Target prices show shine ahead for gold; experts see upside for financiers

Analysts' target prices also indicates good upside for gold financiers

Global gold prices have rallied substantially as inflation has moderated. This seems counter-intuitive since the precious metal is a hedge against inflation. But it’s tied to the way gold is priced in USD. If the dollar is strong, gold prices moderate.

The USD has strengthened through the last year as the Fed tightened money supply and raised policy rates to curb inflation. As inflation shows some signs of easing, investors are hoping that the Fed will be less hawkish. That would mean a softer USD which would lead to higher gold prices.

Inflation remains at high levels, which pushes up gold demand. There are also seasonal factors such as festive and marriage season buying in India and the upcoming Chinese New Year (January 23) which may fuel greater demand.  

As a result, gold prices are at four-month highs. Given a longer-term perspective, gold could remain a decent investment. Inflation is certainly not dead. The Fed may continue to hike, at a reduced rate and other central banks are also hawkish.

What about the prospects for gold NBFCs such as Manappuram Finance, IIFL and Muthoot Finance, which specialise in lending against gold? There are multiple variables to consider. Loans against gold see rise in volumes when there is household distress. That is easing off as the economy recovers.

If there are defaults, the lender auctions collateral. The returns from this may or may not cover the loan plus interest. In practice, a high rate of defaults is bad for the lender. The loan to value ratio is capped at 75 per cent by the RBI. If the price of gold falls, NBFCs can get jittery.

Ideally, the price of gold remains high, and there are few defaults, thus allowing the lender to earn a high yield without fear. The rate of interest is dependent on competition. This is one area where the traditional NBFCs have cause for concern. Banks have started aggressively moving into the segment, and so have new-age fintechs and other NBFCs. Banks have gained market share from NBFCs and unorganised moneylenders.  

In the near-term, enhanced competition will lead to margin pressures: interest rates will be competitive. In the longer-term, investors could consider a couple of things.

One is that Indian households have shown a greater willingness to take on debt in the recent past – gold loan assets under management have risen by 27 per cent CAGR in the last three fiscals. A second factor is that relatively little gold held by households has been pledged, and relatively little of the gold pledged, has been pledged to the organised sector.

One analysis estimates Indian households hold 27,000 tonnes of gold (14 per cent of global reserves) and around 20 per cent is pledged. Only 35 per cent of loans are in the organised sector. If the pledged amount rises to 25 per cent, and the organised sector grabs another 10 per cent market share, which is a huge opportunity. If this happens over the next 5 years, it would imply 13 per cent CAGR for the organised gold loan market.

The increase in penetration could compensate via increased volumes even though Yields and Returns on Equity should stabilise at lower levels. The listed gold NBFCs could therefore see short-term pain combined to long-term gain.

One report values Manappuram at Rs 155, and IIFL at Rs 775, and Muthoot at Rs 1,500. There’s considerable upside from current levels if those targets are hit.