Gilt Trip

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In a gradual west-east shift, India and China will determine world gold prices

Gilt Trip
When finance min­ister P Chidamba­ram finally signs off the government’s financial accounts on March 31, he would have truly taken credit for trimming the current account deficit to a respectable $45 billion, against a humongous $88 billion last year, by severely choking import of gold through custom channels. Yet, in bragging about his achievement, Chidambaram would have actually revived the long-dormant illegal trade in bullion, harking back to the “golden seventies” that spawned legendary smugglers who went on to become stuff of Bollywood lore.

The World Gold Council’s assessment in its latest outlook released earlier this week suggests demand for gold grew by a robust 13 per cent, despite the punitive duties imposed by Chidambaram. The grey market fed much of that hunger, the WGC says.

This goes on to suggest that import curbs or a slowing economy cannot deter the age-old demand for gold in this part of our universe, as has been evident in the way India and China have continued to accumulate the yellow metal in the year gone by. The world’s two most populous nations, home to one-third of its citizens, now account for more than half of the global consumption of gold.

Traditionally, gold prices have been influenced by the global macroeconomic fundamentals: prices go up and hold steady in cycles whenever the world’s biggest economy, the US, is in stress, debilitating the global currency standard, the US dollar. It may no longer be so. Going by the unsatiated hunger in consumption-driven Asia (primarily China and India), actual demand and supply may determine price movement of the yellow metal from now on.

The finance ministry’s data for the 11 months ending November 2013 paints restricted appetite for gold at 653 tonnes. After extrapolating the import value for December, Financial Chronicle has estimated that the import for the month would have been around 30 tonnes, taking total gold imports in calendar 2013 to 683 tonnes, at best.

But that is statistical fudge that comes out of official tabulation of duty-paid imports through custom counters. WGC data cited earlier demand in calendar 2013 at 975 tonnes, up from 864 tonnes a year earlier. This leads us to believe that Indians bought almost a third of what they consumed from non-custom channels.

“This time, the grey market has played a huge role in supplying gold, recycling was relatively higher in the second half and destocking by the trade too has happened to make up for lower imports. Chances of smuggled gold entering the market as recycled gold also cannot be dismissed,” said P R Somasundaram, WGC’s managing director for India. (Somasundaram’s signed article is published in this issue).

It’s a similar story with India’s giant northern neighbour China. A slowing GDP growth (the lowest since 1999) and lower industrial output did not deter the Chinese from consuming more gold than India at 1,066 tonnes. China is now the world’s largest consumer as well as producer of gold.

“China has a long-term policy, which is pro-gold. It also has a good infrastructure for the industry. Now that it is the major consumer as well as producer, it will certainly try to influence pricing,” Somasundaram said.

“Till now, gold pricing was overwhelmed by the futures market. Going forward, the physical market, especially India and China, can play a greater role. The shift in gold trade from west to east will also be a determining factor,” he added.

The physical demand has been robust across gold consuming countries. Demand in Turkey was up 60 per cent and in Thailand 73 per cent, while in the US demand grew by 18 per cent after declining for eight years in a row. Globally, consumers bought 3,864 tonnes of gold last year, 21 per cent higher than in 2012. Of this, the jewellery demand rose 17 per cent to 2,209 tonnes and demand for bars and coins was up 28 per cent to 1,654 tonnes.

However, the average price of gold for the year was down 15 per cent at $1,411 per troy ounce. Selling and buying by tactical investors who moved to bet on the dollar against gold impacted the prices. Total redemption in gold exchange-traded funds (ETFs) in 2012 amounted to 881 tonnes.

“Almost all tactical investors have left gold ETFs. In such a situation, the physical demand-supply equation can influence the price movement,” said Somasundaram.

While the physical demand has been robust, production has been on the downside, as current gold prices are unsustainable for many mines across the globe. In 2013, supply was down by 2 per cent, as the quantum of recycled gold declined for the sixth consecutive year to the lowest level since 2008.

However, price trends have been closely following the US Federal Reserve’s decision on tapering the quantitative easing programme.

Anil Rego, CEO of Right Horizons, a financial advisory, believes that going by the way prices have moved in 2013, much upside is not expected in gold prices in 2014 either. “The tapering of bond-buying programme will boost the dollar and lower demand for safe haven buying in gold,” he said.

“With gold prices closely following the US Fed’s decisions on the monetary policy front, the unemployment and industrial growth numbers coming from the country would continue to influence gold prices. The bearishness in the market is expected to continue. Once prices breach the current support level of $1,200 and $1,180, a further decline to $100 cannot be ruled out. On the upside, gold may rebound to $1,300 in 2014,” said Tapan Trivedi, senior analyst at Karvy Comtrade.

