Gold price loses sheen tempirarily; government schemes fail to attract investors

London (Dec 27)  Gold had a washout year in 2015 as investor interest shifted towards riskier assets. Gold prices had witnessed an uninterrupted 12-year rally till the second half of 2011, but have been on a downward trend since. From its peak of $1,900 per ounce in September 2011, it has corrected to $1,050-1,100 per ounce. This was accompanied by slowing consumption demand.

In 2015, all factors worked against gold and a revival in its price. In fact, experts aren’t expecting things to change in a hurry. Here is why.

Dollar gaining strength

Gold prices shifted further down in 2015 as expectation of the US Federal Reserve increasing its benchmark interest rate gained strength. An increase in interest rates in the US will make its currency, the US dollar, more attractive, drawing more buyers. Since gold is priced in dollars, any gain in the currency will lead to a decline in the metal’s value. Naveen Mathur, head commodities, Angel Broking Ltd, said, “The US dollar has already gained thanks to the rate hike announcement by the US Fed, which has led to exchange-trade funds and investment funds selling gold. In turn, international prices are still bearish.”

To be fair, there was some respite as the rate hike expectations in the US shifted to December 2015 as a result of which, gold prices witnessed some reversal.

The World Gold Council, in its Gold Demand Trends Third Quarter 2015 report, pointed out that after reaching a low of $1,080 per ounce in July, the price of gold stopped falling and looked upwards again. Western institutional investors, such as hedge funds and asset managers, were the driving force behind the rebound, the report said. Due to some uncertainty, both on the financial markets front (think China) and geopolitical issues, global investors bought gold in the third quarter.

In India the situation was different as the rupee depreciated against the dollar. This matters because we import 90-95% of our gold requirement. So, a fall in the rupee against the dollar meant that the domestic price of gold didn’t fall as much through the first half of the year. While the fall may make the metal attractive for a buyer—price was at a high of Rs.34,000 per 10 gm in 2013, but is now at around Rs.25,000 per 10 gm—buying has not picked up. “Despite the uncertainties, gold demand hasn’t picked up substantially. More specifically, physical demand in India and China is still low. Expectation of a positive return from gold seems to have died out,” said Mathur.

A shift to risk

Another factor that troubled demand for gold was the shift towards risk. Priti Gupta, executive director, Anand Rathi Commodities Ltd, said, “Equity markets have done well and there is a positive outlook towards the world economy, except for China. Hence, money is shifting from gold to other assets like equity. At the moment, there is nothing to support prices. Buying from central banks, too, has gone down.”

Gold is considered as a hedge against inflation and a safe haven when capital markets get turbulent. However, as inflation heads lower globally and the capital markets aren’t under any unresolvable threats, the pull to invest in gold has reduced.

Furthermore, in the Indian context, there is increased awareness about various investment options. “Women who till now bought only gold as an allocation of surplus money are asking about returns and other securities that they can invest in. The landscape is changing and it’s unlikely that gold will reach its peak demand levels in a hurry,” said Gupta.

Monetising gold

In the Union budget in February 2015, the government announced two schemes aimed at converting the demand and stock of physical gold into paper gold. These were the gold monetisation scheme and the sovereign gold bonds scheme. These schemes became effective in November 2015. Although the response has been low, experts are hopeful that as the hurdles get smoothened out, the two schemes will do well and will help in lowering the consumption (and, hence, import) of physical gold.

The gold bond issue opened for subscription on 5 November. Essentially, this is a bond issue by the Reserve Bank of India (RBI) on behalf of the Government of India. Hence, there is safety and assurance of payment. The government will use these bonds to borrow funds from resident Indians. The objective is to develop these bonds as an alternative to buying physical gold by linking the face value of the bond to the price of gold. These are long-term 8-year bonds, and carry a coupon of 2.75% per annum to be paid every half year. The issue close date was extended to 30 November. Till the first week of December, the bond issue had collected deposits of Rs.246 crore.

The gold monetisation scheme is for those who have unused physical gold and would like to create value out of it by lending it to banks. Interest and principal payments on gold deposits under the scheme will be denominated in gold. The minimum deposit is 30 gm (995 purity). Interest on the deposit is 2.25-2.50%.

While appreciating the contours of both the schemes and the intention behind them, experts aren’t yet convinced that households will be willing to give up physical gold. But for institutional investors and institutions who own large amounts of gold, these could be beneficial.