Yellow fever

It’s been an incredible golden run for gold, a vertical climb in prices which crossed Rs 18k per 10 grams. Bad news for jewellery buyers, but good news for investors who sidelined retails to rush to bank counters for gold bonds. RBI, too, bought 200 tonnes of gold from IMF lending wind to speculation that Governments the world over were moving away from the dollar economy. Nidhi Mittal explores the yellow metal spiral

The yellow metal is more precious than ever before. With gold prices in India crossing the 18K per 10 gram mark in the last quarter of this financial year, the time of festivities and weddings, ripples in the retail sector are more than visible. The demand for original zari work on garments going down and costume and gold-plated jewellery replacing the 22-carat ornaments are only some examples of India’s most loved metal going out of the pocket.
Seen as the most reliable source of investment and a must for marriage and festivals, the largest consumer of gold in the world has had a longest association with the yellow metal. New York Times in its article published in 1912 said a large part of the world’s gold that goes to India either is converted into ornaments or is burried under the ground. It said that India withdraws a large part from the monetary stock of the world.
Sir James Wilson KCSI, who served in the Indian Government service for many years, in a comprehensive address delivered before the East India Association of London on June 14, 1911, reported the net imports of gold by India since 1840 at about $1,200,000,000 or one-tenth of world’s production at that time. Till today, India is the largest gold consumer, importing between 700 and 800 tonnes of the metal annually or 20 per cent of the global demand.
The soaring prices of gold may have come as a respite to bewildered investors after the dollar slide through the last year, but it has not gone down well with domestic retail consumers. It is estimated that 15,000 tonnes of gold is privately held in India, more than 25 times as much as the official hoard of 558 tonnes after the Reserve Bank of India’s recent purchase of 200 tonnes from the International Monetary Fund (IMF).
Gold purchases in Kerala and Tamil Nadu are almost exclusively meant for weddings, but among the relatively more market savvy Gujaratis, Marwaris and other business communities, gold buying is also driven by the metal’s attractiveness as an investment.
Indian consumption of gold, which stood at about 800 tonnes in 2007, could go up to more than 1,200 tonnes this fiscal, say experts. With Kerala alone accounting for more than 20 per cent of the total gold sales of the nation, the skyrocketing gold prices have created a huge sociological problem in the South Indian State where girls will stay at their parental home for a lifetime without getting married if there is no gold to accompany them to the in-laws.
Reports from several temples in Kerala speak about several postponements of marriage bookings in the past three months, the main reason being rise in gold prices.
In the past month, gold ornament sales fell by more than 40 per cent due to the unimaginable rise in the price, jewellers in the Capital say. “If in the last festival season, my business was 100 per cent, this year it has been less than 60 per cent. The marriage season has not come as a respite because gold is just out of reach of a middle class person. People have even stopped buying gold coins, traditionally given away as shagun in marriages. They are moving to lesser expensive options like silver coins. Also, in such times, people prefer buying Hallmark jewellery which is costlier but sure to fetch more money when given away as scrap,” says jeweller Aditya Aggarwal.
Conversely, a 25 to 30 per cent leap is seen at counters of financing companies with more and more customers approach them with ornaments to pledge. Loan amounts per gram of pledge have also gone up considerably, but these vary from banker to banker.
When gold soars, the dollar is usually getting pulverised, says popular columnist. The bullion market is emerging stronger than ever before while the Dollar is seeing a constant downward turn. With the American economy hit hard by the global recession, and dollar losing on reputation and value, gold is the next option Governments and investors are turning to.
The bullion has risen 38 per cent this year while the dollar has dropped 8.5 per cent against a basket of six major currencies. This advancement in gold is more than the MSCI World Index of shares and US Treasuries and is heading for its biggest annual gain since 1979, say the marketmen. The falling dollar owes itself to various key factors, one of the most recent being that the investors are taking the view that Dubai’s debt woes will be contained, reducing safety bids for the greenback. The domestic bullion market witnessed maximum volatility after the Dubai crisis, which drew back stockists and an investment-led demand triggered a burst of buying spree.
The demand for bullion also increased among Governments after the RBI and Mauritius bought the metal in huge bulk from IMF. China and Russia added to their holdings, spurring the fear that the strongest currency so far is losing on its trademark strength. Two hundred tonnes of gold for a staggering Rs 32,000 crore at a time when world economies are struggling to stand up after suffering major financial crisis, created a furore in the bullion market, further boosting the investor sentiment towards the metal.
Analysts say RBI bought gold from IMF not just to shore up its gold holdings but to also declare globally that the nation has arrived “in a big way”. As he swapped his country’s dollars for hard assets, Finance Minister Pranab Mukherjee was blunt: “The economies of the US and Europe have collapsed,” he said.
“India has shown its strength as an emerging economy. The strong emergence of developing nations has put down the strongest currency. Whenever we see a downward trend in dollar market, we simultaneously notice an upward movement in gold prices. There are several factors which have resulted in the soaring prices of gold led in turn by the fall in the value of dollar. With developing economies like India moving ahead at a faster pace, dollar had to go down.
“Then the employment stimulus package pumped into the US economy after the financial crisis has still not got fully into force. The crisis in Dubai has further pushed the dollar. Recently, we saw that all strong foreign currencies were pegged against the Chinese Yuan, because its strengthening by every passing day. This developed a fear in the minds of investors and therewas a general rush towards buying gold which is, by far, the safest mode of investment. Then we saw a trend when gold was being bought even at high prices, which again boosted its global prices. Two factors come out here — one, that gold is a safer investment, and that emerging economies like India have arrived in a more powerful way than ever before in history,” explains Vikas Roshan, executive director of leading auditing firm KPMG.
