Gold

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INTRODUCTION
Gold has been one of the most important metals that has occupied a major position in human's life; it was mainly used as jewelry and its use has developed along the history to include industrial production and investment. The precious metal has lost part of its brilliance after the Bretton Woods Agreement and the end of fixing currencies exchange rates in terms of gold. However and after the recent increase in gold prices, more research about the history of gold prices and reasons behind their rapidly increase were initiated seeking a clearer view of its behavior through the past years. These high fluctuations in prices that had a significant impact on local and international jewelry markets have raised a world wide debate about the future of its prices and whether it will keep rising to hit new levels.

HISTORY
International gold prices have risen almost unabatedly in the last few years, though there was one large correction in 2008. From July 2011 the pace of increase in gold prices has, however, accelerated further and in the third quarter of 2011, gold prices rose much faster. The spurt in gold prices which occurred in 2011 took place in the background of worsening of financial and economic scenarios initially in the US, followed by the debt problems in the European Countries. As a result of these adverse global developments and “flight to quality”, gold is emerging as a “safe” asset for investment purposes. The impact of the rise in international gold prices is reflected in its domestic prices as well. Despite the sharp recent price rise, in India, demand for gold has sustained, not only as a component of safe savings but also due to its social and cultural importance. Therefore, movements in gold prices in India are of keen interest to all segments of the society including investors. From the policy perspective, gold’s price rise has raised a concern as to whether a future crash in gold prices would have financial stability implications.

CURRENT SCENARIO

Gold futures in India, the world's biggest buyer of the metal, dropped over 8 percent on Monday April 15 to levels below 26,000 rupees per 10 grams mirroring losses in the world market. The key gold contract for June delivery on Multi Commodity Exchange ended down 8 percent at 25,665 rupees per 10 grams, after falling to 25,464 rupees earlier. In the overseas market, gold prices took a dramatic U-turn on Monday, reversing early gains to drop to a two-year trough after bullion futures fell on fears about central bank sales and holdings on global exchange-traded funds sank to their lowest in more than a year. The wedding season has begun in India and will continue till early June. Akshay Tritiya, the second biggest gold buying festival after Dhanteras, also falls in this period. Gold futures in India, which hit the lowest level in more than 18 months on Tuesday, may stage a recovery as key technical indicators point to the yellow metal entering oversold territory, according to analysts. Gold in India, the world's biggest buyer of the metal, has shed 21 percent from the record high of 32,464 rupees for 10 grams struck in November, spreading panic among investors and importers. The Relative Strength Index (RSI) for MCX gold is placed below 20. Normally, when RSI goes below 30, it tends to get oversold and a possible upward correction is seen.

The most-active gold for June delivery on the Multi Commodity Exchange (MCX) was 67 rupees higher at 25,701 rupees per 10 grams, after falling to a low of 25,270 rupees, a level last seen in late September, 2011. Buying is advised on dips to 25,300, with a stop loss of 25,100, targeting 26,000 rupees, said Thiagarajan. Global gold hit an 11-month high in October last year after the U.S. Federal Reserve announced its third round of aggressive economic stimulus, raising fears the central bank's money-printing would stoke inflation. But the gain was erased by a rally in equities, talks that the Fed could soon end its bullionfriendly bond buying programme, and concerns other indebted euro zone countries could follow Cyprus' plan to sell bullion reserves to raise cash. Gold prices on Saturday May 4 dropped by Rs 120 to trade at Rs 27,750 per 10 grams in the bullion market here due to subdued demand at prevailing higher levels. However, silver held steady at Rs 46,000 per kg in restricted buying from industrial units and coin makers. Traders said subdued demand at current higher levels kept gold prices under pressure. Gold of 99.9 and 99.5% purity fell by Rs 120 each to Rs 27,750 and Rs 27,550 per ten grams respectively. It had gained Rs 255 yesterday. Sovereign followed suit and shed Rs 100 to Rs 24,000 per piece of eight grams.

ANALYSIS

After giving fabulous returns for nearly a decade, gold has done the unthinkable. It has actually declined in the past six months! What has turned this safe avenue into a loss-making investment? The main reason for gold's short-term weakness is the rise of the dollar due to the economic crisis in Europe. The dollar has also moved up on the hopes that the US economy is emerging from its crises, which could nudge the Federal Reserve to withdraw the stimulus package earlier than expected.

