Is yellow metal losing its sheen in India? Too early to call!

Since times immemorial, Indians have hoarded gold for personal gratification and as a safe and attractive mode of investment. It is conservatively estimated that Indian households are the largest owners of gold in the world, holding 20,000 tonnes of the precious metal in the form of jewellery and gold bars. 

India’s penchant for gold can be gauged from the fact that based on gold prices of 2012, the cumulative value of gold held by Indian households was estimated at an astounding $1.16 trillion.

Lump in demand 

However, recent data indicates that India’s fascination with the precious metal is on the wane with domestic gold demand recording a significant drop in first half of 2016. 

India imported 248 tonnes of gold in the January-June period, the lowest import figure since 2009 and 42% lower than the corresponding period last year. A bountiful monsoon which is expected to boost rural income levels is likely to generate some demand for the precious metal, though the same may not translate in numbers. 

India is likely to import 650 tonnes of gold in 2016, the lowest figures after 2009, when import numbers were pegged at 559 tons. These numbers are lower than imports in calendar years 2013 and 2014, when severe regulatory stress had failed to moderate the traditional Indian appetite for the metal and imports were a tad higher than seen this year.

Diverse contributory factors  

The dip in gold import figures can be attributed to diverse contributory factors, chief among them being several government measures undertaken to plug the widening gap in the Current Account Deficit (CAD). Hiking of import duty and introduction of different investment options in bullion against its traditional physical form, influenced the investors. With one of the highest gold levies in the world, import of the precious metal was an unattractive proposition, significantly impacting gold inflows. 

Government’s initiatives

Gold Bonds and Gold Monetisation Scheme are the two key investment options introduced by the government, to redirect investment from physical gold. Sovereign gold bonds (SGBs) are papers or certificates issued by the Government of India, indicating that investors bought the stated quantum (in grams) of gold. The value of the bond will be linked to the price of gold. 

The objective of the scheme is to provide an alternative to buying physical gold. The SGB will get a fixed interest at 2.75% per annum, payable semi-annually on initial value of investment in addition to investment in gold as an asset class. These bonds are free from issues like making charges and purity which is of concern while buying gold in jewellery form. As these bonds will be held in demat form, unlike physical gold, there is no risk and cost of storage.

Monetising the yellow metal 

Realising the need to galvanise households and institutions, such as temple trusts, into depositing vast gold reserves in their possession and monetise their value by paying interest on the deposits, the government introduced the gold monetisation scheme. The scheme was also strategised to reduce imports of gold over a long term period. 

The scheme requires the customer to deposit the gold, in bullion or jewellery, in a specified bank as stipulated by the RBI which will determine the purity of the gold and credit the exact quantity of gold. Banks will then lend the precious metal to jewellers at slightly higher interest rates than offered to the depositor. 

The principal and interest accrued to the depositor will be paid in gold, meaning, if a customer deposits 100 grams of gold and is entitled to an interest of 1%, he will avail of credit in the form of 101 gram jewellery on maturity. The tenure of deposit can vary from a short term of one to three years, medium term of five to seven years and long term of 12 to 15 years. 

Having taken on an active role in collecting the vast hordes of idle gold deposits lying with households and public institutions, the government has succeeded to a larger extent to putting the gold to productive use and reducing the imports of the precious metal, giving the general investor an attractive investment avenue and dissuading him from hoarding or importing the metal.

Higher returns on equity

The emergence of equities as an effective risk diversifying asset class has also significantly led to a downfall in the demand for gold as an investment option. With robust macroeconomic fundamentals, improved corporate earnings and an abundant monsoon following two years of dry spells, Indian equity markets are up by 6.5% in calendar year 2016. 

With foreign institutional investors and retail investors making a beeline for frontline stocks on the Indian bourses, markets will continue to maintain a high performance trajectory. 

For the investor wanting to make attractive returns on investments in the mid to long term, equities have emerged as preferred investment assets. Possessing the potential to generate high returns, equities offer high liquidity. 

Fund management is handled by professional fund managers for equity asset classes like mutual funds and investors can avail tax exemptions on long term capital gains. Conversely, gold investments come laden with several risk factors such as high storage cost and security component. There are no accrued tax advantages for gold investments and investors do not have the benefit of enjoying regular income in the form of dividends which equities offer. 

A key reason for the sharp fall in the demand for the yellow metal is a steep downturn in rural demand. With two consecutive dry spells, agriculture and agro-based industries in the rural hinterland of the country have taken a turn for the worse. With little or no liquidity at their disposal and the benefits of the current crop cycle yet to kick in, the rural populace, which forms a major proportion of the customer base of old buyers, has trimmed their demand for the precious metal. Till the investment cycle kick-starts in the rural areas and buoys commodity demand, customers will continue to remain away from gold.

Effects of quantitative easing

With regulated markets like the US maintaining a zero rate interest regime, prices of gold, which is a dollar-denominated commodity, continue to remain on a higher curve. Gold prices and US dollar is highly negatively correlated. Hiking of US rates is to weigh on gold, as higher rates increase, the opportunity cost of holding non yielding assets like bullion. 

Markets are now focused on the decision of the Federal Open Markets Committee (FOMC), the policy making body of the US Federal Reserve, on whether it will go for a rate hike. Speculations abound that the FOMC may go for a rate hike before the year ends. Given the positive outlook of the US economy, the rate hike announcement is a strong possibility, following which there will be an immense selling pressure in world gold markets. This in turn will send prices of gold crashing. 

However, till then, with near-zero rates in place, gold prices continue to revolve in higher orbits, impacting the demand for it negatively. 

Domestic gold prices are usually moving parallel to international market rates. However, a weak rupee has been making the domestic gold prices too expensive for the last couple of years. The value of the Indian rupee which was pegged at 59.60 per dollar in 2013, has jumped to around 67 per dollar in 2016. These value differences in currencies lead to price disparities between the domestic and international markets. The rupee has considerably weakened over the last three years. Going ahead, rupee-based movement will steer the course of the domestic gold market. 

Anti-blackmoney imperatives, like compulsorily furnishing the income tax Permanent Account Number (PAN) for jewellery purchase in excess of Rs 2 lakh and levying of excise duty on jewellery, has withdrawn the traditional and loyal gold buyers from fresh purchases. However, given the fondness of Indians for the yellow metal, India’s love affair with gold may not be over yet.

(The author is Research Head at Geofin Comtrade)

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