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YO-YO of Yellow Metal & BFSI Sector – A Study

YO-YO of the Yellow Metal and BFSI SECTOR

In the international market, yellow metal is expected to touch up to $3,000 for an ounce from $1,700/ounce (An ounce is equivalent to 28.34 grams). The rally that began from April 21, 2020, when the price was Rs 46,450, continues with the prices having touched Rs 48,050.

In India, the gold price is moving to cross Rs 55,000 per 10 grams by the year-end and up to Rs 60,000 in the next 18 months from the current Rs 45,800 per 10 grams, will give a boost to investment in gold. (Prices for gold are calculated per 10 grams of 24 karat gold)

Enhanced spending by the governments and central banks across the world is expected to render currencies weak, but gold, which is seen as a hedge against inflation, is even safer. Gold, considered a safe-haven asset, started rising last year amid uncertainty triggered by the trade war between the U.S. and China and buying by central banks across the world. This has umbilical cord links with USD and crude prices and impacts on the country’s economy in myriad ways. 

This article attempts to unravel the mystery of the chain effect and mitigation efforts GOI and BFSI sector can play.

A bit of history

Gold is a precious metal. It has emotional, cultural and financial value and different people across the globe buy gold for different reasons, often influenced by a range of national socio-cultural factors, local market conditions and wider macro-economic drivers. 

This yellow metal has always been the most reliable form of currency for millennia. From the Greeks and Romans to ancient Indian civilizations, gold has held an important position in the pecking order of metals. It’s what made it universally acceptable; the currency of one kingdom may not have been acceptable in another but you could always trade in gold. That’s also what made it very valuable. And so, if people could save up enough, they’d always buy gold. This deeply embedded practice has continued all the way down to our parents’ generation and indeed our own.

“That system was called the gold standard. Since the supply of gold doesn’t grow very fast, being on the gold standard would automatically prevent the government from overspending and keep the inflation in check. For every denomination of currency issued, that country had to buy an equivalent amount of gold. So, if the US printed half a million Dollars in currency notes, it would have to buy gold worth half a million to keep in its reserves.” Later the US dropped the policy.

“When the global economy does well, gold prices fall and vice versa. At the moment the world’s economy is in tatters and that’s why gold prices are increasing.”

Gold benefits from diverse sources of demand:

  • As an investment, 
  • A reserve asset, 
  • An adornment and 
  • A technology component.
  • It is highly liquid,
  • No one’s liability,
  • Carries no credit risk, and is scarce, historically preserving its value over time.

Gold as a sovereign asset  

As earlier mentioned, gold is held as sovereign assets all over the world and India is not an exception. A look at the infographic below will give details of India’s reserves over a period of time. Gold Reserves in India remained unchanged at 618.16 Tons in the fourth quarter of 2019 from 618.16 Tons in the third quarter of 2019.

The latest update is India’s total foreign exchange (Forex) reserves stand at around USD 485.313 billion on 8th May 2020 breakup of which is as under:

Foreign Currency Assets (FCA)             447.548

Gold Reserves                                           32.291

SDRs                                                            1.423

Reserve                                                       4.051

Reserve Bank of India (RBI) bought 40.45 tons of gold in the financial year 2019-20, taking its total holdings of the yellow metal to 653.01 tons on May 11, 2020. India is better placed in holding substantial reserves. But the irony is that tonnes of gold are lying in private hands in India (Approx 25k tonnes).

Gold as a private asset – Boon or Bane 

A Bane for sure?

Gold has a central role in the country’s culture, considered a store of value, a symbol of wealth and status and a fundamental part of many rituals. Among the country’s rural population, a deep affinity for gold goes hand in hand with practical considerations of the portability and security of jewellery as an investment. 

The yellow metal is considered to be auspicious, particularly in Hindu and Jain cultures. The ancient law-giver Manu decreed that gold ornaments should be worn for important ceremonies and occasions. Aside from Diwali, regional festivals across the country are celebrated with gold – in the south: Akshaya Tritiya, Pongal, Onam and Ugadi; in the east: Durga Puja; in the west: Gudi Padva; in the north: Baisakhi and Karva Chauth.

