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Posts Tagged ‘Indian gold demand’

23
Sep

OF BULLS, BEARS AND BRONCOS

   Posted by: Mr. Gold    in Uncategorized

The conference season is upon us. The luckiest of us are now trekking to Denver, then onwards to Berlin and then to London. As it happens during yet another period of heightened interest in the gold market (as increasingly frequent calls from generalist and multi-strat – oriented friends testify), the collective cerebral power of pundits is weighing, yet again, the bullish and bearish arguments both from the cyclical and structural perspective.

It was not different this week at the Denver Gold Forum. 13 years after I joined this caucus for the first time, it was yet another opportunity to refresh the dusty capacity of face recognition. This was not too much of a test, as most of the gold market insiders look happy and youthful these days. Undoubtedly, happier and youthful-er than investors in many other sectors.

During the conference, the Denver Gold Group organized a “debate” in which two well-known commentators sparred verbally in what was an occasionally entertaining, but largely unsubstantiated exchange. As a result, I left the proceedings intellectually puckish, rather than fully satisfied.

The bear’s argument boiled down to a cautionary story centering on the sustainability of the investment binge. He countered the highly publicized view that gold remains “underinvested” if compared to other asset classes by pointing to the fact that all gold is homogenous while credit products are not. Therefore, in comparison to specific classes of, say, treasury, muni, corporate or other yielding assets, gold is no longer a tiny niche market awaiting discovery. More ominously, the gold market now depends fully on new and sustained flows of investment demand. The moment the growth of investment flows stops, there will be little, if anything at all, to stop a sudden slide of the gold price. Naturally, any hint of higher interest rates could provide such a signal (the debate was held a day before FOMC’s allusion to new asset purchases).

The bull then made his thesis, based on well-known macro observations (unresolved imbalances, lack of exit strategy from the liquidity binge, further liberalization of gold markets around the world, central banks’ attitude towards gold). There was little novelty to these arguments, widely shared among the audience.

The bear’s long-term vision was one of a re-invigorated US growth and central banks re-establishing credibility by linking today’s consumption with future consumption via a more realistic interest rate regime. This would raise the opportunity cost of holding gold and change price expectations of Indian traders, who would react by liquidating inventory. Eventually, other asset classes would return to favor.

On balance, I found the bear’s views more attractive. It is undeniable that no market ever moves in perpetuity in one direction – and nor should gold. It is also true that the underlying jewelry demand is fragile. However, one could have issue with the argument concerning the alternative asset classes. Most US and European investors are constrained in what they can purchase strategically with attractive cash flow profile. Farmable land, high risk private equity in frontier markets, scarce (illiquid) commodities, Renminbi-denominated bonds – may be available to some sovereign wealth funds and alternative vehicles, but will not address the concerns of the ageing baby boomers. Essentially, the post-2008 obsession with capital preservation leads to a binary market in put options – protection against deflation (hence the record-low yields) and against inflation (gold for most of us, copper for the Chinese).
As FOMC proved yet again this week (and BOJ last week), the fear of deflationary vortex entices monetary authorities to lean towards inflation risk. This is understandable for as long as bank reserves remain high and the entrenched output gap protects the developed economies against inflationary pressures. As I have argued on these pages previously, gold provides a good litmus test for what increasingly appears as a series of competitive currency debasements – either through direct intervention in the FX market, or through ultra-accommodative, unorthodox monetary loosening.

These underlying conditions are unlikely to go away any time soon. There is something fundamentally broken in the US job market, which, coupled with the staggering number of yet-to-be foreclosed properties feeds back into the consumption loop making a mockery out of “lagging indicator” from economic textbooks. Still, the short term indicators for the gold market are not encouraging. As the market is testing $1300/oz, much of the action is concentrated in the US dollar (and in Canadian dollar). Unlike last June, this month no other major currency has registered an all-time low against gold. The unhelpful exception is the Indian Rupee. Although one Swiss bank mentioned robust buying from India at $1270/oz, the record prices in local currency terms are unlikely to support the floor under the market as we are moving to a weaker seasonal period on the subcontinent. The impending holidays in East Asia and recovering lease rates are also mitigating against a stronger support for the prices. But the anticipation of a return to aggressive QE on Nov 3, the uncertain timing of AngloGold Ashanti’s hedge book buyback and political outliers (e.g. Beijing rocking – a Japanese – boat) could ensure that any such correction could be shallow and short-lived. Neither bull nor bear, and even broncos need some rest.

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24
Feb

THE FOUR SEASONS – FROM VIVALDI TO RAGAS

   Posted by: Mr. Gold    in Uncategorized

Most readers in the Northern Hemisphere will probably agree that the winter season has lasted long enough and it is high time we turned the calendar page over to springtime, though preferably without floods.  Calendars and seasons are also relevant for the markets – from the summer lulls to ‘January effects’, we are always on a lookout for signs of relative simplicity, reflecting our animal sensitivity to nature’s cycles.

