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Who is the real beneficiary of Physical Gold SIPs offered by Jewellery houses?

I have been seeing a frantic rush to buy gold, both in physical and in electronic forms over the last couple of years. It is natural for investors to use gold as an investment avenue when we go through inflationary conditions, as we currently do. Thanks to huge bailouts packages starting from the 2008 bailout of financial institutions to the latest bailout of Greece, there is a huge influx of paper money into the world economy. This in turn drives the erosion in value of various financial assets like stocks, bonds etc., but an asset like Gold is believed to retain value. This is true according to the classical economic theories and validated by our forefathers who bought nothing but gold whenever they had money. From all aspects the clamour for gold has been increasing among the investing community. The price of the gold has also moved up in tandem over the last couple of years.

Sensing a big business opportunity is the Indian Jewellery community which is now vigorously marketing the systematic investment plan in physical gold. Almost all the jewellers in Chennai have launched schemes where people can invest a specified amount of money and the equivalent amount of gold would be credited to their account at the prevailing rate. The jewellers sweeten this deal by foregoing the traditional making charges and wastage. The jewellers market this scheme by informing the gullible investors that the price at which gold they bought is protected for future price escalations. Their basic assumption is that the "price of gold would continue to raise forever". One of the basic tenets of economics is that nothing can keep raising forever and what goes up has to come down sometime.

There are number of questions which crosses my mind:
1. Lack of regulations: Who regulates these jewellers with regard to these systematic investment plans? The answer is nobody regulates them and nobody independently certifies that the price at which the gold is alloted to investors are in alignment with the market price.
2. Credit worthiness of the jewellers: These systematic investment plans are long term products running for 12-18 months and exposes the investors to default risk. They have nothing else to fall back upon other than the empty guarantees of these jewellers.
3. Price risk: One of the biggest risks is what happens tomorrow if the price of the gold crashes to pre-2008 levels? In my opinion this is one of the biggest risks associated with these schemes. You may ask how it is different if I buy gold today at high prices and subsequently the price goes down? Good question, but the answer is the gold you buy today is a bird in hand compared to these schemes where you just pay the money to the jeweller and expect him to honour the committment after 24 months or so.
4. Lack of transperancy: Normally, for these type of transactions, the seller has to properly hedge their positions in the gold market. But we don't know if these are being properly done by the jewellers on a daily basis. Also, I am afraid they dont mark to market their losses if any and account it in their books of accounts. I think I am sounding too naive to expect our Indian Jewellers to do this prudent accounting. First of all, let them account all their sales!
5. Risk of over-trading in commodities/derivatives exchange: If we assume that the jewellers try to hedge their positions in the derivatives market, then there is a risk of over-trading in the derivatives market by the jewellers. We have seen many instances in the past when the traders have literally lost their shirt by excessively trading on the commodity derivatives market. Very recently, there were press reports of the promoters of KS Oils losing huge money by trading in the palm oil futures.

So, overall there are huge risks assumed by the people who go for this systematic investment plans with jewellers and it is better to avoid them altogether. If you want to buy gold, just buy it over the counter rather than joining a scheme like this.


Anonymous said...

To mitigate the risk, investor can either start a ETF SIP or to go with the gold scheme of reputed houses like Tanishq / Reliance Gold etc.....

Venkysdiary said...

@Anon - your suggestion of Gold ETF SIP is very practical idea.

But I differ with you on the gold schemes with Tanishq. Tanishq may be better off with regard to risk management compared to the local jewellers, but they charge the highest gold rate and above market wastage and making charges.

regards, Venkat

Ranjani Karthik said...

Gold ETFs are the best bet anyday mitigates all the risks you speak of Venky sir!

Venkysdiary said...

@Ranjani Karthik, you are right.
ETF is good way of saving gold. It is cheaper, efficient, liquid, no loss on sale and above all piece of mind.

Nagarajan said...

Nice one Venkat. Can you post something on NCDs. Do you think it is safer to invest in Muthoot NCDs which offers 13.43%. Please share your views.

Venkysdiary said...

@Nagarajan: Thanks! Will write about NCDs in the coming weeks.

To your specific question on Muthoot NCDs, risk and reward go together. So somebody is offering a good 3% above the prevailing market rates, means it comes loaded with added risk. To me the biggest risk in the Loan to Value in Muthoot advances. If the Gold rate remains where it is, Muthoot would have a good cover but if the Gold rates starts to come down and that too drastically, they run a greater risk. Probably the second risk is around the liquidity management of Muthoot. With the increasing restrictions on sources of funding for these NBFCs, there is a liquidity trap which they may end up with.

To summarise, I would suggest that you can take exposure if you are an above average risk taker and not more than 3-7% of your debt portfolio.


King Vishy said...

Whoa.. that brought back very unfond memories of fin classes from MBA!!

But very sensible post!! Hadnt known about these SIP schemes.. Reminds me of the clamour for private chit funds in the late 90s!!

rajni sharma said...
This comment has been removed by the author.
shreeyogjewellers said...

Thank you for sharing this.
Gold Jewellers in Thane

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