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Posted On Thursday, Oct 31, 2013
Gold is innate to Indian culture. This trait is best reflected during times of festivities when people flock to the streets to buy a piece of the yellow metal bringing the touch of auspiciousness to the occasion. Although gold buying is often tagged to the fulfillment of cultural and religious practices, in reality, its economic underpinnings that drive this behavior. For the rural masses, it`s one of the only means of saving and storing wealth. For the urban masses, it`s a store of value and an excellent means to diversify their portfolios.
Will this time be different?
A lot of gold gets consumed in India during the last calendar quarter which holds a series of festivals and also the onset of marriage season. Dhanteras which marks the beginning of Diwali is observed as the biggest gold buying day.
However, the economic slowdown coupled with high inflation is likely to strain consumer budgets this season. Will this deter consumers who are going for gold?
Much of the buying of gold happens in the rural areas which would have likely seen a boost in their incomes on buoyant output supported by good monsoon this year. Since many do not have access to other avenues, may seek gold purchases as a means of savings.
Investments related to gold may likely happen despite the risk involved investing in it.
Also, purchases related to marriages are unlikely be deterred. In India wearing gold is very closely associated with celebration.
A High price to Pay
Most of the buying seems to be "compulsive buying" and is unlikely to be restricted.
Government efforts to bring the surging current account deficit (CAD) under control have resorted to measures that include a quasi ban on gold imports. They have tied imports to the capacity to export under the 80/20 principle which means that you have to export at least 20% of what you import. Looking at the numbers, we really don`t seem to have enough exports to support our consumption needs through imports. This results in a huge supply demand imbalance.
The supply demand imbalance becomes acute during periods of high demand resulting in premiums. Currently, there`s a dearth of availability of physical gold supplies leading to very high premiums in the domestic market. Buyers were already straining on account of high duties and taxes that exceeded 11% over and above the international prevailing prices and now the high premiums are worsening the issue.
If the supply situation doesn`t ease, the premiums can further escalate resulting into additional burden on gold purchases for a consumer who is already stressed with worsening economic conditions and high inflation environment.
Shooting the Messenger
Gold is not the problem but is really a symptom. Increased gold consumption is a signal of imprudent policies prevailing in a country thereby driving people towards gold consumption.
The relentless pressure on the rupee is a constant reminder of the fact that we are running an unsustainable CAD . This has made us hostage to the FII inflows and flow of global risk appetite.
We need to accept the fact that CAD is India`s structural problem, not merely a cyclical uptick driven by strong domestic growth. The data should make this abundantly clear. In 2011-12 we posted the lowest GDP growth rate of 6.5% in the last nine years. Yet, we simultaneously recorded the highest CAD-to-GDP ratio (4.2%) in post-independence history. In short, the CAD is not the result of high imports to fuel high growth - it is instead a manifestation of unsustainable structural imbalances. (Source: Economic times)
Going further, a simple analysis of the inter-linkages between savings, investments and the balance of payments` CAD shows that the predominant component of savings is India`s domestic savings. The India growth story of the 2000s was fuelled essentially by domestic and not foreign capital. There is disproportionate policy focus on foreign capital inflows, rather than on domestic savings. While the objective at the present time is to stimulate domestic savings, there is a great divide between what should be done and what is being done.
In India, inflation is raging and interest rates are not high enough to offset inflationary pressures. In a situation of stock market volatility and inflation has hits savers, it is no surprise that intelligent savers can look to diversify their portfolio by flocking to gold. It is really unfair to punish gold buyers without providing them with options.
An efficient alternative
Buying physical gold mainly in the form of jewelry has been the usual course. Prior to liberalisation of the gold market, gold purchases in form of Jewelry were the only thing permissible and therefore has emerged as a habit. And it still continues for most of the masses even after knowing that gold in such form would attract costs like wastage charges, making charges and the costs /profit margins of those running the jewelry store. It is quite understandable for those who wish to purchase gold to wear as jewelry or for those in rural areas who do not have other means to continue the traditional way.
As transformations usually happen during a crisis, the additional burden in form of duties, taxes and premiums should help alter this behavior and may move the market towards efficiency. Today, comparatively efficient forms of buying and owning gold like Gold ETFs have become available which can save a lot of additional costs/ charges associated with the traditional form of buying through the jewelry route. Of course, the investor would have to bear the premiums prevailing in the physical market as the gold ETFs compete in the supply constrained market to obtain their supplies, but the investor can still save additional costs and thereby may manage within their budgets.
All in all Gold ETF`s have several advantages over physical gold. However, investors should consult their financial advisor before making a decision whether it will be a suitable investment for them as per their financial requirements.
We wish you an auspicious and efficient festive season!!!
Data Source: Bloomberg, World Gold Council
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The views expressed here in this article are for general information and reading purpose only. The views expressed here do not constitute any guidelines or recommendation on any course of action to be followed by the reader. The views are based on the publicly available information, internally developed data and other sources believed to be reliable. The views are meant for general reading purpose only and are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the readers. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and opinions given fair and reasonable. Recipients of this information should rely on information/data arising out of their own investigations. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. None of The Sponsor, The Investment Manager, The Trustee, their respective directors, employees, affiliates or representatives shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including lost profits arising in any way from the information contained in this document.
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