Gold and silver are vital inputs for jewellery manufacturing — but the base prices of these precious metals are highly volatile. This can hurt fabrication margins in the industry. At the Retail Jeweller India Forum 2018, Shivanshu Mehta, head–bullion, MCX, offered a minor master class in how to overcome this issue.
The base prices of gold and silver skate up and down every day, often predictably and to the extent that they can damage jewellers’ profit margins.
To protect already-narrow margins and insure against loss as the prices oscillate, said Shivanshu Mehta, head–bullion, MCX, in his presentation titled “Volatility in Precious Metal Prices, Risk and Its Mitigation via Futures and Options” at the Retail Jeweller India Forum 2018, jewellers can practise hedging via futures and options, on commodity derivatives exchanges like that of MCX.
In the wake of policy changes like demonetisation, the goods and services tax regime (GST) and other supply-side regulation, Mehta observed, the jewellery industry is changing fast from unorganised to organised. Among the best practices of organised business is proper risk management.
“If we multiply India’s gold and silver imports in FY 2017 by their annualised volatility percentage of 9 and 14 per cent, respectively, we get values of Rs19,000cr and Rs2,854cr. This indicates the quantum of risk the industry is exposed to annually,” he said. “This is where MCX contributes, as a risk management platform.”
MCX’s platform offers a complete hedge, Mehta said, covering all components from the international gold or silver price to the currency exchange rate, import duty changes and the domestic premium/discount. This helps the entire value chain, including importers, bullion traders and jewellers, to use the price as a domestic benchmark for their products.
The platform’s correlation with international and domestic spot markets is over 98 per cent, he said, which adds to its efficiency. MCX’s trading hours extend till midnight, allowing Indians to manage price risks as efficiently as their global counterparts.
“One can secure one’s capital via the long hedge or the offset hedge,” Mehta said. “In long hedging, you don’t have the metal but you lock your input price at the exchange-traded futures/options, securing a long-dated price quote. In offset hedging, you have the metal in your inventory and you use it to offset market positions on the exchange.”
Since hedging is attained via a futures transaction, he said, “a margin of about 5 per cent gets blocked, initially. You are free to employ the remaining capital in your business. This leads to price-protection, better cash-flow management and better valuations.”
Options enable jewellers to participate on the favourable side of the price movement and yet remain insured against adverse price movement. “The maximum loss is a pre-decided number of 1–2 per cent, which is the extent of the premium paid by an option buyer to a seller,” said Mehta.
“One can try a combination of futures and options, which has the double advantage of futures trading and security against loss while trading with options,” he added. “The one-time payment and taxation on premium go easy on your expenses.”
He illustrated by describing how gold miners create a floor price by above the money “calls” and protective “puts” below the money. “Jewellers, too, can create flexible pricing schemes for their walk-in customers, by buying “puts” at current prices and offering a choice between the price on that day or on the date of a particular festival, whichever is lower. For inventory price protection, jewellers can write calls above the money when the implied volatility of the metal is higher, thereby reducing cost of carry.”
Mehta turned to MCX’s various bullion contracts for importers, branded jewellers, small and medium enterprises, and exporters. With an average daily turnover of Rs4,501cr in gold and Rs3,353cr in silver, he said, MCX Bullion contracts served over 200,000 participants during FY2017. Since its inception, the exchange has seen deliveries of 103.52 metric tonnes (MT) of gold and 2,808 MT of silver.
Citing amendments to Section 43(5) of the Income Tax Act, 1961, Mehta said that hedgers need not show physical delivery of commodities to prove that their transactions, on regulated stock exchanges, are not speculation. Such income or loss can be offset against business income.