RAPAPORT... Despite the numerous factors pressuring gold, Indian consumer demand for the yellow metal picked up toward the end of 2012. Gift giving during Diwali and purchases for the wedding season helped boost jewelry spending, salvaging what would otherwise have been a relatively lackluster year. According to the World Gold Council (WGC), jewelry demand for the July to September quarter of 2012 rose 4 percent year on year to $7.23 billion, while investment demand in India, the world's largest gold market, increased 8 percent to $4.62 billion.
But what are the prospects for 2013? With continued price volatility, government measures to curb gold buying and new banking restrictions – not to mention persistent economic uncertainty on both the domestic and global fronts – forecasts are mixed regarding gold's performance in the year ahead.
Consumer demand was subdued during the first half of 2012. In March, the Indian domestic jewelry market underwent an upheaval as the government doubled the import tax on gold and imposed a 1 percent excise duty on unbranded jewelry. Jewelers across the country protested and went out on strike for three weeks in opposition to the measures. They re-opened their showrooms only after the government promised to review the tax measures. Eventually, the excise duty – a type of tax charged on locally produced goods – was rescinded, but the import duty on gold remained at 4 percent. This chaos this was estimated to have caused the industry resulted in a loss of some $200 million in turnover.
Weak consumer sentiment coupled with fewer wedding occasions further added to jewelers' woes in the first half. Things began to change in the third quarter when a late recovery in rainfall during the annual monsoon season lifted consumer sentiment, prompting jewelers to increase their inventories for the wedding and festive season in the fourth quarter.
A pick up in consumer demand, a weaker rupee against the U.S. dollar and the uncertain global economic environment pushed gold prices to an all-time rupee high of more than INR 32,500 ($500) per 10 grams in 2012. Despite record prices, jewelers reported comparatively higher demand for gold and jewelry during the festive and wedding season. But as usual, when prices rise, volume takes a beating. Sales of gold and jewelry were no exception – higher prices weighed on retailers' sales volume as consumers curtailed quantity purchases.
Prices have retreated slightly since hitting a record high in rupee terms and in mid-January gold was hovering at around INR 31,000 per 10 grams in India. On the international market, the price of gold is approximately $1,675 per ounce. Prospects for jewelers look better for the first quarter of 2013 as far as consumer demand is concerned, partly due to the wedding season and the uncertain economy.
IMPORT DUTY LEADING TO GOLD SMUGGLING
There is growing dissidence among the local jewelers about the 4 percent import tax on gold, which has caused a surge in smuggling activity. Bachhraj Bamalwa, the chairman of the All India Gems and Jewellery Trade Federation (GJF), stated that the increased import duty has led to increased smuggling activity. In response, the industry has requested that the government reduce the tax by 2 percent.
However, the government is unlikely to cut the duty. It is bent upon curbing imports of gold, which is affecting the country’s current account deficit — which occurs when a country’s total imports of goods, services and transfers are greater than its exports — and exerting downward pressure on the rupee. India's current account deficit widened to $22.3 billion in July to September 2012, up from $18.9 billion in the corresponding period of 2011. As a proportion of gross domestic product (GDP), the current account deficit was at record high of 5.4 percent during this period, up from 4.2 percent the previous year.
“The government won’t even mind gold getting into the smuggling route. They will deal with it. But right now the current account deficit is hurting them badly. That’s the main concern,” said Gnanasekar Thiagarajan, a director at Commtrendz Risk Management Services. He added that when the government makes its federal budget announcement for fiscal year 2014, due on February 28, it might increase the import duty on gold still further.
The government achieved some success in curtailing imports. From April to September of the 2013 fiscal year, India's imports of gold and silver declined to $21.3 billion, approximately a 33 percent year-on-year decline. The Reserve Bank of India (RBI) has also tightened the regulations for non-banking finance companies lending against gold and barred banks from financing gold purchases in any form other than working capital finance. To tackle smuggling, the federal government recently issued a directive to step up vigilance on international borders.
Further measures, such as introducing gold-backed financial products and a new class of investment instruments with tax sops, are in the pipeline that could help the government attract those consumers who purchase gold for investment only. However, jewelry demand will likely remain unaffected by these changes due to Indians' love for the product. “The usual physical demand will continue in India, but the extra demand – which is on the back of investment products like ETFs and bars and coins – might come down going forward,” Thiagarajan noted.
As far as rupee depreciation is concerned, analysts expect some stabilization this year due to the decline in gold imports and various reforms announced by the government designed to attract foreign investment. The rupee declined for the second consecutive year in 2012 after it fell by over 3 percent, but in June it recovered from its all-time low of INR 57.32 to the dollar. In mid-January the rupee was hovering at around INR 55 to the dollar.
Thiagarajan said that in light of the country's general election next year, the government might announce a popular budget for 2014. “All this will be good for the stock market and people who have been putting money in gold as a safe haven investment will start moving money into equities,” he noted.
In the fiscal year that ended March 31, 2012, India’s gold imports jumped to some $56 billion, up from only $4.1 billion ten years ago, in fiscal 2002, creating a huge burden on the balance of payments and accentuating the deficit. The Associated Chambers of Commerce and Industry of India (ASSOCHAM) has warned that India’s gold imports could reach $100 billion by fiscal 2016 if the government does not monitor inflow more strictly. In the New Year, the government appealed to people to moderate their demand for gold, which is the biggest contributor to the nation's import bill after crude oil.
