Gold crossed the US$1800 per ounce level in international markets on 11 August 2011. In India, it crossed an all time high mark of Rs.27,000 per 10 gm. Ever since it crossed the $900 mark in international markets, there have been cynics who have predicted the fall of gold prices. At the same time, there have been strong supporters of gold who have been stating that gold prices would continue to soar. This was more so after the economic meltdown in 2008, when confidence in all global currencies began to ebb. And it was more pronounced when the US Treasury Paper was downgraded (by Standard & Poor, one of the top three rating companies in the world).
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So is gold becoming an asset bubble? Or has it become the last form of currency that is independent of sovereign ratings? Maybe both. To understand what the prospects of gold are likely to be, and also to ascertain what the Indian government's policies towards this yellow metal should be, DNA called in a panel of experts who discussed issues relating to gold. The panel comprised (in alphabetical order) Sanjiv Arole, independent precious metals analyst; Ketan B Kothari, senior vice-president, RiddiSiddhi Bullions Ltd; Chirag Mehta, Fund Manager, Commodities (including Gold), Quantum Asset Management Company Pvt Ltd; Madan Sabnavis, chief economist, CARE Ratings; Bhavesh Sonawala, director, National Refinery Pvt Ltd; and Bhargav Vaidya, Advisor commodities and director, Bombay Bullion Association.
Given below are edited excerpts from that discussion that was moderated by R.N. Bhaskar.
DNA: Gold prices are at an all time high. What's happening? Why is it happening? Can we have your views?
Sonawala: Gold is a hedge against inflation. It is a fungible asset. During any crisis, gold will always be of great help.
Arole: The genesis of this bull rally goes back to 2001. That is when gold was at its lowest levels - at around $255 per ounce. There was supply side ambiguity, the central banks were selling gold, causing all countries to hammer out an agreement limiting central bank cumulative sales to 2,000 tonnes over a 5 year period (the 1999 agreement that restricted sale of gold by Central Banks to 400 tonnes per annum). Moreover, large scale hedging activity meant that there was excess supply of gold.
Soon, hedging gave way to dehedging and one of the major supply components got converted into demand. As a result, there were no more surprises on the supply side.
One could now factor in the supply given that mine supply began to plateau out and scrap supply declined from Asian countries. Gold was ready for higher prices. So when the economic downturn took place, gold was ready to climb.
Compared to other markets, there is not much money flowing into gold. Gold attracts only a small percentage of funds from global investors. But it is a major index of confidence or the lack of it in other assets and currencies. When other assets and currencies weaken, gold is the last refuge.
But I don't think anyone should try to forecast the gold price. The best consultants have been proved wrong, time and again.
Vaidya: People invest in gold when they do not trust any other financial system. Ultimately, all currency in your pocket is basically an acknowledged IOU guaranteed by governments. So the only asset, which is not someone else's liability is gold. And when we do not trust financial systems, the role of gold becomes extraordinary. As long as financial systems do not cool off, gold will continue to gain in importance.
I am more worried if economic fundamentals start falling into place. If financial systems cool down, we will have a correction.
Mehta: If you add all allocations of financial assets to gold, the amounts are minuscule today. That is why it is wrong to describe gold as an asset bubble. And unless and until there is change in the government or the Central bank, gold prices will stay elevated.
Sabnavis: There are two sets of issues I would like to bring up.
Today, if we are looking at the markets as a whole, there is a lot of uncertainty in the stock markets. So if I'm going to put my money somewhere as an investor, gold makes sense. So that is as far as investors are concerned.
Second is the entire concept of downgrading in the US. I think that is very significant because if you look at most Central Banks in the world, they are actually holding their foreign reserves, partly in the form of US dollars. Now today if I say that the US dollar is not as strong as it used to be and also that the Euro is on a shaky wicket, China is something I do not trust, people are talking maybe of Canada or Switzerland for providing the kind of safety anchor for Central Banks, but they are too small to actually matter. They do not have that kind of currency floating around in the world, which could be bought. So under these circumstances, there would be a tendency for Central Banks to look at buying more gold, increasing their gold reserves.
So these two factors put together are going to contribute to upward pressure on the price of gold. But what is going to be more interesting and fascinating in the coming days is the kind of volatility we will see in prices. Because when the dollar weakens, people go for gold, when it strengthens, people move away from it. If you ask me is the dollar going to strengthen or weaken, honestly I do not know. We have some very good reasons for believing that the dollar should weaken because the US government has to take certain steps, the Euro governments have to take steps. So one can't really say whether the dollar will strengthen or weaken vis-à-vis the Euro. As long as we have this kind of uncertainty, gold will continue to be a volatile asset.
DNA: In the West, gold jewellery sales have outstripped fresh gold purchases. Is the same thing happening in India today?
Sonawala: Since 2002 to the year 2005, we saw large volumes of scrap coming in from the local public, because they had never seen gold prices moving up so much. And they thought they could make good money out of it. Now, after seeing the world scenario and how the world financial systems are, many people have stopped selling.