For a poor country, India has expensive taste. It is the world’s biggest importer of gold – a pricey habit that has taken its toll on the country’s current account deficit. So is the recent tumble in the gold price just what India’s economy needs?

Much brainpower has been used in analysing the cause of this fall. Banks have turned bearish on the commodity. Cyprus announced last week that it will sell off part of its reserves. And the US recovery made equities a preferable choice. But in India, it is the consequences rather than the causes that are more interesting. The nation’s current account deficit, which reached a record 6.7 per cent of GDP in the three months ended in December, is widely considered the biggest concern for Asia’s second largest economy. And India’s insatiable appetite for imported gold is at the heart of the problem. Demand for gold grew from 679 tonnes in 2008 to 975 tonnes in 2011, since when the pace of increase has slowed. The government has tried to tackle the problem, raising import taxes and considering changing regulations so that less gold comes into India via the banking system. But the recent drop in gold prices could have provided the most effective fix. The falling price of gold has already begun to affect imports. Bombay Bullion Association president, Mohit Kamboj, told the Press Trust of India: “The imports of the yellow metal is likely to be 25 per cent less [in April] than the corresponding month last year as the gold prices are declining steadily. Usually, when the prices drop traders hold back in anticipation of further decline, while they buy when prices rise with the fear of additional increase in rates”. And India’s investors, who have been stocking up on the precious metal for years, won’t see this price drop as anything but good news. “A lot of investors have gold in their portfolio but they have physical gold coins or jewellery”, Kishore Narne, head of commodities at Motilal Oswal, told beyondbrics. “So this [price drop] doesn’t really destroy their wealth as fast as it would a derivative instrument. The proportion of gold in their portfolio is typically less than 10 per cent and lots entered gold in the last three to four years, so their purchase price is still below trading prices.” Indians’ love for gold is, indeed, a peculiar phenomenon where price isn’t necessarily important. M Sunderdas and Sons is a jeweller on Colaba Causeway in Mumbai. The quiet tinkle of wind

chimes in one corner and the slow smoking of incense draw attention to just how empty the shop is. Abishek Pherwani, 35, who works in the shop, told beyondbrics that demand for gold is currently at 20 per cent of its normal levels as customers only buy when markets are flat. But it doesn’t seem that this drop in prices is bad news for those that have bought the yellow metal in recent years. Quite the opposite. Pherwani says: “We aren’t getting calls for selling, only for buying as this is being seen as a good opportunity to get into the market.” Time to start stocking up, it seems. Plunging gold prices have prompted a rush to buy gold in India, the world’s most voracious consumer of the yellow metal. The drop in prices will also help the government, whose finances have been strained by the high cost of gold imports.

Madhu Walia has been looking closely at a range of gold bangles and chains at one of New Delhi’s largest retailers for precious jewelry. “Prices have fallen, so I am very much interested to buy," said Walia. "But design I have not liked.”

High demand
Amid the sharpest drop in gold prices in three decades on Monday, consumers started flocking to jewelry shops. Indians have a centuries-long cultural affinity to gold. Jewelry is gifted to brides on marriages and bought on auspicious occasions such as festivals. However, a five-fold increase in gold prices in the last decade had dimmed the precious metal's allure. Now, the nearly 20 percent plunge in prices since the start of the year has reignited India’s passion for gold. And, jewelers are upbeat. Sanjeev Agarwal heads the export division of Gitanjali Gems, one of India’s biggest jewelry chains. He says the drop in prices has come just weeks ahead of the “Akshaya Tritya” festival, May 13, considered by Hindus an auspicious day

to buy gold. “Definitely, definitely, [there is] significant increase in footfalls [customers] and enquiries and purchases. It has the benefit of the festival coming next month and also the fact that wedding season is on, so it adds to the quantum of purchases being done.” said Agarwal.

Good deals
There is also increased interest in the wholesale gold market in New Delhi, where traders are clinching more deals than in the past few years. The head of the Delhi Bullion and Jewelers Welfare Association, Vimal Kumar Goyal says orders from retailers have nearly doubled since prices tumbled.

He says people are getting nearly 20 percent more gold compared to what they would have received in their budget, compared to the start of the year. That has enthused customers.

