Can India be a Price Setter for Gold?

Price setting in commodity market refers to the ability of the market to set prices for the given commodity — which would then be widely referenced by all players in the ecosystem for their transactions. Benchmark prices are discovered by traders in price setting markets that also help others enter transactions — making that a referent point, with premium or discount added up based on local fundamentals. The development of organised benchmark marketplaces, in which standardised commodities are traded among players in a transparent manner, led to the emergence of benchmark prices that influence pricing decisions across market/economic/geographic boundaries. Such prices were transmitted to all stakeholders in a commodity market ecosystem, leveraging tools of information and communication technologies (ICT) to help them take efficient transaction decisions. Existence of such global benchmark prices for all commodities also helped the producers’ ecosystem to adjust their production costs, systems and quality standards to the prices that are set in such benchmark markets.

Bullion has not been an exemption, with the first ‘Gold Rush’ of the 17^th century, which led to the Bank of England (BoE) jumping in to set up the London Vault, leading to augmentation of its capacity to serve subsequent ‘gold rushes’.  In addition, BoE had set up the ‘London Good Delivery List’ during the mid-18^th century, to develop trust among gold market participants. The list formally recognised refineries that can produce bars of a certain standard as an accreditation for traders in the London bullion markets to transact, with a standard process for its traceability, efficiently assuring them of quality standards without adding to the trading costs. During the mid-19^th century, major gold trading companies in London came together to establish the London Gold Market, which had also started making available the ‘London Gold Price Fix’, leveraging developments in ICT. As the London Gold Market gathered mass, it also took on the responsibility for maintenance of good delivery accreditations list of acceptable melters and assayers.

As the market and transactions grew, BoE acted upon the need for broad-basing the existing body and made it independent. Thus, the London Bullion Market Association (LBMA) was born in 1987, entrusted with the task of managing the custody, maintenance and development of regulations governing Good Delivery List. LBMA, with a network of professionals working in various stages of the gold value chain and the feedback from both sides — buyers as well as sellers — had put together and updated regulations and rules governing Good Delivery and Responsible sourcing, and the process/institutional setup around its enforcement, for its successful adoption not only for facilitating cost-effective transactions but also to strengthen the process behind price discovery.

While the LBMA took the lead in setting spot prices for gold, COMEX platform of CME took the lead in setting benchmark prices for gold derivatives. We call these benchmark prices, as transactions in major markets in China or India happen at a premium or discount over LBMA in spot markets and CME for derivative market transactions.

Turning onto world’s largest importer/consumer during the last decade, Chinese policy makers moved on with their policy ambitions to set up Shanghai Gold Exchange to trade spot gold and to internationalise the gold derivatives markets in an effort to help Chinese markets set its own prices and provide appropriate price signals to global markets, thereby marking their first step in moving gold benchmark to Shanghai. Given exchange rate restrictions, large dependence on imported gold, lack of a globally accepted delivery standard, restricted participation in spot and derivative markets and weak domestic and international market linkages, these limitations are still keeping China a price taker, as evidenced by the findings of a recent study by Xinyi Qian (2020). Based on volatility spillover and price signaling flowing from Shanghai to London or New York, the same study authoritatively concludes that COMEX and LBMA maintain their dominant positions and act as price signalers to the global gold markets with equal vigour among themselves. Various analytical reports suggest that though China has become the largest producer of gold since 2016, and also the largest consumer of gold — the lack of regulations/governance standards matching LBMA, and the lack of full convertibility or currency, will keep it far away from setting global benchmark prices.

Back to India, are aspirations of market stakeholders to get Indian markets into the pivotal position of setting gold prices for the global markets, given that Indians have the largest amount of gold above land, estimated at 25,000 tonnes, and its position as the world’s second largest importer, at 800-900 tonnes/annum. Despite the higher imports and consumption, gold markets in India remained split in its price discovery across geographies, due to the erstwhile indirect tax regimes (of the Centre and states), regional nature of their operations, and recycling of gold that largely happens for personal value addition than for realisation of the value stored. The fact that more than three-fourths of gold had historically been consumed in the form of jewelry to be passed on from one generation to the next, than in the form of bars or coins, indicates the dominance of aesthetic value of gold among Indian buyers, than its investment value. Thus, pricing largely remained dependent on US dollar price quotes of LBMA fix (converted into Indian rupee) added with taxes and value chain margins. As imports happened based on confirmed orders, the pricing remained sticky towards international markets, with very little premiums or discounts, unlike in China where domestic prices largely remain at a discount or premium over international markets, reflecting the domestic demand especially during the pandemic inflicted market era of 2020. Apart from Platts, which polls the value chain players and announces India Kilobar prices in US dollar (deliverable in Ahmedabad), it is only Indian Bullion Jewelers Association (IBJA) — an association of various value chain players from across the country — that publishes its morning and afternoon prices of three major fineness types of gold in Indian rupees daily, based on polling. IBJA prices largely aim to reflect prices prevailing at retail jewelers, enabling transactions among retail buyers and their member jewellers. However, with the implementation of the GST regime, the problem of multiplicity of taxes has been resolved and yet, problems in integration of domestic markets remain the same.