Most international banks are holding a bearish outlook for gold this year. Deutsche Bank is the most bearish, projecting $1,141 as the average price for the year. Barclays has pegged the average at $1,205 and HSBC at around $1,292 per troy ounce.

In the domestic market, however, the rupee’s movement in 2013 largely dictated prices. Domestic prices even touched an all-time high last calendar due to the weak rupee. The 10 per cent import duty combined with a premium took prices to a high of $1,850 per troy ounce last year.

Even if international prices continue to slide in 2014, domestic prices might not suffer a fall. The tapering plan will hurt investor sentiments in emerging markets and the rupee will come under renewed pressure. Such a scenario will keep the price of domestic gold high, despite the downside in international rates.

However, a possible lowering of duty and the 80/20 formula for import – 20 per cent of every import consignment to be re-exported after value addition – might result in an immediate correction in domestic prices.

With the CAD dropping to 2.5 per cent or $45 billion at the end of the financial year, Chidambaram may eventually revisit his penal duties on gold imports at March-end, despite remaining noncommittal so far.

“The restrictions have brought down official imports drastically in the second half of the year and yearly imports too are down from last year’s level. But as a fallout of the restrictions, smuggling has gone up and gold jewellery exports have shrunk. The government has to address these concerns,” said Pankaj Parekh, vice-chairman, gems and jewellery export promotion council. (read his interview in this issue).

Once the duties are lowered, gold prices will come down, said CP Krishnan, wholetime director at Geojit Comtrade. Relaxation of the 80/20 formula will also ease premiums, which had even gone up to $160 per troy ounce due to limited availability. Domestic gold is now priced at least 20 per cent higher than international prices.

An expected price correction will see a spurt in demand in the first half of the year. Further, the phasing out of large denomination currencies printed prior to 2005 might see some inflow of unaccounted money into physical assets, real estate and gold, all of which stand to gain in such a scenario, said Rego of Right Horizons.

However, the WGC maintains that the annual demand for 2014 will remain stable between 900 tonnes and 1,000 tonnes. Demand for jewellery will also remain stable in India with a large marriageable population. According to a WGC survey, 75 per cent of the customers in India and 79 per cent in China have decided to buy more or the same quantity of gold in 2014 compared with what they bought in 2013.

However, investment demand will surge only with price volatility. The subdued prices did not lend the much-needed volatility to trigger investment demand in 2013, as in the previous years. Government restrictions too affected investment demand more than the jewellery demand.

In June, the all-India gems and jewellery trade federation (GJF) asked its members to stop sale of gold coins and bars in order to curb imports. These products, with very little value addition, have not been contributing much to the bottomlines of either the manufacturers or retailers. Banks, India Post and some of the financial institutions too have stopped selling gold coins through their branches.

According to Haresh Soni, chairman of GJF, the demand for coins and bars should have dropped by over 35 per cent in the calendar year against the previous year.

In the post-financial meltdown years, investment demand has been mainly instrumental in triggering the growth in India’s gold consumption. Overall, consumption went up from 773 tonnes in 2007 to 933 tonnes in 2011. Demand for coins, bars and paper gold in these years grew from 215 tonnes to 368 tonnes.

The payment fiasco at the National Sport Exchange dented investment sentiments in gold last year. E-gold has been a popular product at NSEL. E-gold and e-silver contracts accounted for almost Rs 600 crore worth of metals with the exchange. E-series contracts were suspended following the payment crisis.

Gold ETFs too saw their first yearly decline in assets since their introduction in 2007. Gold ETFs lost over Rs 3,000 crore in calendar 2013 as the AUMs (assets under management) shrunk by 26 per cent that year against a growth of 31 per cent in 2012.

At the end of December 2013, the 14 gold ETFs garnered a total AUM of Rs 8,784 crore against Rs 11,992 crore in December 2012, losing Rs 3,208 crore. Gold ETFs have been steadily growing their assets from Rs 467 crore in December 2007 to nearly Rs 12,000 crore in 2012.

Lakshmi Iyer, head of fixed income and product at Kotak AMC, finds that the redemptions were higher and new investors too were not entering gold ETFs.

“Against their all-time high levels, gold prices in the international market remained subdued throughout 2013. The import curbs imposed by the Indian government and RBI too affected investor sentiments,” said Jiju Vidyadharan, director, funds and fixed income research at Crisil Research.

According to Anil Rego of Right Horizons, volatility in prices will bring back investors to gold ETFs. Due to lower demand, 2013 there was no fresh launch gold ETF in the market.

However, considering the divergent movements in domestic and international gold prices, the National Commodity and Derivatives Exchange (NCDEX) launched gold hedge contract, which tracks international gold prices closely by excluding the custom duties and premiums levied on domestic gold. Using the product, importers can insure themselves against price risk. It also provides good arbitrage opportunities to the various market participants, including jewellers, bullion traders and manufacturers.

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