Is it time to sell jewellery stocks?
The recent measures by the government and the RBI have led to a drastic drop in prices of such stocks, but large-cap players are still good picks.
The other factors contributing to the decline are measures taken by the Indian government and the RBI to curtail domestic gold consumption and import to bring the current account deficit under control. As is evident from the table (see Crash season), the stock prices of some of the leading jewellers have gone down by 20-50% during the past month.
Is there any hope of recovery anytime soon or will these stocks continue to tumble? Most of these stocks are likely to slip further in the short term as the factors affecting them have just begun to unfold. Gold prices have started cooling off after a decade of rallying. However, the price fall won't affect jewellery stocks severely because it may lead to an increase in demand for ornaments, just as it did in April and May this year after the prices declined. Auspicious festivals like Akshay Tritiya during this period also led to the spurt.
The demand for gold jewellery came down in June because the price of gold recovered from the previous lows and there was no major festival in that month. Though the demand for jewellery may not rise as drastically as it did during the two earlier months, it is expected to increase in the future if the price fall continues. "The demand for Indian gold jewellery is based on affordability, and with the price correction, gold obviously becomes more affordable," says Abhijeet Kundu, vice-president, research, Antique Stock Broking.
However, the price fall may reduce investment in gold, which is typified by the demand for gold bars and coins. Investors are also worried that the government and the RBI may take further steps if gold imports don't come down soon. To avoid this, jewellers may stop selling gold bars and coins. In fact, Gitanjali Gems has already announced this and others are expected to follow suit. Will this move hit their bottom lines? "No, this won't affect jewellers much since the sale of gold bars and coins is a lowmargin business," adds Kundu.
Won't these companies be forced to book huge mark-to-market losses on the gold they hold as inventory? Not really, because most of them use the gold lease model, wherein the gold is leased from the channelising agencies. So, jewellers are not affected by the price fluctuations. However, the scenario is likely to change after the new restriction is imposed by the RBI. According to the central bank's latest move, jewellers are supposed to import gold after paying money upfront and, hence, gold becomes the property of the jeweller. To protect themselves from price variations, jewellers will have to take steps like hedging in the forward markets.
However, they don't have to do so immediately as some inventory from the lease model is still in the system. "Titan has leased gold inventory which can last two months. So, it will need to hedge only after this period," says Abneesh Roy, associate director, research, Edelweiss Securities.
Since jewellers have to pay upfront for imported gold now, the biggest impact of the RBI restriction will come in the form of increased working capital needs. "Gold sourcing costs may go up by 400-500 basis points," says Kundu. Though jewellers can pass on these additional costs by increasing making charges, they are likely to do so over a period of time. This means that they will have to withstand the margin pressure in the medium term.
Though the actions of the government and the RBI are aimed at domestic gold consumption, gold exporters seem to be the collateral damage. This is because the new regulations have changed the structure and banks are not clear about the RBI circular.
So, for the time being, they are restricting gold imports. The fallout is that banks don't have gold and exporters are being forced to buy directly from the market, where they have to pay upfront. "As gold exporters are converters, it will be difficult for them to pass on the additional costs to international jewellers," says Kundu. This is the major reason that exporters like Gitanjali Gems are holding back currently. "Banks are waiting for clarifications from the RBI and this is expected within a week," says Mehul Choksi, CMD, Gitanjali Group. Another reason for cutting back is speculation. There are reports that a stock market operator has defaulted and that some shares (like those of Gitanjali Gems) pledged by him are being offloaded by the Clearing Corporation.
How should investors approach the sector? Though it will continue to witness hardship for some more time, there is no need to avoid all stocks. The best strategy is to stick to large-caps because organised large players are expected to garner more market share during uncertain times. Due to their scale, they have an advantage in issues like hedging or raising resources to buy gold by making upfront payments.
For example, Titan Industries, a debt-free company, can increase its resources by leveraging, while other smaller players will find it difficult to raise funds. "Since the correction in the Titan Industries counter is more than warranted, it is a good pick now," says Roy.