Since 2007, scrap sales have gone down by almost 15-20% every year in India. In fact, those who have sold their jewellery during 2004-2007, have now started buying bullion as investment, but not jewellery. Because in jewellery there is a carat loss and making charges, while in bullion there is hardly a 2-5% buying and selling difference. We are basically smelters, assayers, refiners and making bullion bars and coins. Today the maximum money for us comes in the form of selling bullion. We have good sales in coins. There is good corporate and investor demand.
But the refining refining business is going down significantly because people want to keep gold with themselves in whatever form they have right now. There are other reasons as well.
DNA: Do people trust physical gold more than ETFs even though ETFs are backed by physical gold?
Mehta: Perception is changing in a big way today. People are coming to recognize that ETFs are as good as gold as each unit is backed by physical gold. Being a new instrument it takes time to gain acceptability. People are accustomed to the touch and feel of gold. But that is changing in a large way because the premiums that physical gold carry differ. It is an unorganized market where the premiums vary from place to place and there are concerns about the purity. Compared to all this, gold ETFs are a better option.
Vaidya: The main issue in India is that the ETF size per unit is much smaller than the US or any other place. Take all the ETFs together, still physical gold is a bigger market. One reason could be is because people buy gold for their children as an investment. But we cannot invest in the name of your child in an ETF. They say you do not have a Demat account in his name. You do not have a PAN number in his name. An ETF is the most efficient way of buying.
Then again, I may have a kg of gold and go to the NSE [National Stock Exchange's commodity exchange or NCDEX]. Can I tell the NSE, "Here is a kg of gold. Can you give me jewellery instead?" It cannot because the legalities need to be in place.
Sabnavis: Is ETF creating an artificial demand?
Vaidya: ETF is not creating an artificial demand but the futures in gold can create an artificial demand. ETF is creating an additional gold stock.
In the past, when I purchased physical gold from a bank, the bank was free to use the gold whichever way it wanted. Now, when people started losing confidence in the banking system, they requested the gold to be allocated [separately with a trustee]. Once it is allocated it doesn't enter into any of the bank's assets directly and that is the biggest shift in demand.
Arole: But to make an ETF possible you need a Demat Account, a PAN Card and legal money.
Vaidya: If you look at entire India, 80% of the population, mostly rural folk, they are the biggest honest followers of gold. The farmer has no black money as his income is tax-free. And since he has no demat or PAN, he purchases physical gold with cash. I think that is what the finance minister meant when, on the floor of the house, he said, I am trying to make this as an investment model for a normal Indian.
DNA: Madan, as an economist, how do you view gold? India is one of the largest markets for gold deposits in private hands. Does it not make sense for a government to put that gold into productive use in whatever scheme, because gold as a collateral lowers the rate of interest for a government?
Sabnavis: Gold should be looked at a different kind of asset. If anyone is buying it, it is for personal reasons. So putting it all to productive use is not something that is practically feasible. I don't think it happens anywhere. It's like saying I have all the buildings in say the whole of Manhattan, you sell them and you pay off the debt of the US. Indian households are not going to part with their gold to say convert it into cash so that it will help the general good.
DNA: What about gold bonds? The government gets to use gold as a collateral and bring down its interest burden.
Kothari: This is the reason we had launched a product recently called Bullion Plus Plus. The clients don't only get to hold their gold and silver bars but they also have an option to earn a lease income. So what happens is that say for example there is an investor who wanted to have exposure to gold and silver rates, he wants to have physical bars which he wants to take out later on for a wedding or something, but at the same time there are jewelers who have to invest their capital in procuring gold, which is so expensive, here they have an option to take it on lease. So it is a win-win situation where they try and match the borrowers and the lenders. So the lenders are these investors who are earning that lease income also as an exposure to gold and silver and you have the jewelers and bullion dealers who wish to borrow at a lower rate to invest in their capital, which is at a higher cost.
So in this case there is a custodian to be involved and of course there are security agencies like Brinks and all and the borrower always has to give a bank guarantee in case he has to take the gold bars. So it is very similar to how a borrower will take a gold loan from a bank but here the gold is owned the investor and the investor is earning as well as the borrower. It works. It's a relatively newer process. We are targeting 1 tonne of gold in the next one year.
Vaidya: Also what I feel is that the government should recognize that because there is so much investment happening in gold, they should bring about tax laws in such a way that investment is attracted towards gold so that gold can also be put to productive use. For example, in the UK, thought here is a 20% VAT on bullion bars, there is none if it is stored and kept in bank vaults. So if it's lying in a London vault and you are an investor in the UK and you just want to sell it back, you will not lose out on the VAT because you will just want to have exposure to the gold bars.
DNA: This is what I mean. If you can get this kind of scheme done and you bring gold into productive use; if it remains in the vault; you can use that as a collateral or a sort of guarantee. It would further encourage gold as an investment.
