The price of the precious metal may go down further
R Chandrasekaran
The most precious metal has witnessed a loss of about 5 percent since last week. The yellow metal’s 12-year Bull Run seems to be coming to an end this year if the trend is any indication. This will undoubtedly have a repercussion not only on the home budget, but could also have the potential to lead to another financial mess among the financing companies.
Whatever may be the reasons for the drop in gold price, the process of lending money to gold could likely come under the scanner. The price versus loan ratio will be questioned since the lenders would have likely to have interpreted the Central Bank’s stipulations to suit their scheme to lure more customers.
One scenario to be questioned is if the lender fails to get interest for the mortgaged gold, what can the lender do? The immediate option for the lender is to alert the borrower to mortgage more gold or top up or else pay up the principal and clear the loan amount immediately. In other words, the banks will raise the margin or advise the borrower to pay up. If both the options are not entertained by the borrower, the final option for the lender is to sell the gold in the market and realize the loan money before the price falls further.
If one borrower fails to pay the lender, then there will not be much of a problem. However, if more borrowers fail to pay the lender what is the likely scenario? There will be more gold flooding the market for sale and less buyers resulting in poor pricing of the precious metal. This is a similar situation that the U.S. had faced a few years ago on the housing front. But the difference is that the interest rates were climbing steadily in the U.S. resulting in more interest outgo thereby upsetting the household budget before the housing price collapsed during the period 2008 – 2009, whereas the interest rates are more or less steady in the developed economies during the last at least five years.
However, in India, the interest rates were higher due to inflation. While the cooling off of inflation may allow the Reserve Bank of India to cut interest rates modestly, the fall in gold price will play a spoil sport in the financial institutions holding gold as mortgage. This has been amply demonstrated by the weakness witnessed in the counters of Manapuram Finance and Muthoot Finance in the Indian bourses recently at the height of sharp decline in the yellow metal price. These are the two big companies focused on lending for gold. There is also every possibility that if the precious metal price comes down further, there will be more defaulters resulting in higher number of bad loans.
The risk of a further fall in gold price and the threat of large number of defaulters have undoubtedly forced rating agencies such as ICRA to downgrade its outlook on Muthoot and Manappuram to Negative from Stable. Manappuram has gone one step ahead in declaring that more defaulting borrowers could mean that it will suffer a loss for the quarter. However, Muthoot fails to acknowledge the danger ahead and believes that its business model would not have any impact from the falling yellow metal price. Both the companies have witnessed strong growth in recent years.
Similarly, banks are increasing collateral demand for the money lent for pledged gold. Vysya Bank CEO K Venkatraman has told Reuters that his bank is prepared for any further drop in the gold price. He added that customers will be required to make part payments wherever the margins are on the lower side and its branches have been advised to target specific customers in case the need arises.
Last year, the Reserve Bank of India came hard on the lending ratio for gold in an effort to check excessive lending. The central bank has kept a maximum of 60 percent of the gold value pledged as collateral. The lending per gram of gold has dropped between 20 and 27 percent currently after the recent fall in the yellow metal price.
Report also indicates that customers queuing up before the finance companies for gold loan have dropped nearly 50 percent, while some others are trying to release their mortgaged gold anticipating a further drop in the yellow metal price.
Now, if the talk of Cyprus offloading its excess gold to realize Euros 400 million comes true, there is every possibility of gold price nose-diving further. Reports also indicate that more nations are likely to offload excess gold, which is not a good sign for holding up the yellow metal price. The equity markets’ performance in the current year has also slowly weaned away investors from the gold market. Aside from this, a rise in interest rates in the developed economies will further dent the appreciation of gold price.
These situations clearly suggest that the banks and the financial companies lending money to gold will revise their loan ratio periodically in the next few weeks depending upon the yellow metal’s price movement. Analysts’ tend to believe that the recent recovery in gold price may be a short term one and the chances of a further price loss is more on the cards.
From the available indications, any default in gold loan repayment is likely to trigger another financial mess, but the impact is not likely to be as big as it was a few years ago when the housing bubble completely paralyzed the financial system in the U.S. However, there is every possibility that there will be more bad loans and provision for bad loans in the balance sheet of banks and finance companies in the quarters to come.
Given the fact that the precious metal price is waiting for a long time for a correction following a 12-year Bull Run, investors’ appetite for growth from the gold looks remote at least in the current situation. Also, if more central banks dump the yellow metal to realize money to tide over their own financial problem, a mad rush to dispose gold from every corner will drag down the prices sharply. Experts and analysts at present prefer to bet on downside pressures rather than any hopes of an uptick.