Futures & Commodities

Is this a new snag for gold demand?

Randgold CEO: Gold industry broken

New measures by the world's top gold consumer to reduce imports could erode global bullion demand, experts say.

Indian finance minister Arun Jaitley announced the creation of sovereign gold bonds as an alternative to purchasing physical gold during the government's annual budget presentation on Saturday. While concrete details have yet to be fleshed out, these bonds will have a fixed interest rate and will be redeemable for cash on the face value of gold.

The intention is for investors and households, the largest gold hoarders, to move away from physical gold and towards this type of paper gold, which should see demand for the physical metal decline if the bond is successful, explained Radhika Rao, economist at DBS.

"[Sovereign gold bonds] could potentially reduce investment demand for physical gold," agreed analysts at Morgan Stanley in a new report. Asia's third-largest economy overtook China as the largest gold consumer in 2014, according to the World Gold Council; slower Indian consumption tends to impact global demand.

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The sovereign gold bond follows many government-led initiatives to reduce physical demand in recent years. India's massive appetite for gold jewelry boosts imports, which widens the current account deficit – a wide current is often negative for emerging economies.

Every year, India imports between 800 and 1,000 tons of bullion. Data from January this year showed imports soaring 55 percent on year to $1.5 billion.

"Even a modest 20 percent decrease in Indian gold imports will be negative for global gold demand" Victor Thianpiriya, ANZ commodity strategist told CNBC. However, Thianpiriya warned that reducing import volumes through a scheme like the sovereign gold bond will likely take years.

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He expects gold to end the year at $1,280 an ounce, little changed from around $1,220 currently.

Markets will have to wait to see what impact India's gold bond has on gold prices, said David Lennox, resources analyst at Fat Prophets: "It may reduce speculative buying for now but India's cultural attachment to gold will remain strong."

Not everyone agrees

On the other hand, some analysts believe Indian gold demand may remain resilient regardless of government efforts to curb physical demand.

"India's demand for gold should resume its upward trend, reflecting growing incomes and market innovations. We expect strong Indian demand to contribute to a recovery in global prices, to $1,400 per ounce, by end-2015," said Julian Jessop, head of commodities research at Capital Economics, in a report.

Data from the World Gold Council last month showed Indian consumption remained strong at 842 tonnes in 2014 even as global gold demand cooled to a five-year low.