Gold is central to more personal life events too. Gifting gold is a deeply ingrained part of marriage rituals in Indian society —weddings generate approximately 50 per cent of annual gold demand. As a result of this, Indian households may have accumulated up to 25,000 tonnes of gold, thereby retaining the tag of the world’s largest holders of the metal. Most of these are hanging around the necks and ears of millions of people and in lockers as inert assets and do not contribute to GDP. 

Gold imports directly affect the current account deficit (CAD) of India. As a thumb rule, the larger the CAD with respect to GDP, the riskier it is for the overall economy. The country is presently the largest importer of gold on the planet, consuming one-third of the planet’s supply on an annual basis.

GOI is endeavouring to break the sentiment chain in which Gold is consumed as an unproductive asset by launching schemes to monetize the same. We will see the details a little ahead.

A Boon?

Gold can enhance a portfolio in four key ways:

  1. Acts as an effective diversifier and mitigate losses in times of market stress.
  2. Improves overall portfolio performance.
  3. Generates long-term returns.
Gold has delivered positive returns over the long run, outperforming key asset classes

Gold has delivered positive returns over the long run, outperforming key asset classes

  1. Provides liquidity with no credit risk as the infographics here indicates.
Gold trades more than many other major financial assets

Gold trades more than many other major financial assets

  1. Above all, it acts as a big factor for credit delivery from banks/FIIs to a huge population for productive purposes.

Efforts of Government & other agencies to curb consumption 

GOI has three schemes presently running, features of which are tabulated below. These gold schemes are launched with an aim to reduce these whopping quantities of imports. It is also believed that these gold schemes will attract more customers to gold investments.

Exchange Traded Funds (ETF) is another tool. Some of the advantages of investing in Gold ETF rather than investing in physical gold are:

  • Buying gold ETF is hassle-free as compared to physical gold with no risk on the purity of gold.
  • Gold ETF has more liquidity. These funds are listed and traded on a stock exchange like common stocks. So, can be bought and sold at any time of the day.
  • Physical gold attracts various taxes like wealth tax and VAT.
  • No storage problem with Gold ETF. With physical gold, there is a risk of theft.

Gold vs USD – Impact on India

The relation is inverse in nature. We need to study the relationship between the prices of Gold and US Dollars for three reasons: 

  • Use Gold as a hedge against a rising Dollar 
  • Impact on the BFSI sector in India 
  • In a macro sense, how will it impact on India’s economy?  

First, the inverse relation  

The price of all US Dollar-denominated commodities like gold will change to reflect the fact that it will take fewer or more dollars to buy that commodity. When the dollar gets strong, gold price goes down, and vice versa. That accounts for part of the fluctuations that we see in the value of gold.

The other part is an actual increase in the supply or demand for gold. If the price is higher when being measured not only in US Dollars, but also in Euros, Pounds Sterling, Japanese Yen, and every other major currency, then we know the gold demand is higher and it has actually increased in value.

Consequently, if gold is higher in US Dollars while at the same time cheaper in every other currency, then we can conclude that the US Dollar has weakened and that gold has actually lost value in all other currencies. But the price, because it is being quoted in USD will be higher, the stronger the value of the US Dollar, the lower the price of gold. Likewise, the weaker the US Dollar, the higher the price of gold. Thus, typically, Gold has an inverse relationship to the Dollar.

Gold prices and US Dollar correlation – 10-year chart

This chart compares the daily London Bullion Market Association (LBMA) fix gold price with the daily closing price for the broad trade-weighted US Dollar index over the last 10 years.

A look at the chart will reveal the gold price in inverse mode with the index. Almost all our import/export bills are denominated in USD and balancing a sliding rupee can be done using Gold reserves as a hedge.

