Gold on a swing. Time to invest?

The yellow metal is on a roller-coaster ride in India once again.

The price of physical gold, which dropped significantly after the U.S. Federal Reserve meeting on June 16, has begun to rise once again. In the last one week, the prices have climbed back around ₹1,000 for 10 gm of 24-carat gold, reversing half of the nearly ₹2,000-slip from the peak in June.

In June, it had witnessed the largest fall of 2021 after the U.S. Fed signalled an interest rate hike by 2023. The lack of demand in the retail market in India too contributed to the lacklustre performance.

So, what is pushing up the prices now?

The new banking rules, which are part of the sweeping international Basel-III norms that took effect on June 28, have defined allocated gold, in tangible form, as a zero-risk asset. On the flip side, unallocated gold or ‘paper gold’ or digital gold will have a higher risk weighting.

“The move could cause demand for physical gold bars and coins to rise substantially as the metal is reclassified from a tier 3 asset, the riskiest class, to a tier 1 zero-risk weight. Gold will become the same as cash and currencies as an asset class,” says Raghu G., a bullion expert who works with the Kerala-based Manappuram Group.

According to him, paper gold in the form of unallocated bullion, forwards, and other derivatives will not be treated on a par with physical gold. “We could see the demand for physical gold rise as banks and financial institutions add it to reserves. The move could make the cost of derivatives much higher,” he says.

In the last few months, gold prices in India were moving up and down, not so much in tandem with the international prices. More than the fluctuation in international prices, the two other factors that swayed gold prices in India have been the shallow demand in the retail market due to the pandemic, and the fluctuation in the rupee-dollar exchange rate.

Many banks and gold-loan non-banking finance companies (NBFCs) are conducting e-auctions to liquidate gold jewellery accumulated by them in the last few months. The price fall after a peak in 2020 had caught many of them off guard. When the prices moved two months ago, several banks and finance companies rushed back to the auction process and re-initiated the process for offloading their gold assets.

A sudden increase in the supply of melted gold and a delay in demand pick-up too contributed to the price fluctuations. For once, different cities in the country witnessed a diverse trend in prices.

Navneet Damani, vice-president, commodities research, Motilal Oswal, insists that the demand in India will continue to be shallow. He cites the pandemic-induced local lockdowns and the end of marriage season prior to the monsoon season as the prime reasons.

“After international prices rallied from $1,740 a troy ounce to $1,920, a fall was on the cards,” he says. One troy ounce is equivalent to 31.1 gm.

His target for next 15-18 months stands at ₹57,000 for 10 gm of 24-carat gold.

Gold prices in India had begun their ascent in April, gaining nearly 10% from the low it touched in early 2021 soon after the Union Budget was unveiled on February 1. The Budget had reduced customs duty by 5% but introduced an agriculture, infrastructure, and development cess (AIDC) of 2.5%.

The implementation of Basel-lll norms is the new trigger for gold.

While some countries have deferred the implementation of Basel III norms for banking services by a year or so in view of the Covid-19 pandemic, some are going ahead with a phase-wise implementation. India has postponed the implementation by a year till January 1, 2023.

According to MarketWatch Research, European banks will face new liquidity requirements, known as Net Stable Funding Ratio (NSFR) as part of the Basel-III reforms. The ratio is the amount of available stable funding relative to the amount of required stable funding, which should be equal to at least 100% on an ongoing basis. It is a liquidity standard that banks need to follow to ensure adequate stable funding to cover their long-term assets.

According to Alasdair Macleod, head of research at Goldmoney Inc., the NSFR regulations are being introduced to banks in the European Union and the U.S., now, and in the U.K. on January 1, 2022.

Basel-lll was defined by the Bank for International Settlements (BIS) as an internationally agreed set of measures that aim to strengthen bank regulation, supervision, and risk management. It was developed in response to the global financial crisis of 2007-2009.

“If every country implements Basel-lll, it will lead to a sudden surge in demand—of nearly 1,000 tonnes,” says Raghu.

According to him, silver is not considered anything near a zero-risk asset, nor should it be, given the market’s penchant for volatility. “However, increased demand for physical gold would likely have a bullish impact on the silver market,” he adds.