Sun. Oct 6th, 2024

In the last five years or so, gold hasn’t been a great asset in terms of its market performance. The one gram gold rate as of now is around Rs.4,225. Although the drop of gold price in the last month or so can be associated with the after-effects of the corona-virus outbreak, still if you look at the five-year graph of the performance of gold, the picture would be more precise. However, as surprising as it may sound, the gold loan companies during this time have not just maintained profitability. Still, the stock prices of these gold loan companies have also performed exceedingly well. 

If we look at the two major gold loan companies in India, and how their stocks have performed in the last five years, then that is where things get interesting. In the previous five years, Muthoot Finance Gold Loan has returned 163.10% on its investment, while Mannapuram has returned 141.63%. Even if you reduce these numbers to CAGR growth, it’s still impressive compared to Nifty. However, in the same period, the return on gold metal has been negative. This is a paradoxical situation as usually, the financier of an asset grows along with the asset. 

Here are four key points that will shine more light as to why this paradoxical situation exists.

 

  • Low Degree of Asset Price Risk:
    In case of hypothecated gold, the risk of asset or gold price is very low. Since gold is not as volatile as equities and gold loan companies finance only up to 60-70% of the gold value, the loss for these companies gets minimized even when the return on gold in the last five years has been negative. What this reflects is that the rate of interest charged by these gold loan companies is hefty, and the risk of asset price default is negligible. Since the gold loan business is not fully regulated like MFIs, the gold loan companies get enough leeway to make high profits.

 

  • Distributed Low-Cost Networks:
    The most significant advantage of these gold loan companies is the low-cost networks they enjoy. The demand for gold loans is huge in semi-urban and rural areas; in these areas, these companies operate through franchisees and brokers. This means they have to pay only a small variable payout instead of a large establishment and operation cost. Also, the people in rural and semi-urban areas prefer gold loan companies due to the simplicity of required documents, promissory note, and a simple form. You can go for usda mortgage. Thus, the low-cost operations in rural and semi-urban areas have helped a great deal to these gold loan companies in maintaining their good stead.

 

  • Substantial Appreciation of Asset Value:
    The most significant alpha for the gold loan companies is when the price of gold increases substantially. They won’t increase your loan proportionately, but a high gold price enables them to get higher funding from refinancing banks along with better spread and margin. Since most of the customers of gold loans are uneducated and dispersed, they do not possess the bargaining power to demand better terms for funding. Thus, in the scenario of rising prices, the whole situation works exceptionally well for the gold loan companies.

 

  • Gold Funding and Spread Arbitrage:
    This may be the most crucial aspect of the gold loan business. The gold loan is extended only for about 60-70% of the value of gold with which you have approached. Also, the amount of gold is adjusted much lower, which makes the actual margin much higher. After providing you with the loan, these gold loan companies approach banks and pledge this gold to get funding of 80% or even more to the value of gold. Another factor that works for them is the vast divergence in the rates. The PSUs finance the gold loan companies between the rate of 11-13%, these gold loan companies then go on to charge anywhere between 18-32% from its customers based on the credit risk of the borrower.

Apart from the gold loan service, these companies also raise money through deposits, which is generally on a long term basis. So, they raise money at a lower rate on long term deposits apart from other sources of raising debts to finance the high rate short term gold loans to make an above-market spread. So, on the whole, the unique nature of gold and the vast arbitrage that the gold loan companies enjoy gives them the advantage. That’s why they have been able to perform well even after negative returns on gold.

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By Meets Patel

Meets Patel is a well-know business and tech advisor with the abilities to keep a track and predict the market trends with the utmost accuracy.

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