The relevance of seasons to the gold market is a question of debate.  As the importance of Indian gold demand grew since the 1980s, the interest in South Asians’ purchasing patterns grew.  Although recently the increased affluence of Middle Eastern and Chinese buyers may have also turned the spotlight on the timing of Eid-al-Fitr and the promotion of October Golden Week in the PRC, the seasonal impact of these dates on global gold demand has not yet been firmly established.

On the other hand, it is well known that Indian jewelers usually replenish their inventory several weeks before key festivals and auspicious dates.  Most attention has been paid to restocking in January and in September – roughly two months prior to the traditional wedding seasons.  Even though re-smelting of family gold has been commonplace, the ubiquity of 22 carat bridal ornaments (traditionally consisting of two earrings, two bangles, a nosering, a necklace and one ring) turned the South Asian wedding season into a yardstick used to indicate by how much COMEX paper gold trading may have diverted from the “fundamental” demand.  In fact, the actual volume of purchase by jewelers would vary, depending on the prevailing gold lease rates and expectations of future gold price.

A glance back at the last ten years of gold price data allows us to determine if stronger demand from South Asian holiday seasons could influence gold investors’ returns and risks.  By compiling quarterly data of the last decade, we quickly find that the fourth and the third quarter offer the strongest average returns (6.4% and 5.1%, respectively).  The second quarter sports the lowest returns (1.7%), but also the lowest volatility.  It also turns out that the volatility peaks in the third quarter.  Using an average 3-month Libor for the last 10 years, we find that the fourth quarter returns have the highest Sharpe ratio, outperforming quite significantly the 3rd and the 1st quarter (in this order).

The second observation that can be made is that the inter-seasonal returns, chunked out into four quarters each year, present little variability over time.  The intra-year standard deviation of these returns varies somewhat between the low of 3.15 in 2002 and the high of 7.90 in (the otherwise extraordinary) 2008.  However, it would be misleading to believe that there is a rising trend to this variability, given that the second highest standard deviation was registered in 2001 and the second lowest in 2009.

We cannot, therefore, entirely refute that the November-December wedding season does solidify the gold demand.  Still, this very basic analysis suffers from a somewhat ethnocentric bias.  South Asian wedding calendar does not obey the rules of the Gregorian calendar, but follows the regularity of the traditional, Hindu calendar.  It begins in March-April (during the month of Chaitra) and ends in February-March (Phagun).  This year, Chaitra began March 1, coincidentally close to China’s post-holiday season.

I decided to shift our quarters by two months, to reflect the beginning of the Hindu calendar.  This exercise chunks out the seasonality into four equal periods: Mar-May, Jun-Aug, Sep-Nov and Dec-Feb.  And – surprise, surprise – a very different picture emerges.

First, we find that the variability of returns is much more pronounced.  It ranges from 8.15% in the Sep-Nov “quarter” and 7.8% in Dec-Feb “quarter” to a loss of almost 0.4% in Jun-Aug “quarter”.  Note that the Sep-Nov period covers both the restocking binge (Sep) and the period including the key festivals: Navaratri, Dussehra and Diwali.  On the other hand, the Jun-Aug period falls shortly after Akshaya Tritiya (during the Hindu month of Vaishakha, this year falling on May 16).  Akshaya Tritiya happens to be the last significant summer festival.  There are very few auspicious dates and no major festivals until after the monsoon season.

We can also observe that the standard deviation of returns varies much more among the shifted “Indian quarters”.  As a result, the Sharpe ratio is negative early in the year and then picks up significantly from September till February.

But the most unexpected finding from this statistical overview comes from the comparison of data for inter-seasonal volatility.  Unlike in the case of traditional (“Western”) quarters, the modified quarters show a strong and rising tendency in inter-seasonal standard deviation.  It increased from 1.68 at the beginning of the century, to 7 in the middle of the decade, to 14.5 and 12.6 in the last two years.

This difference in the seasonal volatility of the returns is too consistent to be entirely accidental.  It could mean that, contrary to our expectation of the East Asian demand gradually offsetting the traditional Indian seasonality, the seasonal variability of the demand has actually deepened over the years.  In other words, as the price of gold has gone up (in Rupee terms), the consumers purchase gold when they really have to, with much more secondary product flowing back to the market around the dates which are not known to be auspicious for major family or community events.  This was born out recently by dishoarding in India, which was particularly pronounced early in 2009.

This subtle shift from the rhythms from Antonio Vivaldi to Pandit Pran Nath also offers a lesson for value investors who are keen to time their purchase properly.  Avoid large purchase in Dec-Feb period.  Begin accumulating from March, but reserve the bulk of your purchase for the summer.  And if you wish to realize profits according to the calendar, make sure your liquidity allows you to stick around until late September or early December.  Otherwise, pray for a good monsoon and a strong Rupee.

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