While the Indian derivative markets have been in existence for more than 17 years, various studies about the spillover impact of COMEX/CME prices and Indian gold derivative markets suggest that price signaling has been unidirectional from the COMEX/CME markets to the Indian markets. Back in 2015, IBJA announced its intent to set up a rule-based electronic spot trading platform for Indian retail consumers to trade gold for delivery in both dematted and physical format on the lines of spot exchanges such as Shanghai Gold Exchange. It also spurred the thought process among policy makers and stakeholders for the need to set up a platform for spot trading in gold, to revitalise the recycling industry and to enable efficient domestic price discovery. While the objectives for setting up such a physical platform is spot-on, the pillars on which such a platform can rest, and generate trust among stakeholders, such as standards, vaulting, logistics, traceability and rules and regulations governing the same, are yet to be tweaked, and are disconnected from global standards, despite the fact that India commands about 6 per cent of the global jewellery markets, amounting to an estimated $12 billion, and is world’s second largest importer. Though an attempt has been made in terms of hallmarking of jewelry from the start of the 21^st century, the standards, traceability systems, dispute settlement, governance rules and regulations are yet to gain roots, and their equivalence with global standards would have to be attained to achieve its integration with global markets. Secondly, economic and trade data impacts gold supply/demand and hence, pricing would have to be made available at a high frequency like that of developed markets, to strengthen the price discovery process. Thirdly, for such markets to discover prices, there should be minimum interventions in the gold markets, especially in terms of the fiscal regime. Fourth, a road map for free convertibility of currency should be drawn up and movement towards full convertibility will enable robust foreign and institutional participation in the Indian markets, besides enabling foreign traders setting up shops in Indian shores and moving capital across borders seamlessly. Finally, the fiscal regime, both on imported gold and domestically traded gold, would have to be stabilized, so that markets can discover prices and not policy decisions. Strengthening price discovery in Indian spot markets backed by volumes and trust among the broad spectrum of participant ecosystem, through reinforcement of the above discussed pillars, are essential in price signaling the global markets, if not setting up benchmark prices for global markets.

With the launch of trading on Gold of India Good Delivery standards and LBMA, will percolation of good practices around Gold Vaulting, as well as quality assurance — percolate down to Indian Good Delivery standards, as the market institutions and regulators closely work with each other, ensuring trust among players on the quality of delivered gold? On the other hand, not only the robust trading but also the trust behind the standards, will get refining, assaying and logistics system in order, providing robust clearing and settlement regime on the spot platform. The current challenge of converting idle gold will be untangled slowly as exchange trading and price discovery gathers momentum, developing the entire ecosystem of refining, assaying, vaulting and logistics, making bars and coins of LBMA/India Good Delivery gold a liquid financial asset class. The estimated gold in hand of 25k tonnes would have to be converted into financial instruments, and that needs a vibrant gold spot exchange-based ecosystem under a seasoned regulator, to start sending its signals to the global markets, including LBMA, with a robust quality standards and assaying ecosystem in India, in addition to refineries and vaults with a trustworthy traceability mechanism. This way, Indians may not only be monetising their idle gold, but also contributing to financialisation of physical gold, thereby evolving Indian price benchmark that can signal global markets. In line with the budget announcement, Securities and Exchange Board of India (Sebi) had recently published a consultation paper on the framework for gold exchange and regulations for vaults. Rightly so, the paper attempts to provide for electronic spot trading by converting standardised gold into a security, namely ‘Electronic Gold Receipt’. However, the paper had sought stakeholder’s views to make the price discovery and transactions efficient, seamless, and trustworthy. It’s a timely step in the right direction but its success needs active stakeholder interests right from this consultation to active participation on the proposed spot exchange platform.

The writer is a consultant with the National Institute of Securities Markets

DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.