Rising inflation could boost gold demand as a hedge: UBS report

Despite the World Gold Council forecasting a fall in consumer demand for the precious metal this fiscal year due to rising prices and record imports last fiscal year, a foreign brokerage firm has suggested in a report that demand could rise more than widely forecast as households could collapse Metal as a hedge against spiraling inflation.

Gold imports rose 33.3% in FY22 to $46.14 billion to 837 tonnes, or 1.5 times the FY21 pandemic low and 12% above the FY16-20 pre-pandemic average, leading to led to a higher current account deficit of 3% of GDP, government data showed last month.

Imports were worth just US$34.62 billion in pandemic-hit FY21.

After a record $54 billion in imports in fiscal 2013, inbound gold shipments had waned over the years but then started to pick up again, climbing to $25 billion in FY21 and then to just over $46 billion in fiscal year 22.

Gold imports are expected to decline slightly to $43 billion in FY23, according to the UBS Securities India report released on Monday.

The increase in gold imports in FY22 helped widen the trade deficit to US$192.41 billion from US$102.62 billion in FY21.

India is the second largest gold consumer in the world after China.

Imports are largely driven by the jewelry industry. Gem and jewelry exports grew about 50% in FY22 to about $39 billion. The current account deficit widened to $23 billion, or 2.7% of GDP, in the first three quarters, according to RBI data.

“Our regression analysis suggests that a 1 percentage point increase in inflation leads to a 2.6% increase in gold demand. While the economic fallout from persistently high inflation, stretched equity market valuations, recent losses in retail equity markets and still low interest rates on deposits may make the short-term case for gold as an alternative asset class for households,” UBS Securities India said in a statement on Monday.

Gold has grown in importance as an investment asset over the years and is seen as a good short-term hedge against a fall in the rupee and against inflation. Notably, gold’s long-term returns have outperformed stocks and debt over the past 15 years, although those asset classes have moved broadly in the same direction, according to the report.

The report was quick to add that higher prices could act as a deterrent and dampen investment demand.

Tanvee Gupta Jain, UBS’s chief economist for India, expects gold demand to slow to 750 tons in FY23 from 837 tons in FY22.

Beyond safe-haven interest, there is evidence that a broader strategic interest in gold is emerging. With most of the country’s gold supply imported, despite slightly weaker volume demand, higher global prices imply net imports could remain elevated at $34 billion or 1% of GDP in FY23.

She attributed the modest decline to higher global prices for the metal and weaker domestic growth as real incomes were hit by rising energy prices, spiraling inflation and an incomplete recovery in jobs.

UBS recently raised its gold price forecast but maintained a bearish price profile into early 2023, largely reflecting safe-haven inflows following the Russian invasion of Ukraine in late February. Post-pandemic reopening of the economy, higher household savings and pent-up demand boosted gold demand in FY22, with the December quarter seeing a whopping 357 tonnes of imports. But imports/demand fell to 141 tons in the fourth quarter, down 60% from the third quarter, on the back of higher prices triggered by the Russian invasion of Ukraine.

Households are getting richer due to record high gold prices and their imputed wealth (based on their gold holdings) has risen sharply in recent years.

According to WGC data, Indians hold the world’s largest gold reserve at around 27,000 tons, which is 13% of the world’s stock and valued at approximately $1.675 trillion, or 53% of nominal FY22 GDP.

In contrast, as of December 2021, retail bank deposits accounted for only about 46% of GDP, and the Reserve Bank holds $48 billion worth of gold in its gold reserves.