Home >market >stock-market-news >Gold is last man standing as rupee fuels inflation

Mumbai: Unprecedented outflows from Indian gold funds are set to reverse as money managers predict the rupee’s slump to an all-time low and resurgent inflation will spur demand for bullion as a store of value.

Kotak Mahindra Asset Management Co. and Reliance Capital Asset Management Ltd expect investors to boost holdings after withdrawing a record 310 crore in June and July. Bullion prices in the world’s biggest gold-consuming nation have surged 21.8% since 30 June, according to data compiled by Bloomberg, while indexes measuring Indian bonds fell 6.4% and stocks dropped 4.5%.

“Gold is a natural hedge on your portfolio," Lakshmi Iyer, a Mumbai-based fund manager at Kotak Mahindra Asset, which manages 37,700 crore, said in an 21 August telephone interview. “It’s the last man standing."

Bullion has rallied at almost twice the pace of global prices this quarter as the rupee plunged, threatening to fuel inflation in a nation that imports 80% of its oil. Optimism is rising in India at a time when gold traders elsewhere are more bearish on the metal as they prepare for the Federal Reserve to end stimulus that weakened the dollar.

“Gold helps portfolio diversification, especially in an environment of rupee depreciation," Hiren Chandaria, a Mumbai- based fund manager at Reliance Capital Asset, which oversees $15.6 billion, said in an 16 August interview. “We are likely to see a good rebound in demand before Diwali," he said, referring to the Hindu festival that falls in November this year.

Inflation hedge

“Indian investors will be attracted to gold as long as inflation stays above 7% and should allocate 5% to 15% of their portfolio to the metal," Kotak Mahindra Asset’s Iyer said. Consumer prices rose 9.64% in July, official data show, while State Bank of India, the nation’s largest lender, pays 6.5% on three-month deposits.

Withdrawals from exchange-traded funds in gold were 107 crore in July, 48% lower than the 206 crore outflow in June, according to data from the Association of Mutual Funds in India.

Stronger gold demand amid the rout in local debt and equity markets thwarts finance minister P. Chidambaram’s efforts to channel savings locked in bullion into financial instruments. Policy makers have raised import tariffs three times this year to curtail shipments that account for about 80% of the nation’s current-account deficit.

Current account

The shortfall in the broadest measure of trade widened to a record 4.8% of gross domestic product in the year ended 31 March, official data show. The Reserve Bank of India considers the gap the biggest risk to Asia’s third-largest economy, which is growing at the slowest pace in a decade.

The rupee has lost 6.2% this quarter, the second-worst performance in Asia. It rose 2.1% to 63.33 per dollar on 23 August, paring its losses to 2.6% for the week. The cost to insure the notes of State Bank of India, a proxy for the nation, against non-payment for five years climbed 111 basis points in August to 370, according to data provider CMA.

Import duties on gold and platinum were increased to 10% on 13 August from 8%, while the levy on silver was boosted to 10% from 6%. India plans to limit bullion imports to 850 tonnes in the year through March 2014 to narrow the deficit to $70 billion from a record $87.8 billion in the prior period.

Smuggling has risen as the tariff increases fail to supress demand for the metal before upcoming festivals and the wedding season that runs through the end of the year. The World Gold Council estimates demand will rise to as much as 1,000 tonnes this year from 868 tonnes in 2012.

Illegal shipments

“Customs agents at Mumbai airport seized bullion worth 93 million from April to June, almost as much as they nabbed in the whole of last year," Rishi Yadav, assistant commissioner at the customs department’s Air Intelligence Unit, said in a 15 July interview. “Illegal shipments were rampant until the turn of the century because of high duties, which were slashed in 2001."

“I grew up in an India where there were high tariffs, and there’s no doubt that high demand will find its supply," Arvind Sethi, chief executive officer at Tata Asset Management Ltd in Mumbai, said in an 14 August interview. “India has always had very strong demand for physical gold, in the form of jewellery and as an investment, because real yields have been low."

Wholesale prices rose 5.79% in July from 4.86% the previous month, official data showed 14 August. The inflation-adjusted yield on 10-year sovereign notes has fallen 18 basis points, or 0.18 percentage point, since 30 June, according to data compiled by Bloomberg. The yield on the benchmark note rose 4 basis points to 8.27% on 23 August.

Gold outlook

During a 12-year bull market, international gold prices surged more than sevenfold. After peaking at $1,921.15 an ounce in September 2011, the metal fell to $1,180.50 in June, the lowest since 2010, before recovering to $1,373.82 on 23 August. ABN Amro Group NV analysts predict the respite will be shortlived, and that the price will average $1,000 next year and $840 in 2015 because a stronger US economy will limit gold’s appeal.

Indian gold exchange-traded funds saw outflows of 358 crore in the first seven months of this year, the first since the product was launched in 2007, according to AMFI data. The withdrawals will continue, with the money flowing into other assets, according to IDBI Federal Life Insurance Co. and SBI Funds Management Pvt.

“Gold-related investments are not giving the same comfort to investors as they were earlier, and the outflow is underlining that sentiment," Navneet Munot, chief investment officer in Mumbai at SBI Funds, which manages $9.7 billion in assets, said in an 16 August telephone interview. “Flows from gold will move to segments that are liquid and less risky."

‘Store of value’

“The Indian government’s measures to damp gold demand are comparable to trying to hold sand in one’s fist," according to Martin Rapaport, chairman of the Rapaport Group, which operates a diamond-pricing service.

“The more the government squeezes Indians to force them into rupees, the more the currency will depreciate and they will go into other things," Rapaport said in an 14 August interview in Mumbai. Indians want to maintain a store of value, so they go to gold.

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