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The Indian Gold Rush - Outside View

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The Indian Gold Rush
Jul 17, 2010

We are in a seasonally lull period when it comes to gold purchases, especially in India. No major festivals around the corner and the end of another marriage season ensure gold buyers remain at bay. However, contrary to the earlier statement, I witnessed one of the craziest gold buying frenzy recently!

One large jewelry shop was more packed than a Virar local at 6.00pm. I saw buyers scrambling to even get inside the shop and jumping over each other in an attempt to do so. The shops admin guys along with security were busy outside the shop trying to calm people down and were even issuing tokens to buyers to get inside the shop. There was hardly any place to stand at the counters and the sales people were struggling to entertain customers.

It was because the jewelry shop was offering a bargain - no making charges on gold jewelry.

In the normal course, this making charge tends to be around 8-10% of the total cost. Now, that's significant!

One thing that immediately caught my attention was what would an 8-10% correction in gold price mean? This was being offered at just one shop, a correction in price would mean a bargain throughout the country. This is what will support prices if there is a meaningful correction.

Yes, the jeweler did come up with the offer of no making charges and thereby giving buyers a reason to buy. But, the poor buyers didn't know that they were being ‘swindled' on account of higher gold price being charged.

Let me explain this to you in detail:
The converted gold price (from International spot gold prices and rupee rate plus the duties and taxes), the one used for arriving at real time fair value for Gold ETF was Rs. 1,863.20 for 0.995 purity (24 carat). If you deduct VAT that is included in pricing, you get a one gram price of Rs. 1,844.75.

Gold jewelry is usually made of 22 carat gold, hence you convert the above price to 22 carat, it will be equal to Rs. 1,699.52 per gram.

MCX gold price for the near month contract was Rs. 18,414 per 10 grams. If we convert this price to 22 carat equivalent, it would amount to Rs. 1,696.43 per gram.

But, the jeweler that was offering no making charges was levying a price of Rs. 1,805 per gram for 22 carat gold jewelry.

Comparison of prices: (price per gram for 22 carat gold, excluding VAT charges)
  Price in Rs. per gram
Real time Gold ETF conversion price* 1,699.52
MCX equivalent price for 22 carat** 1,696.43
Jewelers price # 1,805
Source: Bloomberg, Industry * price converted using09th July 2010 (Friday) closing International gold price and rupee rate
MCX closing price on 10th July 2010 (Saturday) for the August Contract #Jewelers price on 10th July 2010 (Saturday)
Note: Gold markets and currency markets remain shut on Saturday and Sunday and therefore Fridays closing prices prevail over the weekend.

The jeweler charged more than 6% higher than the actual prevailing price. All those buying gold in form of jewelry lost the moment they bought it. Knowing and tracking gold price closely, I questioned the sales person "Why are you charging such a high price?"

His answer was: "It's not higher; this is the price of gold. This is the price that we charge and you would find a similar price across all the jewelers".

Luckily, being in the gold market, I knew what the right price of Gold is.

The Confession
Even I was one of those who bought from that jeweler during the offer. It was out of compulsion following a cultural tradition driving the purchase.

Please do not take us wrong. Indeed there's no alternative to buying jewelry purchased for adornment purposes. Women in India have a high fascination for gold jewelry, as most men might testify, and there's no other substitute than to buy it from jewelers. Investors need to recognize the fact that there is a difference between buying gold for ornamental value, and buying gold as an investment.

Exercise prudence while investing
Owning gold is very important, and desirable, for all investors. But the ‘golden' question is - how should one invest in gold? The facts say that most of the investment in gold in India is in the form of jewellery. But that is not the best way to invest in gold.

As discussed above, when investing in gold through jewelry purchases, there are making charges, mark up (profit margins) and also high liquidation charges plus the risk of purity.

So, what does investment in gold via gold jewelry purchase sum up to?

10% making charges, 6-10% margins (on gold value), 5% liquidation charges (melting charges levied while selling back) and doubtful quality!

Would you ever invest in a mutual fund which charges 15-20% entry load, 5% exit load, and whose quality of investments is doubtful?

Of course not! The same way, investing in gold in the form of jewellery is not wise. In fact, it is probably the worst way to invest in gold due to the reasons discussed above.

Earlier, there were gold import controls that restricted holding gold in other forms forcing people to buy gold in jewelry as a mode of investment.

But, now the sector has been opened up, Indian prices move in sync with international prices and there are better options like Gold ETFs available for investments.

So, dear reader, please remember to purchase Gold ETF's for investments and jewellery for ornamental purposes only.

Disclaimer:
The Golden Truth is authored by Chirag Mehta. Chirag is Fund Manager - Commodities at Quantum Mutual Fund. Views expressed in this article are entirely those of the author and should not be regarded as views of Quantum Mutual Fund, Quantum Asset Management Company Private Limited and Equitymaster. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Equitymaster has not verified the facts contained in this column and it does not accept any responsibility for the same. Please read the detailed Terms of Use of the web site.

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