BOE, PBOC, BOJ, SNBSource: Bloomberg, Central Banks, World Gold CouncilFrom a supply perspective total annual gold supply from mines equals about 1.6% of the existinggold stock. Despite the significant increase in gold prices over the past decade there has been nosupply response. Total annual production from mines is up only by about 10% in the last fifteenyears, primarily due to the lack of discovery of new gold deposits. Central banks have historically1Theoretically, it may be argued that although rising asset prices lead to lower prospective returns there may be no loss ofpurchasing power if the rate of goods and services inflation itself falls. However, this is circular logic. For a given rate ofinflation lower returns by definition lead to lower purchasing power. The concept of capital gains as a benefit from risingasset prices is also fallacious. In aggregate, capital gains cannot add to returns as it is merely the transfer of assets fromone owner to another. As long as the underlying value of an asset (derived from cash flows) does not change capitalappreciation merely front loads the returns from an assetNote: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios 3. Avant Garde Wealth Management Pvt. Ltd.added to supply as net sellers of gold from their reserves. However, central bank gold reserves havebeen increasing after bottoming in 2009 (see chart below), which means central banks have becomenet buyers of gold and a source of demand in recent years2. Fabrication demand (jewellery andindustrial) has remained relatively stable over the years at ~50% of total annual supply. Theremaining demand comes from investors, which should again hold up relatively well in the currentenvironment. In short, the physical gold market should remain well supported by lack of materialincreases in supply and stable demand growth.Total Central Bank Gold Reserves (Tonnes)34,00033,00032,00031,00030,00029,00028,000Source: World Gold CouncilGold does not produce any cash flows and so is not amenable to traditional valuation tools.However, there are a few different ways to think about what the price of gold could be in the future.At current price of $1780/oz, the total gold reserves held by central banks make up about 11% oftheir total assets. So theoretically if the entire central bank reserves were to be backed by gold, aswas the case under the gold standard, the price of gold would be greater than $15000/oz3. Anotherapproach is to look at what the price would be if the total assets of central banks were backed by thetotal stock of gold in the world, rather than just the gold owned by central banks. In this case theprice of gold would be greater than $3000/oz4.History is littered with examples of countries where significant debasement of currencies ended indisaster. This is because the corrosive effects of inflation tend to increase inequality and makesocieties more prone to instability. In the past there have been individual countries that havesuffered from this malaise at any given point in time. It may be for the first time in history thatcountries that comprise the majority of the worlds GDP are simultaneously engaged in moneyprinting on such large scale, and that in a world that is more integrated than ever before. We do not2The incremental buying has mostly come from central banks of developing economies (China, Russia, India, Thailand,Turkey, South Korea, Saudi Arabia, Mexico, etc.). This trend could perhaps be construed as a lack of faith in the monetarypolicies of the developed world in the post-Lehman era3Total central bank gold reserves as of Q2 2012 is 31142 tonnes (World Gold Council), which translates into 1.1 billionounces. Assets of the major central banks (Fed, PBOC, BOE, ECB, BOJ, SNB) is $14.4 trillion as of Oct 2012. Assuming totalglobal central bank assets is 120% of this figure, the implied gold price is $15729/oz4Total stock of gold mined till date is 171300 tonnes (World Gold Council). Assuming 90% of gold ever mined is available,the gold stock is 5.44 billion ounces. In order to back the entire global asset base of central banks as calculated above theimplied gold price would be $3177/ozNote: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios 4. Avant Garde Wealth Management Pvt. Ltd.expect economic Armageddon and are not preparing for such an eventuality. However, it would befoolish to not recognize the risks posed by this huge monetary experiment and to take some steps toprotect the portfolio in case current policy experiments have unintended adverse consequences.So far we have been focusing on the prospects of the gold price in Dollars. If one owns gold inRupees then the Rupee/Dollar exchange rate also plays a role in future returns. This is a topic wediscussed in our June 2012 letter. As long as inflation in India remains ahead of inflation in the USA,the Rs/$ exchange rate will need to depreciate over time to maintain Purchasing Power Parity.Hence the probability that the Rupee price of gold will lag the Dollar price of gold over the next fewyears does not seem very high.The analysis of gold as an investment would be incomplete without considering its attractivenessrelative to equities. A crude way of looking at this relationship is via a time series of the ratio of theSensex to the price of gold, which is illustrated in the chart below.Sensex / gm of Gold2.402.202.001.801.601.401.201.000.800.600.40 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12Source: BSE India; World Gold CouncilBased on the historic relationship between gold and the Sensex, currently gold looks overpricedcompared to Indian equities. This implies that investors should sell gold and buy equities. However,the choice is