‘Tactical allocation to gold may go up if uncertain times continue’

How will the current environment affect gold as an asset class?

Income contraction amid higher gold prices leading to a prolonged period of low consumer demand will affect gold. In India, we could also consider an optimistic scenario where a credible set of reforms are rolled out after the crisis, a la 1991, and the second half of FY21 could see a big step-up in economic growth, with a positive rub-off on gold demand.

We believe that recent volatility in gold prices has been driven by massive liquidation across all assets, and likely magnified by leveraged positions and rule-based trading. Gold has also likely been used to raise cash to cover losses in other asset classes.

The deceleration in economic growth will undoubtedly impact consumer demand and gold’s volatility may remain high, but high-risk levels combined with widespread negative real rates and quantitative easing will support gold demand as a safe haven.

What are India-specific factors that will have an impact on the price of gold?

India is the second-largest consumer of gold globally, but the industry is a price taker, as a combination of factors such as unorganized trade set-up, negligible export performance on gold, consumers’ indifference to price transparency and purity due to overwhelming cultural affinity and a desire to evade high taxes on gold, have resulted in under-developed standards and infrastructure.

Imports in March 2020 were a washout and sales stalled, while weddings got rescheduled due to the lockdown. This is reflected in local discounts on gold prices. We anticipate this summer season, starting with Gudi Padwa and Akshaya Tritiya, to be subdued. Things might ease late in the September quarter and we may see a rebound during Diwali. However, recycling of gold and loans against gold jewellery will jump significantly once the markets open. This will be a good time to allow banks to buy back gold and will be a great start to the Gold Monetization Scheme too. The existence of the grey market can have a deleterious effect on organized and compliant entities. It limits India’s potential to play a meaningful role in exports and doesn’t allow us to become the “jeweller to the world”, leveraging our vast karigar network.

It is advised that investors should invest only 15-20% in gold. Should investors consider a tactical increase in the current situation?

Our extensive analysis has illustrated that a range of 6-17% of gold allocation to an Indian rupee-based portfolio will boost risk-adjusted returns and deliver tangible improvement on a sustainable, long-term basis. This is based on back-testing studies of portfolio performance and, is typically, a long-term proposition. Gold is inversely correlated to most assets such as equities and bonds which have an annual coupon or dividend yields.

Gold provides liquidity with no credit risk, acts as an excellent diversifier and improves the overall portfolio performance. It brings stability and generates higher risk-adjusted returns, especially in times of uncertainty. We should see higher tactical allocations if the uncertainty and volatility continue. The current crisis is unprecedented and gold has a critical role in a typical portfolio, depending upon one’s risk appetite, time horizon and return requirements. Given the global and financial uncertainty, low-interest rates and debasing currencies, gold is expected to have a good run in the coming few years.

There have been disruptions in gold ETFs in India with some funds suspending lump sum investments. What can be done to prevent such disruptions?

Gold ETFs have temporarily halted further inflow of investments as physical gold vaults have closed due to the lockdown. Gold ETF subscriptions would open up again once the lockdown is lifted. The current situation serves as a good reference point to have a solution in place when the movement and storage of physical gold is restricted. A functioning spot exchange could have eased trading issues and enabled ETFs to source gold, albeit in a limited manner, within BIS’s good delivery framework.

Digital gold is becoming popular. But there are no regulations around it which increases the risk for investors. Where do the risks lie and what would you see as reasonable regulations to protect investors’ interests?

Digital gold is physical gold bought or sold through a convenient digital gold service provider. It enables micro-savings which will be a boon for small investors who can’t buy a gram in one go, you can accumulate gold with as low as ₹1 every time you buy. So it is to be encouraged. The current digital entities, MMTC PAMP and SafeGold operate through a variety of digital platforms, from banks to NBFCs and e-wallets. Their unique advantage is that gold sold by them is allocated and belongs to the customer instantly. However, this is bound to pick up and could attract fly-by-night operators unless guidelines are issued and a regulatory framework established. Gold must be “allocated” physically with an independent custodian. It should not just be a “promise”, that is key. In addition, customers’ interests must be protected by disclosures on price, purity, delivery charges and others. Gold bought by any customer must be “insolvency proof” from the provider to eliminate risks we have seen in jeweller schemes in recent times.