Gold on Lease: An ideal hedging mechanism? - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Gold on Lease: An ideal hedging mechanism?

Jul 10, 2012

With the growing middle class in India, demand for branded jewellery is expected to increase.

However, given the weak economy, demand has been slowing and is a cause of worry. To make things worse, the since jewellers import most of the gold they use, the falling rupee added to their woes. And of course, jewellers always have to contend with the volatility in gold prices.

This situation forces jewellers to find more effective ways to buy imported gold.

Traditionally, import of gold has been managed via inventory replenishment. In this approach, gold inventory is replenished on the same day as it is used to make jewellery and sold. Then, if the gold prices go up they purchase lesser quantity and vice versa. This method, to a large account, helps jewellers mitigate the gold price fluctuation risk.

However, given the severity of the challenge they are facing, jewellers are now increasingly moving to another option - "gold on lease or loan?" with hedging.

How does Gold on Lease work?

Jewellers use gold as raw material to produce jewellery. They can either purchase this gold from banks on loan or lease it.

If they buy, the gold sits as inventory on their balance sheets.

However, more and more jewellers prefer to lease the gold from banks. In this way, they hold no inventory, and so mitigate any inventory holding risks.

A jeweller usually leases gold from banks for a period of 180 days. A spot rate that varies daily is applied on the amount of gold they use each day. Then the jewellers settle with the banks at the end of six months. Any daily unused gold is hedged for a few days so any currency fluctuation risk is minimized or eliminated.

This gold on lease has many benefits.

The Benefits of Gold on Lease

Hedging mechanism: First and foremost, this scheme acts as a hedging mechanism against fluctuating gold foreign exchange rates. Since rates are determined daily as the gold is used, jewellers do not have the risk of buying larger amounts of gold and the price varying till it is sold. Here the gold is paid for each day as it is used.

No Inventory Risks: If gold is bought, the jeweller's inventory is valued on the constantly changing purchase prices. However, in case of gold on lease, there is no inventory, and so no inventory loss or gain occurs . Holding no inventory also protects against falling customer demand. Gold on lease from banks serve as a "just in time" inventory mechanism. With no inventory, jewellers also do not have the risk of losing inventory due to theft or natural disasters.

Lower financial expenses: Lease interest rates are normally in the 5% to 8% range. This is much lower than the 12-13% that banks charge for corporate loans.

Improved efficiency: With the gold on lease approach of holding no inventory, return on capital will be higher making the company more efficient.

Expansions: Players who usually would buy inventory for their new showrooms now benefit as they take the gold they need on loan.

All the above benefits greatly reduce risk and also improve the profitability of the company.

Does this make branded jewellers attractive?

The unpredictable global economy, and the dependence on gold imports have made it imperative for companies to hedge their commodity and foreign exchange exposures.

By procuring "gold on lease", jewellers find a number of benefits - hedging against fluctuation of gold prices as well as foreign currencies, carrying no inventory, paying lower interest rates for the gold they need, reducing pilferage and related risks and improving return on capital used.

It seems that more jewellery retailers are moving towards this approach of procuring gold on lease for these reasons.

And hopefully this gold on lease idea will make branded jewellers shine more attractively as investment options.


Equitymaster requests your view! Post a comment on "Gold on Lease: An ideal hedging mechanism?". Click here!

  

More Views on News

TRENT LTD Announces Quarterly Results (2QFY20); Net Profit Up 16.3% (Quarterly Result Update)

Nov 14, 2019 | Updated on Nov 14, 2019

For the quarter ended September 2019, TRENT LTD has posted a net profit of Rs 383 m (up 16.3% YoY). Sales on the other hand came in at Rs 8 bn (up 32.8% YoY). Read on for a complete analysis of TRENT LTD's quarterly results.

TITAN Announces Quarterly Results (2QFY20); Net Profit Up 3.8% (Quarterly Result Update)

Nov 7, 2019 | Updated on Nov 7, 2019

For the quarter ended September 2019, TITAN has posted a net profit of Rs 3 bn (up 3.8% YoY). Sales on the other hand came in at Rs 47 bn (up 2.1% YoY). Read on for a complete analysis of TITAN's quarterly results.

PC JEWELLER 2018-19 Annual Report Analysis (Annual Result Update)

Oct 18, 2019 | Updated on Oct 18, 2019

Here's an analysis of the annual report of PC JEWELLER for 2018-19. It includes a full income statement, balance sheet and cash flow analysis of PC JEWELLER. Also includes updates on the valuation of PC JEWELLER.

TRENT LTD 2018-19 Annual Report Analysis (Annual Result Update)

Jul 4, 2019 | Updated on Jul 4, 2019

Here's an analysis of the annual report of TRENT LTD for 2018-19. It includes a full income statement, balance sheet and cash flow analysis of TRENT LTD. Also includes updates on the valuation of TRENT LTD.

TCNS Clothing: Is this Retail Company Focusing on Women's Apparel Worth Betting On? (IPO)

Jul 17, 2018

With topline growth of 50% CAGR over a period of four years, should you apply to this initial public offer?

More Views on News

Most Popular

How to Buy the Best Safe Stocks in 2020 (The 5 Minute Wrapup)

Jan 17, 2020

Don't fall for the safe stocks narrative going around in the stock market these days.

Guess Which Stocks Are Rising at Double the Speed of Sensex (Profit Hunter)

Jan 15, 2020

These stocks can move twice as fast as the Sensex - to take advantage of their money multiplying power get in now as the rally is still just taking shape.. read more to not miss out.

For 1,000%+ Gains, Follow the 8-Year Cycle in the Stock Market (Fast Profits Daily)

Jan 17, 2020

This is how the biggest trading profits are made.

What the Infosys Results Tell Us About the Next Infosys (The 5 Minute Wrapup)

Jan 15, 2020

If you're interested in the next Infosys, I'll tell you where to look.

The Best Asset Class to Invest in 2020 (Fast Profits Daily)

Jan 24, 2020

Why I'm most bullish on this asset class above all else in 2020.

More

India's #1 Trader
Reveals His Secrets

Secret To Increasing Your Trading Profits Today
Get our special report, Secret to Increasing Your Trading Profits Today Now!
We will never sell or rent your email id.
Please read our Terms

COMPARE COMPANY

MARKET STATS