India, Mauritius and Sri Lanka, all developing nations, have in the last quarter bought more than half the 403.3 metric tonnes of gold that the IMF sold to bolster its balance sheet and boost lending to low-income nations.
Since the collapse of the Bretton Woods monetary agreement in 1973, the world has conducted its trade and paid its bills in dollars — not gold which held considerable importance in the preceding era. This, because America had a strong economy, was a major creditor nation with low debts and had a reputation for fighting inflation and defending the dollar’s value. However, in times to come, as America encouraged the world to collect dollars and dump gold, an unforeseen, dramatic reaction occurred, and dollar started slumping.
Foreign importers began to replace American industry. The US manufacturers were forced out of business or relocated overseas. The US economy changed radically. America evolved from a production-focused economy into a consumption-focused one. It went from being the world’s creditor nation to the world’s largest debtor nation. And, over just the past decade, its currency lost one third of its value.
“So much so that investors now typically look for avenues where they can get out of the dollar depricated situation. And in such times, there’s nothing better than gold. After the global meltdown, central banks have pumped in a lot of liquidity into the system to defreeze financial assets. People now don’t want to hold back the cash and are investing in assets other than the dollar. There are options like real estate which is still very down in the West, crude which is not likely to pick up anytime soon, other metals like aluminum or steel which are not very attractive options. Hence, gold is a hotsell,” says senior economist Sunil Sinha.
With this IMF gold purchase, India is now ranked 11th, up from 14th in September 2009 as per World Gold Council (WGC) statistics. India now has a mammoth gold reserve of 557.7 tonnes which, analysts say, will take it a long way. However, with the soaring prices, the WGC in its Q3 2009 report says that the retail industry is not recovering much. Third quarter demand in India continued to improve from exceptional lows witnessed earlier in the year, but absolute levels of demand remained reasonably weak, says the WGC report.
Jewellery demand, at 111.6 tonnes, was down 42 per cent in Q3 2008, while net retail investment demand, now at 26 tonnes, recorded a decline of 67 per cent over the same period. Total tonnage was down 49 per cent relative to year-earlier levels. “Given that the annual decline in tonnage Q2 2009 was 38 per cent, it may appear logical to conclude that the trend is continuing to deteriorate. However, such an assumption would be misleading, as Q3 2008 was exceptionally strong. A quarter-on-quarter comparison shows a very healthy 26 per cent rebound, but once again, this is somewhat misleading due to seasonal effects. A more appropriate benchmark for comparison would be a “typical” third quarter. If one takes the average level of Q3 tonnage off-take over the five years to Q3 2007 (152 tonnes) and compares Q3 2009 against this average, the decline is a more moderate nine per cent (-5% for jewellery consumption and -25% for investment demand),” explains a source in WGC.
The high prices of gold continued to be the biggest constraint on jewellery demand during Q3 2009, along with poor monsoon, which resulted in low levels of income for the rural community. Furthermore, the southern part of the country suffered a flood which kept buyers at bay. In fact, income growth has not kept up with the sharp rise in the gold price of the last year, and with the cost of living continuing to climb, consumers have compromised by buying lower weights. Whereas consumers buying for a special occasion would, in the past, have had a target weight in mind, a rupee budget has now become more common. The high gold price has also seen a shift into gem set jewellery, costume and imitation jewellery, points out the report.
“Fluctuations in recycling activity of gold are an integral part of the Indian market. Jewellery is sold by weight at a low margin, with consumers paying close to the spot price in rupee terms. Furthermore, many Indian families own significant holdings of gold, most specifically in jewellery form. Consequently, bouts of profit-taking are a relatively logical response to a volatile gold price in a market that has low transaction costs and a very low margin. It is, of course, the volatility in the gold price that primarily drives the fluctuations in both demand and recycling flows,” says the source.
Nowhere globally is the desire to own and accumulate gold stronger than in India. While there has been some dilution of this desire in the less traditional metros like Mumbai and Delhi, these cities account for just 26 million out of a total population of over 1 billion people. The southern and rural parts of India, in particular, are still very traditional, both in their customs and in their love of gold. Kerala alone has more than 6,000 jewellery shops and about 40,000 artisans in the industry. The total number of people employed in the sector could be more than 2,00,000. Thrissur, the Capital of gold trade in Kerala, accounts for more than 3,000 shops.
While price levels are currently acting as a constraint on demand in India, gold will remain a key savings vehicle for consumers and also for Indians in many other parts of the world, experts say. India is a nation of very high savers. “We believe that the effect of a growing Indian population combined with rising per capita incomes will, over a long term, lead to growth in total demand for gold in India,” says the WGC report.
All said, even though gold dominates the economic scene right now, its price rise is not an indicator of an economy doing good or bad. “The rise or fall in gold prices does not affect the economy, but it does indicate inflation. There is such a hue and cry about it because of the lust for the metal in India. The general fascination for gold will keep up the price,” says Roshan.
He, however, adds this not the end of line for dollar though. “We cannot ignore that the US economy has inherent strengths. Even though it is recovering at a slow pace, even a two per cent growth is promising. Having said that, it is possible it may not gain as much strength as earlier because the developing economies are emerging stronger,” says Roshan.
Economist Sunil Sinha seconds this to insist that there is no alternative to dollar. “Dollar will continue to hold ground, but depending on the investor sentiment and global imbalance, it will see a positive or negative movement. Right now it’s a negative movement with worried investors looking for other avenues,” he says.