Vaidya: In India too, as of today they have removed the VAT on bullion. But the VAT on jewellery remains. But I would still recommend gold as a currency. This is because if it is a currency, all our state governments and local governments cannot put VAT or octroi on it. We always had foreign exchange usage tax. So legally you can tax anything but currency. Gold would be able to move freely within the country without additional tax of any sort. And it will continue to enjoy the respect of being an investment instrument.
Kothari: Its investment value in India is well established. For instance, in 1960 when the rupee was barely Rs.3 against the US dollar, gold was trading at 35 USD per ounce. Today, when rupee is at 45.10 to a dollar, gold crossed $1800 an ounce yesterday [10 August 2011]. In dollar terms, gold appreciated 51 times. But in rupee terms it appreciated over 700 times [One Troy Ounce is 31.1 grammes]. At 1960 prices, 10 grammes of gold would have been worth $11.6, or Rs.35. The market price of Rs.27,000 per 10 grammes has been divided by this price]. So Indians investing in gold in India have benefited more than those investing in gold in say the US.
So is gold not a currency which is gives you a hedge against all the other currencies and inflation and everything?
Vaidya: When Ketan said 35 dollars, one should remember that till 1969 the Brettonwoods agreement was still in place. Gold was a commitment by the US government to exchange dollars to gold at 35 dollars.
Arole:In fact, 13 states in the US are in the process of treating gold as a currency. I think Ohio has already passed the legislation.
DNA: Do you think the government needs to modify its policies related to gold? If yes, what are the measures you suggest, both as trade and as investments and as economists.
Vaidya: I would look at one product to be introduced, which is more friendly to agriculture than to gold, which is 'options'. This is a time when maybe the industry needs options like no other time. It allows a safety net of an exit price.
If I am a jeweler who starts a shop today, I am really worried about investing money in gold at this price and worry about what will happen tomorrow. But I have made my plan of 20 shops coming up down the road. What do I do? I don't want to take a gold loan, because technically if I borrow gold with a 100% cash margin, Options would help me to hedge in case the price goes down.
Sabnavis: I agree as far as hedging is concerned. I feel that looking at the commodities and futures market, getting in institutional players, giving them a restriction to trade only in gold markets, since agriculture is the one that has created problems [the government has often banned futures in agricultural commodities], definitely help to make the market more robust. Getting the FIIs, mutual funds, etc to trade only in gold is a very good idea.
DNA: Bhavesh, can we know more about your refining capacity?.
Sonawala: Well the refining capacity right now, at the Indian level, we are just operational at 20-30%. And the government must encourage getting gold Doray [semi processed gold ore] from other parts of the world so that we can get gold at a cheaper rate after refining it in India. Gold Doray is raw gold, which needs to be refined and converted into 995/999.
Vaidya: It is processed ore. Gold is often found at 15 grams per tonne. It is then processed at the mine. And the Doray that is allowed to be imported into India should have a gold content of 80% at the very minimum.
DNA: What about certified gold coins.
Kothari: It is quite strange but coins manufactured in India attract an excise duty of 1%. And after that you pay VAT, and of course these coins are manufactured out of gold bars, which is where you have already paid customs duty.
And if I just go and import coins from international markets, I just have pay import duty and VAT. So you are actually putting the domestic industry at a disadvantage. Imported coins are cheaper than domestic ones. There are no restrictions on imported coins.
Sadly, if there is no brand name I can sell without excise. First you are encouraging imported coins and secondly you are encouraging non-branded coins [which are often substandard]. No logic.
You are therefore encouraging substandard material to come in.
Sonawalai: None of the imported coins, or even banks, guarantee buybacks. Banks are not allowed to buy back. We buy back our coins and bars. But if we put our name there it invites 1% excise. How do we sell our coins?
Arole: If there is hallmark, or there are quality conscious people, they should get a favourable treatment from the government. The government needs to encourage standard materials.
Kothari: In fact, the government's tax structure has actually incentivised the import of the 100 gramme bar. As a result the 10 tola [the traditional Indian standard] bar has vanished from the market. India was a ten tola market some years ago and today it has totally become a 100 gram market. Benefiting overseas producers, not Indian refiners.
Sonawala: A lot of gold coming to the market has iridium [a radioactive substance] as an alloy that looks like genuine gold, but is not.
Mehta: Moreover the government should take care of the SEBI vs FMC [Sebi is the regulator for stock markets and mutual funds while the Forward Markets Commission is in charge of commodity markets. There is ambiguity about gold and silver being a commodity] The silver ETF is not seeing the light of day.
Vaidya: The government has put in some sort of a requirement, a value addition clause. What we are saying is that if you want the trade to flourish, free two-way trade should exist.
Kothari: The industry needs a GST [a nationwide uniform General Sales Tax]. It needs a common single regulator. We need certain policies like the waiving of excise duty on domestically produced and certified gold. And you need silver exports and silver ETFs. These are the major things we need.
DNA: Do you think the government should introduce any urgent measures in view of this panic that is taking place in gold prices?
Everyone [in a chorus] No. Let the markets decide. They will take care of themselves. |