not binary. Investors can own equities and still invest some portion of their portfolios ingold. This is the path we advocate due to the reasons discussed above.Bull and bear markets Where are we in the cycle?Simplistically, at any given point in time equity markets can be thought of as being in a bull marketor a bear market. A bull market can broadly be defined as one where the indices make new highsover an extended period of time accompanied by P/E multiple expansion. On the flipside bearmarkets can broadly be defined as a significant fall in the indices over an extended period of timeaccompanied by P/E multiple contraction. In our Dec 2011 and March 2012 letters we analyzedhistoric data to highlight that it is P/E multiples and not earnings growth that are the primary driverof bull and bear markets.Note: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios 5. Avant Garde Wealth Management Pvt. Ltd.After closing at a high of 21000 on Nov 5th 2010 the Sensex5 has yet to regain that level. So a bearmarket can be said to have started on that date. Lets look at the progression of the index itself andcorresponding P/E multiples for this bear market as compared to previous ones6. Sensex Bear Markets Progression 0% Did the bear market end here?-10%-20%-30%-40%-50%-60%-70% 108 120 132 144 156 168 180 192 204 216 228 240 252 264 276 288 300 312 324 336 348 360 372 384 396 408 420 432 444 456 468 480 492 504 516 528 540 552 564 576 588 600 612 624 636 648 660 672 684 696 708 720 732 744 756 768 780 792 01224364860728496 Number of Trading DaysSep 94-Dec 96 Aug 97-Nov 98 Feb 00-Apr 03 Jan 08-Mar 09 Nov 10-PresentSensex Bear Markets P/E Progression40353025Did the bear market end here?201510 108 120 132 144 156 168 180 192 204 216 228 240 252 264 276 288 300 312 324 336 348 360 372 384 396 408 420 432 444 456 468 480 492 504 516 528 540 552 564 576 588 600 612 624 636 648 660 672 684 696 708 720 732 744 756 768 780 792 01224364860728496Number of Trading DaysSep 94-Dec 96 Aug 97-Nov 98 Feb 00-Apr 03 Jan 08-Mar 09 Nov 10-PresentSource: BSE IndiaIn the period since Nov 5th 2010 the Sensex closed at a low of 15175 on Dec 5 th 2011 and is highersince then. So a pertinent question is whether the bear market ended on that date or whether theindex is still in a bear market. If the bear market ended on Dec 5 th 2011, compared to the prior fourbear markets this would have been the shortest bear market at only 277 trading days from high tolow. It will also be by far the shallowest bear market with a peak to trough correction of only 28%compared to 40% or more in prior instances. Previous bear markets have ended at TTM P/Es ofbetween 10-13x7. On Dec 5th 2011 the Sensex TTM P/E was significantly higher at 16.2x.5For this analysis it is preferable to use a broader based index that includes a larger number of stocks rather than theSensex which includes only 30 stocks. However, the reason for using the Sensex is that it has the longest time series dataavailable. The difference with other broader indices like the Nifty or CNX500 is also not significant for the purpose of thisanalysis over comparable periods6thThere was a significant change in the composition of the Sensex on April 10 2000, which caused the index P/E multipleto rise by 50% on that day. In order to make the data comparable, for the Feb00-Apr03 bear market P/E data, the pre ththApril 10 2000 P/E multiple have been adjusted upwards proportionately. A similar change happened on June 13 1995thand the P/E data for the Sep94-Dec96 bear market pre June 13 1995 has been similarly adjusted7We prefer to use TTM (Trailing Twelve Month) P/E ratios for our analysis. While forward P/E ratios are commonly used,the accuracy of forward multiples depends on the accuracy of forward earnings estimates. Historically, consensus EPSestimates have been prone to significant revisions and hence our preference for a more accurate valuation metricNote: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios 6. Avant Garde Wealth Management Pvt. Ltd.It is not by accident that bear markets tend to suffer sharp peak to trough corrections and end onlywhen P/E multiples contract to low absolute levels. This is the outcome of a process where investorsentiment moves from extreme optimism to extreme pessimism. Extreme pessimism is reflected instock prices in the form of low valuation multiples, with investors fearing what lies ahead and thusbecoming very cautious about the prices they are willing to pay. It is this very fear that then lays thefoundation for the next bull market. Conversely, if investor sentiment does not become pessimisticenough, as reflected by peak to trough corrections and P/E multiples, then it could be argued thatthe underpinnings of a sustained bull market advance are not present.Using history as a guide it is not clear that the bear market ended in December 2011. But there are afew reasons why history may not be an appropriate guide. First, the sample size is quite small andmay not truly capture the range of possible outcomes. This is a valid observation. Second, it could bethat money printing by central banks has put a floor under asset prices and limited the severity ofthis bear market. This is a more tenuous observation as its theoretical validity is questionable andhistorical evidence is limited. Also, the words this time is different have proven be quite expensivefor investors historically.Portfolio positioning Cash position remains highWe continue to hold a sizeable cash position in the absence of compelling investment opportunitiesthat meet our risk/return criteria. No new positions have been added during the quarter. This is notreally a cause of concern for us. If we can find three