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Do You Know Why Gold Price Is Moving Up?

Posted on 28-Jun-2019 Comments  0

Gold Rally

What exactly is driving the gold prices higher so rapidly?

If you were to open the price chart of spot Gold on your Bloomberg terminal, you will not miss the sharp rally in gold in the last few months. In the last 6 months, gold is up by nearly 20% and is one of the best performing asset classes in risk adjusted terms. What exactly is driving this gold rally in recent months?

Geopolitical risk

If there is one factor that has always managed to drive the price of gold higher, it is geopolitical risk. Be it the chaos post Lehman or the European default, gold has been the natural beneficiary. Currently, the trade war is threatening to expand its horizons to other areas. At the same time, the Middle East and West Asia are on a boil with Iran shooting down an American drone. With Iran and Saudi Arabia in direct confrontation, the risk is that oil movement could be impacted.

Falling interest rates

With the Fed turning dovish and the ECB and the Bank of Japan also hinting at lower rates and more liquidity, it is not great news for financial assets. That is prompting a shift to gold. There are two more reasons. Firstly, with low rates of interest, there is no opportunity cost in holding gold. That is driving demand. Secondly, a negative yield curve in the US is hinting at a likely recession and that is naturally leading to safe haven demand for gold as an asset class.

Currencies debased

This is one of the principal reasons why gold is back in demand. The dollar has been under pressure and it is actually symptomatic of a larger problem. Since the financial crisis of 2008, leading central banks like the Fed, ECB, BOJ and Bank of England have purchased bonds worth $15 trillion to prop up the economy. That kind of currency printing has surely debased their currencies, which is not visible due to a different set of reasons altogether. The market is now betting that with central banks unable to get out of their dovish approach, the currency debasement may actually happen. In such a situation it is gold as a currency that emerges as the safest currency. After all, gold supply is limited and it is not a fiat currency. In addition, the gold prices have always represented an anti-dollar trade and that is what is showing up.

Negative yield curve

The case for buying gold is also coming from the inverted yield curve in the US. When investors prefer short term bonds over long term bonds, it is a sign of lack of confidence. In the US, this has been a consistent lead indicator of slowdown in the last 100 years. As we have seen through the seventies; in times of low confidence in paper assets due to weak growth, it is gold as an asset class that shines brightest. Gold is inspiring a lot more confidence among investors!

Market Reforms

SEBI moves in decisively on key areas of market reforms

The SEBI Board meeting held in the last week of June made some far reaching announcements. While some were for the current market conditions, others were intended for longer term. Here are four such areas that SEBI addressed.

Special rights shares

Special rights (SR) shares are something that founder promoters have been asking for, especially in the case of high technology and low capital companies. Like the DVR shares of yore, the SR shares will give additional voting rights but can only be issued to the promoter group in the case of high technology companies in IT, AI, biotech etc. The combined net worth of the promoters in this case will have to be less than Rs.500 crore. This has been obviously driven by the recent case of hostile acquisition made by L&T for Mindtree where the promoters could not prevent the takeover. Voting rights of SR shares will be limited to 75% of overall.

Regulating royalty payments

There were two interesting changes here. Firstly, the cut-off for approval by shareholders in case of royalty payment has been moved up from 2% to 5% which is a lot more realistic. Secondly, the regulator has also clarified that the vote of shareholders in such an event will be counted by excluding the interested parties in the deal. That will bring in more transparency.

Tighter pledging norms

This particular activity had come under scrutiny for the value loss that it caused to minority shareholders. SEBI has made two interesting announcements in this regard. Firstly, the definition of pledge is widened to include direct and indirect pledges like liens, reverse lien, restrictive covenants etc so that pledges cannot be hidden behind semantics. Also, any promoter pledge above 20% of share capital or more than 50% of promoter holding must be accompanied by a detailed explanation of the reason and must be put up on the website of the stock exchange. That will usher in better disclosure practices.

Needle falls on mutual funds

Mutual funds have been at the centre of attention for all the wrong reasons so regulation was coming. Now, liquid funds will have to keep 20% of their corpus in cash, bank deposits, G-Secs and treasuries only. Also, mutual funds can make fresh investments only in listed NCDs, listed CPs and listed equities in future. Thirdly, any credit enhancer or structured product will have to be a dedicated product and cannot be mixed with other debt funds. Mutual funds will have to take steps to prevent mis-selling. Lastly, post the Essel Group fiasco equities pledged by promoters must cover at least 4 times (400%) of the value of investment. Surely, these measures will go a long way!

5G Auctions

Sounds fantastic but is it really practical at this point of time?

A recent report in a leading magazine a few months back claimed that the introduction of 5G in India will literally revolutionize telecom. 5G is the fifth generation of bandwidth which is perfectly suited to high intensity mobile usage and the massive spread of data, audio and video content. But how feasible is the entire plan really?

Not for now, at least

In a recent report on the launch of 5G services in India, Moody’s has estimated that the auctions for 5G is unlikely to happen before the second half of 2020. Even about that, Moody’s is not overtly optimistic. The reasons are not far to seek. Indian telecom has just seen a recovery in ARPUs and their financials are still in a lot of stress. ARPUs had dipped to below the Rs.100 mark and it has just about bounced above that mark in the last quarter after Bharti Airtel and Vodafone took a conscious decision to weed out low value customers. But it is still a long way away from generating healthy ROA and ROE. Then there is the issue of massive debt in the books of these telcos. Currently, the telecom companies put together have a total debt of nearly Rs.4.35 trillion. The government proposes to auction the 5G bandwidth (3.3 to 3.6 GHz band) at a total price of Rs.5 trillion. Moody’s is of the view that with the current balance sheet stress, there is no way any of the telcos are going to be in a position to commit that kind of auction fees.

Learn from global experience

One thing that India needs to really do is to learn some quick lessons from the global experience. In Asia, other emerging economies like Indonesia and Malaysia are also in consultation with the telecom operators and are likely to initiate 5G auctions only in the second half of 2020. India may have to look at these experiences as a benchmark and hence the 5G auctions are likely to be delayed. Then there is the issue of spectrum pricing. Most countries have historically priced spectrum at low rates to make the entire business proposition feasible. But, India plans to keep rates steep and so viability becomes the big question. Price may be too steep!

Where are the big applications?

That is, perhaps, the billion dollar issue. What exactly does India do with 5G at this point of time? Where exactly can it apply because for 5G to be a viable proposition, you require applications of that order and scale? That is the biggest challenge. For example, 5G can really find applications in advanced segments like medical services, robotics, home automation through smart devices etc. Then there are multi-dimensional services like Internet of Things (IOT) where 5G can really find application. Moody’s is right that India may be putting the cart before the horse. It is time to first put out telecom house in order. 5G can certainly wait!




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