The gold jewellery sector is currently grappling with significant challenges, facing a dual crisis that is shaking its foundations. Following an alarming 15.7% rise in gold prices since January, the industry is now also contending with a severe liquidity issue. This situation is further exacerbated by banks enforcing margin calls on their gold metal loans, adding pressure to an already strained market.
The Role of Gold Metal Loans in the Industry
For many jewellers, gold metal loans (GML) are crucial for maintaining liquidity and managing inventory. Approximately 20% of the jewellery market relies on these loans to operate effectively. In this arrangement, jewellers borrow gold bars from banks, create their jewellery, and repay the loan with the proceeds from sales. This method serves as a natural hedge against market fluctuations.
Gold metal loans allow jewellers to borrow gold for up to 180 days, avoiding the immediate expense of purchasing gold outright. Currently, the GML market in India is estimated to encompass about 120 tonnes of gold.
Impact of Rising Prices on Liquidity
Shekhar Bhandari, President of Kotak Bank, highlighted that the combination of escalating gold prices and a slowdown in consumer demand has created liquidity challenges for jewellers. “This is a temporary hurdle,” Bhandari noted, suggesting that as consumers adapt to these higher prices, demand should rebound, particularly during the wedding season and other festive occasions.
In the first quarter of the year, demand has been sluggish, while gold prices continue to climb. This has prompted banks to request that jewellers cover the difference between the initial borrowing price and current market rates.
Increasing Lease Rates and Their Consequences
Moreover, the lease rates for gold have surged, effectively doubling from 3-4% to over 6%. A representative from one of India’s leading jewellery chains expressed concern that the rising lease rates, combined with margin calls, have made jewellers hesitant to take on new gold metal loans. Elevated leasing costs are squeezing profit margins, forcing many to explore alternative strategies for liquidity management.
Chirag Sheth, a principal consultant at Metal Focus in London, pointed out that larger jewellery chains heavily rely on leased gold. However, with banks now demanding additional margins based on fluctuating gold prices, many jewellers face a liquidity crunch that could impact their overall profitability.
Factors Influencing Gold Lease Rates
The spike in gold lease rates can be attributed to a tight liquidity environment in the global bullion market, driven by record shipments from London to the United States. Additionally, rising interest rates in India and a depreciating rupee have made gold imports more costly. While international gold lease rates have begun to stabilize, this trend has yet to reach Indian markets.
As a result of these rising costs, small to medium-sized jewellers are likely to approach gold metal loans with increased caution, re-evaluating their financial strategies in light of the current climate.
Strategies for Survival in a Volatile Market
With profit margins typically ranging from 5-8%, Indian jewellers are now under severe pressure due to rising gold prices and fluctuating lease rates. To navigate this turbulent landscape, many are considering various financial strategies:
- Hedging against market volatility
- Renegotiating lease agreements
- Optimizing inventory management
Rajiv Popley, Director of the Popley Group, remarked, “The current state of the GML market is becoming increasingly unsustainable. Those unable to find better financial alternatives will likely continue relying on GML, despite its inherent risks.”
As the gold jewellery industry faces these challenges, adaptability and strategic financial planning will be key for survival and growth in the coming months.