to four compelling investment ideas every yearthat should be adequate to help us generate strong overall portfolio returns. Independent of broadeconomic trends, at any given time there is volatility in the operating environment of certaincompanies, either due to business specific issues or due to industry wide issues. This leads tochanges in earnings trajectories, which translates into volatility in stock prices. We are confident thatthis volatility in individual stocks will remain an ongoing feature, irrespective of overall markettrends. As long as we understand the underlying value of a business, and remain vigilant to identifysubstantial deviations from that value, we should be able to find investment opportunitiesperiodically. In the interim we prefer to remain patient.As of quarter end September 2012 we were 47% net long (62% long, 15% short), with 38% of theportfolio in cash and equivalents (the short positions are via futures)8.We estimate that the long positions in aggregate have 50%+ upside to their intrinsic value underbase assumptions. Even under stress scenarios the aggregate intrinsic value is only 5-10% lower thancurrent prices, indicating limited risk of capital loss. For our short positions we estimate intrinsicvalues 30-50% below current prices and believe that the stocks are trading at a premium to evenoptimistic estimates of intrinsic value.8In our earlier letters we mistakenly understated the long position (and hence also the net long position) by 3-4%Note: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios 7. Avant Garde Wealth Management Pvt. Ltd.Stocks in the portfolio Some more gold platingPiramal Healthcare remains the largest position in the portfolio. We have added to our gold (bullion)position during the quarter, making it the second largest position. The other large positions ofroughly equivalent size are Blue Star, Noida Toll Bridge, Manugraph, SunTV and ThangamayilJewellery. The investment rationale for Thangamayil is discussed in more detail below.Thangamayil is a retailer of gold jewellery. For some time the companys only outlet was its flagshipstore in Madurai (in the state of Tamil Nadu). However, over the last few years they have beenexpanding aggressively into smaller towns in Tamil Nadu, where they are often the only brandedretailer. Their key competitive advantage lies in leveraging the trust associated with the brand togain market share. The top line is driven by both volume, which has more than doubled in five yearsgiven the expansion, and gold price. Since the company keeps inventory, the primary driver ofprofitability is inventory gain from increases in gold prices. Rising gold prices ensures very highreturn on equity, which has averaged 40% over the last seven years, but also makes the growthtrajectory quite volatile. The stock trades at 4.7x TTM P/E and 2x TTM P/B with a 3% dividend yield.Thangamayil is an indirect way to benefit from our positive outlook on gold prices. In a rising goldprice environment the business should be able to comfortably maintain a 30%+ earnings growthtrajectory along with 40% ROE. Incrementally, the company is leasing most of its gold inventory,which will mitigate the impact of changes in gold price but also make the business more capitalefficient. This merits a standalone investment case for the company, along with being a proxy for thegold price.Portfolio performance Satisfactory so farSince we started investing in June 2011 the portfolio is up 11.2% while our benchmark, the BSE500index, is up 0.2%.Cumulative Returns 15% 10% 5% 0% -5%-10%-15%-20%-25%NAV (pre-fee) BSE500Clearly our portfolio did not benefit much during the most recent leg of the market rally. This issimilar to the trend witnessed in Jan-Mar 2012 and is not unexpected. The stocks we own generallydo not tend to be those that market participants rush into in order to benefit from bursts in positivesentiment. Our substantial cash position also acts as a drag on returns in rising markets. In case theNote: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios 8. Avant Garde Wealth Management Pvt. Ltd.economy actually shows improvement we expect that to be reflected in the stock prices of thecompanies we own, helping drive them up to their intrinsic values.The two short positions continue to be a substantial drag on portfolio performance till date. Asprices have moved against us we have spent a lot of time revisiting our theses. As discussed before,our initial evaluation of these businesses was too pessimistic and they have performed better thanexpected. Both the short positions also happen to be participants in certain themes that are infavour with investors. In hindsight we would not have initiated these short positions at the prices wedid. Today, however, the prices are much higher and we would be willing to initiate short positionsat current prices. Hence we are willing to hold on to our shorts for now.Since we invest in listed equities short term volatility in markets does impact us, either throughchanges in the prices of stocks we own or as a determinant of investment opportunities available tous. The attempt is to use this volatility to our advantage in order to deliver on our goal of protectingyour capital and delivering high absolute returns over market cycles.Gaurav JalanOctober 14, 2012Note: Portfolio refers to the weighted average of all client portfolios managed by us over the relevant time period. Any metrics such asreturns or portfolio weighting similarly refer to the weighted average of all portfolios. Individual clients portfolios may defer materiallyfrom the blended Portfolio and clients should refer to their portfolio statements for details on their portfolios