Vijay Kumar Gaba

 Five months ago, I had highlighted the likelihood of a trading opportunity emerging in gold. (see here) The opportunity did present itself, though not exactly in the manner I had anticipated. Nonetheless, the gold prices rallied about 19% in USD terms; from a low of USD1630/oz in early November to a high of USD1950/oz in early February.

Since peaking out in early February, the gold prices have corrected about 7% in USD terms. It would therefore be pertinent to ask what traders and investors should be doing with their gold positions.

It has been my long standing view that gold is no longer an investment asset. (for example see here and here) The view is even strengthening with each passing year. I believe that it is highly unlikely that gold will stage a comeback as a widely accepted medium of exchange (gold standard); and it will be gradually phased out as a store of value as better digital options emerge.

In this context, the latest report of the World Gold Council (WGC) presents some interesting data that needs to be noted.

Demand structure of gold demand is changing

WGC highlights some important changes in the demand structure of gold in the past three decades.

·         The consumption demand of gold has declined structurally.

·         Gold demand in paper form (ETFs etc.) has turned negative in the post Covid period.

·         Demand for gold in bar and coin form has been sustaining since the Global Financial Crisis (GFC).

·         Central Bank demand that was negative for two decades has been sustaining since GFC.

It is therefore clearly evident that the demand for gold for social security, vanity and social status purposes is on the decline structurally.

Share of India and China in global gold demand peaking

India and China had emerged as major growth drivers for global gold demand during the 1990s and 2000s. The combined share of China and India in global gold demand had increased from ~20% in 1992 to ~55% in 2008. Post GFC this share stagnated and has declined to less than 50% post Covid.

Central Banks major buyers since GFC

In the post GFC period central banks have been a major driver of the global gold demand. The banks which were net sellers of gold in the 1992-2008 period, turned net buyers of yellow metal, buying close to ~1200tonne in 2022. Apparently, the unprecedented money printing prompted the global central bankers to diversify their reserves away from USD and EUR.

The major surge in central banks’ gold buying was also driven by the demand by central Asian and East European bankers for the fear of NATO sanctions.

Now since most central bankers are pursuing a policy of quantitative tightening and inflationary expectations are well anchored in medium term; the bond yields are expected to stay higher for longer; the sanctions on Russia and allies have failed to show the desired impact; global consumers continue to remain under severe cost of living stress; demographic indicators continue to deteriorate in the developed world and showing signs of population peaking in China; there are few demand driver for gold to sustain the current prices.

The short term trading opportunity in gold is therefore over in my view. The medium and long term outlook for gold continues to remain weak.

 The classical Bollywood blockbuster Mother India (Mehboob Khan, 1957), was one of many Indian movies of that era that exposed the ugly realties of Indian society, especially feudal dominance, repression of destitute, and exploitation of women. But made Mother India a classic was the courage and grit of a destitute woman, who stood not only against the oppressor but also against her own son who decided to rebel and take the path of crime and violence. One particular instance from the movie that has stuck to millions of minds is about the pledge of gold bangles by the protagonist Radha (played by Nargis) to the unscrupulous money lender Sukhi Lala (played by Kanhaiya Lal) to repay an old debt. In the end, the rebel son of Radha, Birju (played by Sunil Dutt), attacks Sukhi Lala’s household and forcibly takes the bangles and kills Lala to avenge the atrocities done by him to his family, especially his mother. The pair gold bangles thus became the symbol of feudal repression, women exploitation, rebellion by poor and oppressed, and revenge.

Traditionally, gold has been an important means of social and financial security for rural and semi urban population in India, due to poor availability of banking facilities. The success of financial inclusion program in past one decade (especially in past 6years) has however changed the things in many respects. Gold has emerged as key collateral for working capital and emergency credit in past one decade. Though still there is no dearth of exploiters like Sukhi Lala and oppressed like Radha in hinterlands, but conditions have improved materially from 1950s and 1960s. Especially in past one decade, the business of gold loans in organized sector has recorded remarkable growth. Lower rates, easy access, convenient and fast disbursal has made gold loans popular amongst the middle and lower middle class households.

A recent report published by World Gold Council (WGC) highlighted how gold loans are helping Indian households to weather storms, like global financial crisis (2008-10) and Covid-19 (2020).

The following points highlighted in the report are noteworthy for investors, especially the investors in gold loan companies.

·         As of 3Q2019, 52% of investors owned some form of gold, with 48% having invested in the 12 months preceding 3Q2019. The average Indian household holds 84% of its wealth in real estate and other physical goods; 11% in gold and rest 5% in financial assets. Dependence of rural households in physical assets such as gold has been a result of not just love of gold, but also poor banking penetration till lately.

·         Digitalisation of economy and e-commerce penetration are fundamentally altering the age-old scenario, so an element of option beyond gold and real estate in asset portfolio is setting in – though this may take time and may need some catalyst to show tangible results. As of now, love for gold and a window to accumulate wealth without much of the disclosure that financial assets ensue, keeps gold central in rural wealth.

·         Gold loans are popular in both urban and rural areas. They compare favourably with personal loans regarding quicker processing time, no requirement of income proof or prior credit history, and low processing fees. With such advantages, the overall gold loan market has grown from INR 600bn (US$12.6bn) in FY 2009-10 to INR 9,000bn (US$122.6bn) in FY 2019-20, a compound annual growth rate (CAGR) of 31.1% over the last decade.

·         Unorganised gold loan market still accounts for 65% of the gold loan market but organised gold loan market has grown with the market penetration and geographical expansion of financial service institutions and financial inclusion.

·         Gold jewellery kept as a collateral against gold loan by top three gold loan NBFCs (Muthoot Finance, Muthoot Fincorp and Manappuram Finance) totalled 298.8t at end of FY20. The combined gold holdings of these three NBFCs would rank in the top 20 gold reserves of central banks and supranational organizations.

·         Gold loan NBFCs became a de facto choice of consumers during 2006-10 due to their convenience, quick disbursals of loans, and lower interest rates. The growth was also supported by rising gold price during the period.

The organised gold loan market has opportunity to grow with collateralised gold holdings of 1,280t, equivalent to approx. 5% of the total outstanding gold stocks in India. The organised gold loan market can continue to provide lending against gold jewellery both to individuals and small businesses, potentially helping to meet their financing needs. Technology has also become a key enabler in spreading the reach of gold loan business, increasing the penetration of financial inclusion through gold loan industry. The digital offerings in the form of online gold loan (OGL) scheme had become popular since inception.

·         Technology can become a key enabler in the growth of the gold loan market in India. Gold loan NBFCS have already embraced online gold loan scheme which has increasingly become popular since its launch. But more can be done in this area with launching of self-servicing kiosks in branches and public location, launch of gold valuation machine. e-KYC and loan disbursement and repayments using e-wallets and prepaid cards.

S&P expects NPAs to rise

The rating agency S&P Global, has cautioned that the Indian bank NPLs will rise to 10%-11% of gross loans as forbearance is phased out. The rating agency however believes that Top-tier private sector banks and finance companies have sufficient capital buffers but public sector banks would need more capital to tide over the crisis.

“India financial institutions will likely have trouble maintaining momentum after the amount of new nonperforming loans (NPL) declined in the first half to Sept. 30, 2020. S&P Global Ratings believes forbearance is masking problem assets arising from COVID-19. With loan repayment moratoriums having ended on Aug. 31, 2020, we expect to see a jump in NPLs for the full year ending next March.”

Monetary policy at critical juncture