Tuesday, October 20, 2015

How Gold bonds would win over physical Gold?

Last few years Gold as an asset or investment has not done well, it had negative returns. Though demand and supply decide the price equilibrium for most commodities, Gold’s value depend on multiple factors. It is an alternative currency, so it has inverse relationship with US Dollar. When dollar does not do well, Gold will do better and vice versa. In the last few months, Dollar is gaining so Gold is not. US Fed is set to raise rates and most of the developed world is facing deflation (not inflation) are the other reasons for poor performance of Gold.

Looking at India as consumer base, we import around 1,000 tonnes of Gold every year. That is approx. $40 B of import bill a year. Majority (60%) of that goes to making of jewelry. Around 30% is in the form of bars and coins which is the target market for Gold bonds. Govt. aims to reduce the physical gold bought for investment purposes with proposed bonds and save precious forex. If Govt. and RBI succeed with this plan, India would save around $10-12 billions of imports a year which would reduce our trade deficit by 10-15% a year.

This has some hidden benefits that intrigue me. India is one of the biggest gold buyers in the international market. And if we reduce it by 30% (or 300 tonnes bars and coins), it would impact the demand situation of gold (global demand is around 4,000 tonnes/year) and it may result in softness in price. Other benefit is, reduced import bill will help Rupee. This would mean, Gold price in Rupee terms have higher chances of remaining where they are or soften rather than see an appreciation.

This would mean last few years bad performance in Gold would continue for some more time. And the Gold Bonds offering a consistent and positive return would become an advantage over owning physical gold. I have a wishful thinking that consumers will surely notice this and if they curb some jewelry demand too (and start giving a mix of gold bonds and jewelry as wedding gifts), it would reduce gold imports further.

India has around 20,000 tonnes of Gold with its citizens. As Gold’s bad performance is about to continue and due to that, if some of this reserve gold comes into trading market for monetization, the need to import Gold further reduces for India. Though this trend may take long time to catch up, it is not completely improbable and when the time comes, momentum will be difficult to stop.

The summary is, gold bonds will keep the gold prices in check and reduce the pressure on Rupee. When and how this gold bond scheme will be implemented is something we need to wait and watch.