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Gold has posted positive returns even in uncertain times, but it may see a drop in investment demand, should government intervene in the market. Yet, consumption for functional purposes will continue to rise

Indian households have always used gold to hedge against inflation and to preserve family wealth. Investment demand in the metal has been showing a steady rise since the 2008 economic slowdown, though there has been a bull run on gold for well over a decade now. Gold is the only asset to post positive returns in uncertain times. Small wonder then, consumption of gold in the form of coins, bars and more recently, in the paper format, has been growing.

However, should the new financial products being touted by the government to curb gold imports prove effective, these would probably hit investment demand rat­her than the demand for jewellery. While it may be true that investors are likely to shift to products offering better returns, for those buying gold for functional purposes, consumption would continue to rise. So, while the bullion industry is not too worried about duty hikes, the market awaits clarity on the financial products planned by the government and the Reserve Bank of India.

“Both taxes and the new financial products aim at curbing investment demand. New products will give more choices to investors, which could be positive for the economy as well,” said Anil Rego, CEO Right Horizons.

Industry insiders say the government is mulling to introduce gold-linked fixed interest products that would offer returns that are slightly higher than the 13 per cent return on gold last year. Such products could probably trigger some shift in investments from gold coins, bars and other existing gold funds. Similarly, RBI’s proposed products like modified gold deposit scheme or gold pension plan aim at bringing out idle gold stocks lying with individuals, trusts and religious institutions. These may help cut imports, said Kunal Shah, head of research at Nirmal Bang Commodities. “Better returns combined with the government’s involvement in such schemes would certainly win the confidence of investors who use gold as a hedge against inflation,” he said.

However, some fund managers insist that hiking import duties only indica­tes that the government is ne­ither sure of rising exports nor certain about how the rupee may move from here on. In such a situation, people will increasingly hedge on gold.

“Gold ETFs are likely to be perceived as more investor-friendly by urban investors due to ease of transactions than gold bond schemes sponsored by state enterprises, which may have more appeal in rural markets,” said Lalit Nambiar, fund manager and head-research, UTI AMC.

For investors, taxes matter because they squeeze returns, especially when a particular commodity is not performing well. Investors who dabble with a larger portfolio of financial products could probably cut their asset allocation in gold if the metal is not performing well.

Investment demand for the metal largely remained volatile last year. In the first quarter of calendar 2012, investment demand fell by 46 per cent, when demand for jewellery was down by only 29 per cent, despite jewellery stores remaining closed for over a month. After the government hiked duties once more in March, demand during the second quarter fell 51 per cent against 30 per cent drop in jewellery demand. In the third quarter, when overall demand for gold had risen, investment demand rose by 12 per cent against a 7 per cent rise in demand for jewellery.

Investment demand is price-sensitive too. Investments in gold exchange-traded funds grew 172 per cent from Rs 3,516 crore to Rs 9,568 crore between January and November 2011, when gold gave a yearly return of 30 per cent. Between January and November 2012, when prices rose almost 13 per cent, investments grew by only 30 per cent. Because of the wide volatility, investment demand is highly susceptible to developments on the price front.

Gold ETFs

Following the current economic downturn, gold ETFs have gained momentum in the country. In the past five years, their asset size has grown to Rs 12,000 crore. During this period, 14 gold-backed ETFs and nine gold fund-of-funds, which function as feeder funds for the ETFs, have come up. Yet, Benchmark Gold Bees, the first gold ETF to be launched in the Indian market, still dominates with 60 per cent share. Most funds, apart from the top four or five, have less than 1 per cent market share and introduction of more products will further fragment the market.

According to Rego of Right Horizons quoted earlier, there could be marginal impact on gold ETFs when more options are available, depending upon their attractiveness. “The demand might get fragmented, though new products will deepen the market. The effort they put in to increase visibility and brand recall of individual gold ETFs will determine their market shares,” said Lakshmi Iyer, head of fixed income and product at Kotak AMC.

Demand for gold savings plans, offered by mutual funds and jewellers, will remain stable, as those who invest in them largely have a long-term perspective. Such systematic investment plans would be free from market upheavals.

Coins and bars

Coins and bars offer investment opportunity in physical form. Several institutions, including banks, mutual funds and NBFCs are retailing coins and bars to feed the increasing investment appetite. Banks have been demanding approval to buy back gold sold by them, amidst concerns on current account deficit. This, they argue, would help in wider circulation of the metal within the system, cutting dependence on imports.

However, for some time now, the jewellery industry has been clamouring for a ban on sale of gold by banks and other financial institutions. Instead, they have been demanding that retail of coins and bars should be solely left to jewellers and bullion dealers. Either way, imports of coins and bars would come down, they say.


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