Although business has been brisk in recent days, jewelers expect it to become even more so in the weeks to come. They say many customers are waiting to watch if prices drop further. They are people like Shipra Chabbra, who has come with her mother to a jewelry shop. “The anticipation is there will be more falling tomorrow or this week, so we are holding on, but that does help the decision, because you tend to save a bit more,” she stated.

No benefit for government
However, while jewelers may benefit from India’s affinity for gold, the government does not. Massive gold imports have strained government finances and prompted several policy measures to moderate gold demand in a country that imports almost all its requirement. Gold imports added up to a record $60 billion in the last fiscal year. That hefty bill has contributed to a worrying trade deficit.

Indian gold imports have been declining. They plunged by nearly 25 percent in the first three months this year. Rating agency India Ratings today said falling gold prices, if sustained, could significantly impair the asset quality of the gold loan portfolios of non-banking finance companies (NBFCs) and banks. It said the impact of the sharp fall in recent weeks could be absorbed by high profitability but more softening of domestic prices would make a larger part of the portfolio vulnerable. Companies with significant exposure to gold loans could, thus, be impacted severely.

Muthoot Finance and Manappuram Finance are two large NBFCs which give loans against gold. Some South India-based lenders such as Indian Overseas Bank and Indian Bank also have a significant gold loan portfolio. In such debt, the loan to value (LTV) ratios are high, due to intense competition to gain market share, said India Ratings.

Though the Reserve Bank of India had capped the LTV for gold loans at 60 per cent of the value, liberal interpretation of the LTV (including making charges) had moved it to over 80 per cent in some cases, it said.

High LTVs, with largely bullet repayment structures (principal and interest paid together) in the sector, leave limited cushion for a correction in the value of security, it said. By its own assessment, a sizable proportion of gold loan dues (principal + accrued interest) might already be close to the realisable value of the collateral and further accrual of interest on these.

Recently Manappuram Finance had declared falling gold prices would mean it faced reversals of interest and it would book a one-time quarterly loss in the fourth quarter of 2012-13.

A further 10 per cent correction in gold prices in the near future could result in a majority of loan amounts due being higher than the realisable value of collaterals, resulting in increased possibility of losses, said India Ratings. It said the impact of falling gold prices could be felt across the sector. Gold loan NBFCs were more vulnerable than banks, despite similar LTVs at the time of disbursal.

Among the banks, South India-based private sector banks are likely to be more impacted, primarily due to the higher proportion of gold loans in their books, said Prakash Agarwal, associate director (banks) at India Ratings, in a note. He said the agency was reviewing the gold loan portfolios of rated banks and NBFCs, to evaluate the impact on the fall in gold prices on profitability.

Gold loan NBFCs could also see pressure on business growth, as banks will become cautious in lending to them, creating liquidity pressures if the fall in gold prices is sustained, he said. However if gold prices bounce back in a short period, these concerns might not materialise, said India Ratings.

The current slide has exposed the vulnerability of loan portfolios, disbursed primarily on the basis of collateral values, with limited consideration for underlying cash flows, the rating agency added. “For such portfolios, the ability to liquidate collateral in a timely and profitable manner remains of primary importance,” it said.

To Buy Gold or Not?
Should you buy gold or not? That’s the question and everyone seems to have an answer. Unfortunately they’re never the same. Some analysts fear the low prices of Gold that we’ve seen in the past month will surely signal another recession. Others say that it was just a fluke and justify it by the fact that the price of gold is improving. Slowly yes, but still improving. Gold prices are currently up $22.00 to $1,475.60 an ounce. Considering it was well below $1,400 an ounce this time two weeks ago, many investors are breathing a sign of relief as it’s steadily rising. If this trend continues, gold will be over $1,500 an ounce in no time. What investors need to understand is that like with anything, gold will have their good days and bad days. Stop-losses will occur and profits will be made. But no way is it a “sure thing” that if

you invest in gold you will come out richer than you ever thought imaginable. If you come into the gold business expecting it to be easy, than you’ve been sorely mistaken. If gold prices increase what’s the point? Everyone would be owning stakes in gold. Fortunately or unfortunately, as an investor you must take the good with the bad. Investors today are learning that the hard way. But hopefully they will forget their current sorrows when gold eventually gets back up to trading at $1,800 an ounce in the future.

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