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'Gold'en opportunity - Views on News from Equitymaster
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  • Nov 30, 2007

    'Gold'en opportunity

    Besides equities, there are two other asset classes that investors have shown an incessant appetite for over the last two fiscals. As most of you are aware, these were real estate and gold. While the former has been in flavour a couple of times in the past and has been evaluated as investment option, the latter is a recent addition to 'investors' portfolio' as opposed to being a 'consumption commodity'. Given that India is one of the world's largest gold consuming nations, in this article we look at the precious metal from an economic perspective.

    International gold prices began to pick up from 2001 and the year 2007 so far, has witnessed a sharp rise in the same. Gold prices crossed the US$ 700 per ounce mark in the beginning of 2007 and touched US$ 824 per ounce on November 23, 2007 (earlier record of US$ 850 an ounce set on January 21, 1980) (Source: www.kitco.com). Domestic prices of gold in India also showed sharp rise in tandem with the international trend. While the growing supply-demand imbalances is primarily responsible for the secular rise in gold prices, the weak US dollar and firm crude oil prices are attributed as the reasons for the recent spurt in gold prices.

    According to the World Gold Council, factors such as gradual firmness in gold prices and strong economic performances in the key consuming regions all helped gold to set records in 2QCY07. Global demand for gold jewellery showed the strongest surge, reaching a record US$ 14.5 bn in 2QCY07, a 37% YoY increase over 2QCY06, particularly with strong demand across the key gold markets such as China, India, the Middle East and Turkey. The supply weakness emanated mainly from the decline in old gold scrap.

    World gold demand and supply
    (Tonnes) 2004 2005 2006 1HCY07 CAGR
    Mine supply 2,070 2,464 2,106 918 0.9%
    Official sector sales 469 674 329 225 -16.2%
    Old gold scrap 849 886 1,106 579 14.1%
    Total supply 3,388 4,024 3,541 1,722 2.2%
    - Jewellery 2,614 2,707 2,279 1,272 -6.6%
    - Industrial & dental 411 427 452 231 4.9%
    Subtotal of above 3,025 3,134 2,731 1,503 -5.0%
    Bar & coin retail investment 338 385 383 244 6.4%
    ETFs and similar 133 208 260 33 39.8%
    Total demand 3,496 3,727 3,374 1,780 -1.8%
    Source: RBI Bulletin November 2007 * CAGR from 2004 to 2006

    The domestic scenario
    The price factor has a larger implication on consumption and trade in India, being a major consumer of gold in the world. A major share of India's imports is meant for catering to domestic consumption. Consumption demand for gold in India stood at 716 tonnes in 2006. India's gold imports in the last four years have shown a sharp rise, registering a compounded annual growth rate of 42% between FY04 and FY07, while prices in US$ terms showed an increase of 18% (CAGR) during the same period. While jewellery demand showed a decline (-11%) due to fluctuation in prices, demand for retail investment showed an increase of 44% in 2006 (Source: RBI Bulletin-November 2007.

    The latest data available from the Gems and Jewellery Export Promotion Council (GJEPC) showed a 22% YoY growth in the exports of gems and jewellery during 1HFY07. The surge in international prices of gold in the context of strong demand can be attributed to be a major factor for higher growth in export realisation during the current year.

    Vs the black gold
    In recent times there have been comparisons drawn between the two most sought after commodities - gold and crude oil. 2QCY07 witnessed strong revival of gold jewellery demand (89% YoY), as well as retail investment (98% YoY) (Source: RBI Bulletin-November 2007). During the same period, gold jewellery exports also showed a steady increase, partly reflecting the increase in gold prices.

    On the other hand, the 'black gold' or crude oil witnessed a tail off. Oil imports sharply decelerated during April to August 2007 (6% YoY growth as compared with 45% a year ago), on account of moderation in the oil prices. The average price of Indian basket of crude oil at US$ 68 per barrel during April to August 2007 was marginally lower by 0.6% YoY.

    The change in 'economic' perception
    The World Bank commodity prices data for 2QFY08 reveals that while energy prices increased by 7% YoY during this period, non-energy commodity prices increased by 13% YoY. Also, the contribution of gold and silver to the country's non-oil imports (increased from 15% in 2006 to 20% in 2007) was the second highest after capital goods (dropped from 35% in 2006 to 30% in 2007).

    While the demand supply trade off and price movement of the two 'precious' commodities will remain dynamic and sensitive to several economic variables such as growth rates, interest rates and currency movements, what needs to be understood is that neither is perceived as a mere commodity and will continue to evince considerable interest in determining the fortunes of several economic aspects such as currency rates and fiscal deficits.

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