The year so far has seen the price of gold curb some of the losses of 2013. Gold at $1371.52/ounce has rallied by 14 per cent year to date (price as at March 17), versus last year’s loss of circa 28 per cent. The drivers? Most prominently, tension in Russia/Ukraine and a Chinese bond default have led to an increase in investor appetite for the metal’s safe-haven status.
Safe haven assets are those which investors flock to when the markets are in risk-off, i.e. when investors reduce their exposure to riskier assets and turn to an asset where they feel their capital will be preserved. Hence with the Crimean crisis, investors would not only feel the urge to pull their investments out of Russia, but will also reduce their exposure to other risky areas.
As with any other good, an increase in demand equates to an increase in price. Apart from Crimea, we see another two events that may affect the price of gold over the coming months.
First, India. In June 2013, the Indian government introduced a set of measures to curb gold imports and reduce the country’s current deficit. These included strict import quotas, raising the import duty to 10 per cent (from two per cent), and requiring that 20 per cent of all imported gold be re-exported as processed gold.
The restrictions seem to have worked – at least officially. The price of gold in India had initially dropped in line with its international value; however, Indian rupee gold prices rallied resulting in an India-international premium of around $200/ounce. Gold imports fell by 63 per cent in the period July-October 2013, and given that gold accounts for a large significant proportion of the country’s merchandise exports, the current account deficit fell from -4.9 per cent to -1.2 per cent of annualised GDP.
More recently, senior politicians in the Indian government have been lobbying to ease these restrictions. The market is now expecting that this could well happen by the end of March – a popular move ahead of general elections taking place from April 7 to May 12.
Gold has rallied by 14 per cent year to date
However, the World Gold Council claims that the gap in demand in the Indian market is being fed by other sources, mainly through illegal imports. So while the drop in import taxes could reduce the incentive to smuggle gold, officially India’s demand for gold should increase, but will this be larger than the reduction in smuggled gold? Probably yes, but whether this would have a real effect on the global price remains to be seen.
Earlier this month China saw its first corporate bond default since the early 1990s when Shanghai Chaori Solar, a solar cell maker paid just 4.4 per cent of total interest of 89.8 million Chinese yuan (€10.4 million) due on one billion yuan of its 8.98 per cent bond maturing in March 2017. In bond investments, failing to pay interest when due leads to the issuer being declared in technical default.
Hot on the heels of this failure, Haixin Steel, a privately-owned mill failed to repay bank loans that fell due.
The central government had so far stepped in to bail out companies in financial distress. However, last week, Chinese Premier Li Keqiang told lenders to the country’s private sector to expect more debt defaults. Various analyst reports have suggested that this is an attempt by the country to address the issue of moral hazard in the economy.
It could also be possible that the boom and bust of the Japanese economy served as a lesson to the authorities – this had led to Japan’s two “lost” decades of deflation. At the time, Japan even prevented companies from declaring bankruptcy.
A Bank of America Merrill Lynch report said that the Chaori event could mark China’s ‘Bear Stearns moment’ – a reference to the US bank that failed in 2008. The collapse of Bear Stearns was a prelude to the global financial crisis of 2008 which brought down other banks, most notably Lehman Brothers.
It is premature to expect that the Chaori default could have a domino effect on the Chinese economy, although it is not a zero probability event. The market had been expecting this default, so in relation to China’s €3 trillion bond market (the corporate sector is roughly a quarter of this figure) it might not be that significant.
Let’s just hope these events are viewed as improved governance rather than a trigger to a larger scale crisis.
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This article is the objective and independent opinion of the author.
The information contained in the article is based on public information.
Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
Vincent Micallef is an executive director at Curmi and Partners Ltd.