“The Sovereign Gold Bond Liability makes it logical for RBI to buy gold”
Somasundaram PR, Managing Director of the World Gold Council India, speaks to Paisabazaar.com in an exclusive interview about gold as an investment, rupee depreciation and and the growth of digital gold.
Q- The gold price has been stagnant for the past 5 years while equity markets have given double digit returns. Are there any reasons to be optimistic about gold in the next 5 – 10 years?
Ans – As you know, gold as an asset performs well when other assets perform poorly. Particularly when equity markets do not perform well and gold performs well, the correlation is negative. In the last few years, the equity markets have done exceptionally well including the equity markets in the US. That’s probably a key reason why gold price has not yielded the kind of returns that the equity market has done.
This is in fact how gold is supposed to perform. Gold is a hedge investment, an insurance against really difficult times and an insurance against the impact of monetary policies over the long term.
So we should not assume that the 5 year window is enough. Looking only at the 5 year period now you might say that returns from gold are low, but providing high returns is not gold’s purpose. If in the past 5 years equity has performed well, that doesn’t mean that in the next 5 years equity will perform well too. After all anything that goes up will have to come down at some stage. In the long term, gold as a hedge investment will perform well as it is correlated inversely with the equity markets.
Q- What do you see driving overall gold demand in the next decades – consumption or investment led demand? India’s gold imports are driven by consumption demand, have fallen considerably over the past five years.
Ans – If you really look at what drives gold demand, you will find that both gold consumption and investment play an important part.
As of now, jewelry is the more important segment both domestically and also globally. In India and China the contribution of consumption to overall gold demand ranges from 70% to 80% – that’s the jewelry demand.
But even jewelry demand in not completely consumption-driven. This is because people don’t buy jewelry just for the design of the ornaments. There is of course branded gold jewelry but still if you see how ultimately gold jewelry is purchased and sold, it is based on the weight of gold. Branded gold jewelry does feature slightly higher margins that unbranded jewelry, but the weight of gold is still the major cost of the purchase. Obviously, over time, other types of gold investments will grow but investment does not only mean bars and coins. If we only consider bars and coins as investment, then we will be making a very incorrect assumption about gold purchases. People who buy jewelry do use it for investment. Loan against gold is taken even by those in the lower end of the social and economic strata. Loan against gold jewelry in India is currently $28 billion.
There is investment intent even in gold jewelry purchases. Taking that into account, I would say that investment demand for gold will continue to increase.
Of course there are new players like pension funds, which are linked to monetary assets and subject to market-linked risks. Investments in such products may increase, it is happening in the West and I am pretty sure it will happen in India and China as well. So you will find that these two big so called “consuming markets” will add greater investment demand for gold going forward. In short, I am bullish on investment demand for gold in the future.
Q- Will continued rupee depreciation and its resultant effect on the INR price of gold make the precious metal an appealing hedge against currency depreciation?
Ans- Well, you see on the price front, there are two things happening. Internationally because the dollar is strengthening and equity markets are doing well, international prices are coming down. On the other hand, depreciation of the Indian rupee has caused gold prices to go up domestically. This is the reason you see gold prices hovering around 29-30k and we haven’t seen either a sharp drop like we saw in 2013 or a huge hike. In a way during the past few years, international gold price changes have been neutralized by local gold price changes. But even then I feel that in the long term, the ability of gold to act as a hedge investment will continue.
Q- But do you see that accelerating through the current bout of INR depreciation? After 5 years of relatively rupee stability, the picture has changed dramatically in the current year.
Ans – When it comes to gold you need to think long term. Short term movements in asset classes like bonds or equity can lead to massive sell offs, but to a large extent this does not happen with gold. Because gold especially physical gold is not traded as frequently, in fact, households that invest in gold treat it as a generational asset. Physical gold in households maybe be sold for raising money by selling it in times of economic distress but that happens relatively rarely and gold tends to be held for the long term even generations.
I do not think that the recent rupee depreciation will lead people to choose to hold gold over other assets. Let’s not forget, our equity markets are still doing well, so I do not the situation is the same as we saw in 2013. At that time, inflation was high, the rupee was depreciating and gold price dropped significantly, that’s not the case right now.
Q- RBI has bought gold for the first time in 9 years. Do you see this as a major contrarian signal for gold investors?
Ans- I wouldn’t say contrarian, we have always issued statements about Central Banks buying gold. We have seen that since 2010, Central Banks globally have been consistent net buyers of gold. Even big central banks like China and Russia as well as smaller central banks have been buying gold during the past few years. The Central Bank Gold Agreement in Europe which says that central banks will not sell gold, has been in place since 1997, and it continues to guide the behavior of the central banks in Europe. As globally central banks become net buyers, I don’t think RBI buying gold when its reserves have also increased is not something unexpected. The timing of the purchase is something for the central bank to decide. Also let’s not forget another thing, the government has issued the sovereign gold bond and they have issued these equivalent to 23 tonnes of gold. The central bank has bought only 8 or 9 tons out of that, so though it is significant that the Central Bank is buying gold that too in the open market instead of a block deal, I definitely do not think it is unexpected. Reserves of central banks need to grow. Every other central bank tends to do it, not just RBI.
We have a 23 ton gold liability in sovereign gold bonds so it is logical that RBI ends up buying some gold.
Q- What percent of an investor’s portfolio should ideally be in gold?
Ans- We recently released our “Gold as an Asset Class” Report, there you can see that it all depends on the risk that the investor’s portfolio has. The higher the investment risk of your portfolio, resulting from say greater exposure to equities than debt, the higher the proportion of gold you need in your portfolio.
This could be anywhere between 15-20%, depending on the risk of the portfolio
If you keep gold in your portfolio, it performs better in terms of both volatility and returns.
Q- Earlier only physical holding was possible, but now there is a plethora of options including digital gold. What are your thoughts on this?
Ans- Digital gold is also physical gold. That is something that we have to be very clear. People call it “paper gold”. Paper gold is sovereign gold bond. It is not backed by gold but by government guarantee instead. Digital gold is vaulted centrally by somebody else and you get allocated the gold, even though you might not take delivery, it is still your gold. That’s how digital gold is in fact physical gold in a dematerialised form. Basically instead of buying gold and keeping it in an almirah, you are keeping it in a central vault and can take it any time. I think this dematerialised gold is a good development and it just makes people comfortable holding gold in a central vault rather than with themselves. Digital gold actually has the potential to redefine monetization of gold assets. This is a better choice instead of asking people to come and get their jewelry melted, which they will never do.
Having the gold held by a custodian on your behalf in a central vault can also help you get it monetized a lot easily. You can almost instantly take a loan and you can transfer the gold easily this makes the use of gold a lot more productive for economic purposes. You can even lend the gold and earn interest. Just as money you keep with the bank can be lent to others, you can choose to lend the gold held by the custodian in a central vault to others. It is a very good development, makes buying of gold easier, it is easy to operate and the various value added features offered by digital gold have the potential to make gold a real asset class, just like any other investments you buy.
Q- Going forward do you see a significant shift from people buying gold physically to people buying gold physically but through digital means?
Ans – I don’t think digital gold will overtake physical gold jewelry. People will still love their physical gold, keep it in their houses, wear it, etc. I don’t think that physical experience of ownership can be compensated through digital means. But digital gold will definitely have its own space in the gold ecosystem and I think it is good for the economy.