Are there alternatives other than the above mentioned measures that the government can look at to cut down gold imports? Certainly, according to Bamalwa. He suggested that the government come up with an amnesty scheme to recover gold held by Indian households, which comprises of an estimated 20,000 to 25,000 tons. According to Bamalwa, if the government could bring 10 percent of that amount onto the market, India would not need to import any gold for the next three years.
One way or another, the government – seeking to curb its worsening deficit – will certainly do everything possible to discourage gold buying. “I may add that we may be left with no choice but to make it a little more expensive to import gold. This matter is under [the] government’s consideration,” warned the finance minister, Palaniappan Chidambaram. There is fear among industry players that the government may hike the gold import duty by another 2 percent in February's budget announcement.
EVOLVING CONSUMER PREFERENCE
Consumers' taste in and appetite for jewelry has evolved over the past few years with rise in disposable income, changes in lifestyle, exposure to media and brands. But surprisingly, only certain established jewelers seem to have managed to catch customers' fancy as the Indian jewelry market largely remains unorganized.
Is evolving consumer preference a threat to jewelers, or an opportunity? If they adept to trends and satisfy customers' needs, this evolution presents a major business growth opportunity. But jewelers who don't adapt quickly risk losing business and falling behind their competitors.
Twenty years ago, it was mainly the elite class that would buy diamond jewelry. But slowly the upper middle class also became consumers and now the trend is gradually spreading throughout the rest of the middle class. “Consumers used to buy heavyweight, plain jewelry but now they are purchasing lightweight jewelry, mainly diamond-studded. This is because gold prices have risen significantly and [the] consumers’ lifestyle has also changed,” explained Bamalwa, adding that consumers are looking mainly for jewelry set with small-sized diamonds of lower color and clarity.
There has also been a shift in the customers' mindset, as the majority of consumers are now both design conscious and have brand preference. “They have become very selective now. They know what they want to buy. That is a big change that we have seen,” noted Divyesh Shah, the group head of retail business at Tribhovandas Bhimji Zaveri (TBZ). “The demand for diamond jewelry is growing fast compared with [demand for] gold jewelry.”
MAINTAINING MARGINS AMIDST PRICE VOLATILITY
Evolving consumer taste in jewelry amidst a volatile price environment has added to jewelers' difficulties in maintaining their profit margin. But many have adopted new tactics to both maintain margins and keep consumers happy. An increasing number of retailers are now buying “gold on lease” from banks rather than purchasing gold outright. Buying gold on lease offers a hedge against fluctuations in gold prices and foreign exchange rates, eliminates the need to maintain inventory and allows jewelers to pay lower interest rates on the gold they require.
“As a retailer, we take gold on lease from banks, where my gold prices are completely open. On days when I sell jewelry, I convert my loan in to purchase. So my selling and buying price both are matched,” explained Shah.
Gold on lease is not the only method jewelers are using to safeguard their interests. Many have also changed their method of determining charges. Instead of setting a fixed price for their jewelry, sellers are implementing a "variable price" approach, which links the cost of jewelry directly to the market price of gold.
One Mumbai-based jeweler noted that charging fixed prices would affect gross margin in the event of major fluctuations in the gold price. Charging variable prices, he explains, keeps gross margin intact.
DEMAND DRIVERS
It is well known that the demand for gold in India is influenced by many social, cultural and economic factors. The rural income distribution, amount of black money, rate of return on alternate financial assets and the general price level all drive gold demand.
Given the entrenched Indian tradition of buying and giving jewelry for family weddings, and with such a large young population set to marry in the next few years, long-term demand for gold remains bullish. The wedding season is the single biggest driver for consumer gold demand. “About 70 percent of sales are related to weddings,” Bamalwa said.
Meanwhile, consumers have adjusted to new gold price realties and sentiment is positive, so steady growth in demand and prices can’t be ruled out going forward. And given the fact that there are more wedding occasions in the first half of 2013 as this period will see a greater number of auspicious days, there is good reason for jewelers to rejoice about their business prospects.
“The momentum has been positive so far and there are lots of weddings taking place in January and February. So, there will be compulsion buying for the consumer,” said Shah, adding that if the equity market was good and the economy was doing well, customers would be more likely to make impulse purchases.
Jewelers point out that retail consumers are only interested in gold prices when buying jewelry and are not bothered by such factors as a weak rupee, which also plays a role in determining local prices. According to jewelers, consumers are only concerned about high price volatility, since they know that the resale value of jewelry will be based on current gold prices.
Global investment demand has been one of the major components of gold demand in recent years. Rising gold prices have not deterred acquisition of gold in India, suggesting that investment in gold is becoming price inelastic.
Bamalwa said that global economic uncertainty, gold buying by central banks and demand from investors and consumers will continue to drive the demand for gold. He estimated that prices for the precious metal will reach around INR 35,000 per 10 grams in 2013. Thiagarajan, meanwhile, noted that international gold prices are currently in a corrective phase and that, while there may be a further price erosion in the first half of 2013, gold’s long term trend remains firm at above $2,000 per ounce. In rupee terms, gold should be around INR 30,000 for 10 grams in the first quarter of 2013, he stated.
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