A Market in Mint Condition: India Invests in Gold Coins

India’s seemingly insatiable and unending appetite for gold has long fascinated market participants. Such is the importance of the country’s wedding season and its major religious festivals that all physical gold commentators refer to them when analysing the global market. The average Londoner may not have any idea when Diwali occurs, but many gold market participants do.

Statistics alone cannot convey the scale of the buying: to truly appreciate how massive it is, it must be witnessed firsthand, as delegates of the LBMA Conference will have the opportunity to do in November. In any jewellery emporium in one of the main gold centres (see map) during a time of peak demand, hundreds of customers are crammed onto four or five floors stocked solid with jewellery. On one auspicious day this past September, there were 30,000 weddings in the city of Delhi alone. Before days such as this, it may not be physically possible to even enter one of these large stores.

In order to cater to this unparalleled appetite for gold, India must import considerable volumes of metal, as very little is produced domestically (see sidebar for details about import procedures).

According to GFMS data, on a gross basis India imported over 800 metric tonnes in 2005 (excluding some trade-related exports), compared to 533 metric tonnes in 2003.This substantial increase came about despite a sharp rise in price. It can mainly be traced to the usance letter of credit scheme, which effectively allowed importers to purchase gold at a discount to the London price by giving them an opportunity to arbitrage, one year forward, rupee and US dollar interest rates. However, the opportunity proved short lived: the government became so concerned about the amount of business being transacted that it changed the law to allow only 90 days of credit on gold LCs. This action, together with rising US dollar interest rates, killed off the arbitrage.

Even without interest rate arbitrage, imports for 2006 will likely be strong. Prospects look good for 2007, although a rise in price above $650 would likely trigger a buyers’ strike, causing imports to dry up for as long as three to six months, until either prices fell back or buyers adjusted to the elevated levels.

Oval coin depicting Lakshmi, Hindu goddess of wealth and beauty

A Problem with Purity…

A look at a breakdown of the forms of Indian gold consumption shows that one type of investment has had a stronger rate of growth than the others: while overall imports have shown 50% yearly growth over the last two years, according to GFMS data, coin has consistently outperformed other forms of gold consumption recently. For example, GFMS data for the third quarter of 2006 shows that demand for coin grew by more than double the rate of hoarding and jewellery (measured on a quarter-on-quarter basis – see chart).Meanwhile, the figures for silver demand as an investment class – traditionally popular among the rural classes – have decreased dramatically over the last two years, as these communities are now turning to the smaller denominations of gold coins.

Gold trading centres are located across India

In order to understand the reasons for this development, it is worth remembering that India has one of the world’s youngest populations, coupled with one of the fastest growing economies. Consequently, the standard of education is improving, and the new middle class has gained an increasingly international perspective. As a result, Indians are becoming ever more aware of the existence and advantages of alternative asset classes. These increasingly sophisticated investors are still purchasing gold – but with a difference.

Poor and rich alike in India have bought gold for centuries, as a product for both adornment and investment purposes. The tradition of giving gold jewellery at weddings and other ceremonies, combined with a poorly performing national currency, have contributed to elevating gold to this dual role.

Unfortunately, there has been another strong tradition in India – the quality of local jewellery was never guaranteed due to the lack of hallmarking. Indeed, 88% of the jewellers tested in a recent survey are selling gold at poorer quality than they advertise.

This problem has been addressed by the Bureau of Indian Standards (BIS), which sets quality standards for all products in India. It introduced a hallmarking scheme in 1999 on a voluntary basis, pointing out to the public through advertising that quality cannot be assured unless the gold is hallmarked. However, acceptance of the scheme thus far has not been widespread: although many reputable companies have signed up in an effort to stamp out inferior quality, the majority of the country’s estimated 100,000 jewellers are still not using hallmarking. Acceptance of the scheme would be broadened by setting up more hallmarking centres, as the service is not easily accessible to all jewellers across the country, and the government is rumoured to be considering the introduction of mandatory hallmarking of gold by 2008.

Because all Indian jewellery is supposedly 22-carat, consumers have been paying a premium for a product whose quality is not guaranteed. In fact, those buying gold jewellery are well aware that the meltdown purity of their purchases could be as low as 14 to 18 carat. Ironically, for a country that is synonymous with high-carat jewellery, the actual purity of it is very similar to that on offer in Western markets, such as Europe and the United States.

Photo courtesy of World Gold Council (www.gold.org)

Everyone’s Happy (Except, Perhaps, Jewellers)

Needless to say, many jewellers aren’t happy to see the shift to coins: they are losing business. Although jewellers are also often retailers of coin, the margin on coin is substantially lower than that on jewellery. Nonetheless, their future success may depend on how they adapt to this new trend, and whether an approved certification policy is more widely adopted.

In looking at the recent and forecasted success of gold coins, certain questions arise. Will ETFs succeed when they are introduced into India, or will investors shy away because they distrust paper gold? Although the market has traditionally been based on physical metal, the use of gold as collateral is widely accepted. ETF contracts will eliminate having to ship and store the metal, but investors will probably use a combination of the two, because taking delivery of physical coin has the benefit of anonymity.

Yet another driver of the investment phenomenon will be the issue of VAT uniformity, as states compete to offer the cheapest tax rates for storage. Significant progress has been made recently to impose uniform VAT across India, but there are still examples of tax competition.

The shift in investment towards coin is a permanent one, and one that carries many benefits for the Indian market. It brings gold into the reach of more consumers than ever before, thanks to the diversity of sizes, while giving consumers a form of gold that can be trusted to carry the stated purity. It also allows for more opportunities for gold to be used as collateral.

Over the long term, gold coinage should help to sustain or increase Indian demand for gold. Looking to the future, the Indian gold market will always remain extremely price sensitive, but whatever the ebb and flow of imports, it seems certain that coin’s position in the gold market will continue to grow.