The Price Drivers

INVESTORS: Rising interest in commodities, including gold, from investment funds in recent years has been a major factor behind the bullion's historic highs. Gold's strong performance has attracted new players and increased inflows of money into the market

WEAK US DOLLAR: The currency market plays a major role in setting the direction of gold, with bullion prices moving in the opposite direction to that of the US dollar. Gold is a popular hedge against currency weakness. A weak US currency also makes dollar-priced gold cheaper for holders of other currencies and vice versa

OIL PRICES: Gold has historically had a strong correlation with crude oil prices, as the metal can be used as a hedge against oil-led inflation. Strength in crude prices also boosts interest in commodities as an asset class

POLITICAL TENSIONS: The precious metal is widely considered a “safe haven”, bought during uncertain times. Major geopolitical events, including bomb blasts, terror attacks and assassinations, can induce price rises. Financial market shocks, which cause other asset prices to drop sharply, can have a similar effect

CENTRAL BANK GOLD RESERVES: Central banks hold gold as part of their reserves. Buying or selling of the metal by banks can influence prices. On August 7, a group of 19 European central banks agreed to renew a pact to limit gold sales, originally signed in 1999 and renewed for a further five years in 2004. Annual sales under the pact are limited to 400 tonnes, down from 500 tonnes in the second agreement, which expired in late September. Sales under the agreement were low in the later years of the second pact, however. Gold sales under the second Central Bank Gold Agreement totalled only 1,883 tonnes, down from 2,000 tonnes under the first agreement

HEDGING: Several years ago when gold prices were languishing at $300 an ounce, producers sold a part of their expected output with a promise to deliver the metal at a future date. But when prices started rising, they suffered losses and there was a move to buyback their hedging positions to fully gain from higher market prices — a practice known as de-hedging. Significant producer de-hedging can boost market sentiment and support gold prices. However, the rate of de-hedging has slowed markedly in recent years as the outstanding global hedgebook shrank

SUPPLY/DEMAND: Supply and demand fundamentals generally do not play a big role in determining gold prices because of huge above-ground stocks, now estimated at around 158,000 tonnes — more than 60 times annual mine production. Gold is not consumed like other commodities. Peak buying seasons in major consuming countries such as India and China exert some influence on the market, but others factors such as the dollar and oil prices carry more weight