On BFSI sector 

Rising Gold prices will enable more credit flow in the form of Gold loans. The credit ticket size for gold importers will go up. USD will become cheaper to help the importers. Siding Gold prices will see less outgo in import finance. Also, there will be brisk outgo of personal loans to buy Gold. USD will become dearer and exporters will realize more INR. Gold bonds and ETF trading will look up. 

On Indian Economy 

Rising gold price will deter gold imports. Pressure on CAD will ease. Customs duty realization will be higher. Buying Gold for consumption will decrease. Conversely, if gold price slides more imports can happen to strain our CAD. There will be a shift in investment holdings to other assets if the slide continues.

Gold vs crude prices – Impact on India

Let us take a peek view of the price relationship gold enjoys with crude prices in the following infographic. Redline denotes crude prices and gold price in blue. The correlation is positive except in 2020 where it is inverse.

This aberration is due to the crashing of crude price in COVID-19 times as the energy sector is destroyed due to lockdown. Also, lack of storage facilities for crude has come in the way of picking up ordered supplies.

Reasons for a positive correlation 

The main idea behind the gold-oil relation is the one which suggests that prices of crude oil partly account for inflation. If gasoline is more expensive, then the cost of transporting goods and their prices go up. The final result is an increased price level – in other words, inflation. The second part of the causal link is the fact that precious metals tend to appreciate with inflation rising (in the current – fiat – monetary environment). 

So, an increase in the price of crude oil can, eventually, translate into higher precious metals prices.

Relationship between USD, CRUDE, GOLD and INR

If the US Dollar falls,

  • Gold will remain the same/less price for the rest of the world.
  • But, the U.S will end up paying more for the same amount of gold.
  • Oil prices will rise in the U.S. market.
  • It will fall to other countries. This is because crude oil is primarily traded in US Dollars.
  • If oil prices go up, so does gold prices.
  • A weak Rupee can add to the price of gold.

As India has now a huge storage facility, they can buy crude and stockpile them to some extent amid COVID-19 times.

Banks/FIs and gold loans

One of the ways to put inert gold to productive use is availing loan against pledge of gold ornaments, that every household in India possesses. Though it is a traditional loan scheme in all banks since long, there has been a spurt in lending on the advent of NBFCs and FinTech companies lately.

The emergence of the online and digital models in the gold loan space by NBFCs and new-age FinTech players that offer gold loans at the customers’ doorstep, has opened up an untapped market among digital-savvy customers.

The organized gold loan market comprising banks, NBFCs and Nidhi companies contribute to nearly 35 per cent of Indian gold loan market. The size of the unorganized gold loan sector is estimated to be three times the size of the organized sector

According to a KPMG study, India’s gold loan market is expected to reach Rs 4,617 billion by 2022 at a five-year compounded annual growth rate of 13.4 per cent.

Endnote

A few points to ponder:

  • India aims to grow at 9 per cent GDP to achieve the target of USD 5-trillion economy by 2024.
  • India should curb Gold imports so as to avoid the flight of capital if it wants to achieve the $5-trillion economy.
  • We have remitted $100 billion over the last nine years for gold import. It is a loss of savings in the economy and the flight of capital.
  • $100 billion retained in the country would have added around $200 billion to our GDP, which is around 7% of our current GDP, assuming a multiplier of two.
  • Financial innovation to monetize existing holding of gold, especially held in religious trusts, should be explored.  
  • Banks to popularize sovereign gold bonds issued by GOI and ETF buying. 
  • Import to be curbed and sterner measures to be taken against gold smuggling.

 

About the Author

Venkata Raman

K. Venkataraman is a senior professor at Manipal Global Academy of BFSI. He is a multi-talented person – a banker, an advocate, faculty in many educational institutions. He retired as an executive from Canara Bank after serving the bank in various managerial capacities for 34 years.

Prof. Venkataraman holds an MBA in HR, and LLM besides many certification and membership in Karnataka Bar Association. He is a faculty in ICAI, Bengaluru, conducts online classes for business administration students of Sikkim Manipal University and he is a viva panel member in four universities. He also works as an IPR consultant. Since 2011, Venkataraman working with Manipal.

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