Why the government’s gold scheme did not work

The Indian equity markets and gold prices have been sharing an inverse relationship for the past two years. The BSE benchmark Sensex has gained 25%, while the MCX gold prices and the international spot gold prices have dropped 15% and 17%, respectively, as you can see from the chart.

Investors are postponing their investment-based purchases in the yellow metal because of lower yields. This may have weighed on the government’s plan to lure gold out of Indian households.

Five years ago, Sensex and gold had a positive correlation, but this has turned negative in the past two years. “Investors have flocked to financial assets such as equities as the world became more stable and the geo-political risks subsided because of the ‘risk on’ trade,” said Lakshmi Iyer from Kotak Asset Management.

International gold prices are hovering at a five-year low as investors anticipate the US Federal Reserve will increase interest rates for the first time in 10 years by the end of the year. The dollar index, which is pegged against major world currencies, is strengthening and is hovering at an eight-month high.

The recently launched gold scheme received a lukewarm response because investors look at past returns when making investment choices. Gold clearly has underperformed other asset classes such as equities, added Iyer. Moreover, high inflation was the reason financial savers turned to gold and this is no longer the case—inflation has eased and real returns have turned positive in India.

There were some technical issues as well with the gold scheme. The sovereign gold bond scheme was issued between 5 and 20 November when gold prices started falling sharply. The government managed to raise ₹ 150 crore from around 60kg of gold, according to analysts’ estimates. “The price of gold issued under the sovereign gold bond scheme was 2% higher than the spot gold prices in the domestic market. This is because prices were taken based on the previous week’s average. Investors were more comfortable buying physical gold which was slightly cheaper,” said Sudheesh Nambiar, lead analyst from GFMS.

Only around 400 grams were collected from the gold deposit scheme—compared with around 20,000 tonnes lying around in Indian households and temples. One of the reasons is that there are around 35-40 collection centres, which is a small number given the size of the country, leading to a concentration effect mostly in the Tamil Nadu and Kerala belt, added Nambiar.

Unless gold prices rise sharply and there is more awareness about gold schemes, it will be a while before Indian households put money into gold schemes.