Home > Uncategorized > Should RBI write covered calls on gold?

Should RBI write covered calls on gold?

Should RBI provide liquidity to the Indian gold market?

India produces no gold.  All gold is imported into India.  Imports this year will exceed 1000 MTs of physical gold valued at $64 billion.  Gold imports are the 2nd largest item of import next only to oil. Gold imports are 3 times the total FII and FDI investments in India.  India exports $3 of savings abroad for every $1 of savings received from overseas investors. What else is capital flight?  Foreigners are selling us beads for our hard earned wealth.  The situation is ridiculous.  It persists only because our experience with banning gold imports prior to the 90s, and the consequent smuggling rackets, deters us from examining the matter unemotionally.  Gold still drives people crazy. Policy measures are required to moderate gold imports using market based regulation rather than communist style controls of yore.  One way to do this would be for RBI to encourage gold ETFs on Indian bourses and afford them flexibility in operations by writing 3 months to 3 year covered call options. This would help moderate gold inflows triggered by investment demand and also give the RBI a handle by which to monitor and moderate gold metal inflows.

RBI could use a part of its existing portfolio of gold, say 100 MTs to write 3 months to 3 year call options on gold.  Only ETFs who sell gold units to investors would be eligible to buy these options to begin with. Their purchases of calls, would naturally be linked to their portfolio of gold held, units outstanding, annual sale & purchase of gold etc.  RBI should afford the ETFs some flexibility but overall the ETFs would have to keep their net long or short position in gold to within say 20% of the total units outstanding to investors at any given point in time.  This would limit risk to them and cap the possible demand for such call options from the RBI.  It would also ensure that RBI is not called upon to import any gold over and above what would have been imported had the ETFs not sold units to investors.

RBI in turn could import gold when its call options get called in or any time during the currency of the calls outstanding. Ideally RBI should create an independent body under it to run a portfolio of physical gold, calls and puts using the local and overseas gold markets in order to manage its operations in the gold market in much the same way as it intervenes in the FX markets.  We need to realize that gold imports now are 2nd only to oil in our import basket and not some residual item that can be left to fend for itself.  There is need for proactive monitoring & management of the gold market.  It bears repeating that gold imports are 3 times the inflow of FII + FDI investments into India.  Yet contrast the policy attention paid to FII + FDI with that given to the gold market.  Policy makers ignore the elephant in the room.

To the extent ETFs replace the physical demand for gold, we avoid importing gold which is nothing but export of savings from India to overseas investors. Gold remains largely un-monetized in India, locked up in household vaults playing no further role in wealth creation. Therefore every ton of gold import avoided is every ton of gold earned by the economy. That is not a small amount. In fact it is humongous and provides the economic motive for a body like RBI to go out and write the call options.  The economy has nothing to lose and everything to gain even if RBI manages to defer import of just 10 or 20 Mts of physical gold. There is no downside to RBI or the economy in writing gold calls to ETFs.

RBI, as the central bank has the mandate, indeed the responsibility, to encourage savings in financial instruments rather than a physical asset like gold. Most central banks the world over pursue policies designed to promote the active use of fiat currency over gold.  In fact some like the FeD have powers to actively discourage citizens from holding physical gold.  So RBI intervention in the markets through writing call options would be in line with global central bank practice.  The intervention need not, indeed should not, be massive. Instead it needs to be used to promote use of gold ETFs and signal RBI intentions at market extremes as in the FX markets.

Gold prices have a phenomenal bull run from early 1990 to date with prices having shot up from $250 an oz to over $1850 now.  That bull run may continue but there is no denying that we are in a very mature bull markets and nearer its end than the beginning. While it is nobody’s case that RBI take a view on gold prices, it is worth noting that many investors will get badly burnt as gold prices correct, now or the near future.  Writing gold calls, covered by a small part of its gold reserves, will help avoid or defer very expensive gold imports at the top of a mature gold market.  While investors in ETF will certainly pay the price in case of a correction, as they should, the economy as a whole need not take the fall with them.  Indeed RBI has an obligation to issue some caution on gold prices at market extremes as it does in the case of equity or FX markets.  Writing covered calls would be a good way of issuing such a caution as well as making some money on the side while saving the country a whole lot of money buying a metal has little use locked in household vaults.

Categories: Uncategorized
  1. Mohit
    August 28, 2011 at 6:26 am

    Creating options on gold is an idea whose time has come. I have been nourishing the thought for a couple of months; thanks for putting in such concrete terms.

    One point of departure I have from you relates to gold being beads sold to us by foreigners; the image echoes those of American ‘Indians’ captivated by novel, and worthless, baubles offered up by English traders. Gold, on the other hand, has been seen as a store of value by Indians long before Christopher Columbus, Amerigo Vespucci, or any of the European men of fortune.

    For some reason – a fear of debased currency, the value of scarcity…- a pretty old civilisation sees gold as a reliable store of value. We see exactly the same phenomenon asserting itself in China, as economic freedom begins to make its way into that old nation. There is something happening here, which may prove to be of value in a time when profligate governments are the biggest threat to economic stability.

  2. August 28, 2011 at 7:07 am

    Why not dig for gold ?

    Why NOT prospect for gold internationally as our govt internationally looks for oil ??

  3. Tulsidas Thakur
    August 28, 2011 at 1:46 pm

    Very timely wake up call for RBI and Govt.of India. Likely sharp decline of rupee against US$ shall further push pressure on Balance of Payments , which I suppose is not comfortable. By suggesting covered calls on Gold , you have come up with a brilliant idea to stop export of scarce capital , as far as possible. Congratulations.

  4. Tulsidas Thakur
    August 29, 2011 at 2:48 pm

    Yes, Subu has rightly asked why not dig for gold? Sorry to state , our politicians are myopic.Deccan Gold Mines Ltd., a listed co. has done all prospecting work but are still awaiting licence from Mining Ministry, of Central Govt.

  5. sunny
    August 30, 2011 at 4:49 pm

    few Question here RBI hold only about 600 MT of Gold how it can manage it .
    secondly in Forex market RBI can intervene as it has every ammunition at his pocket to control rupee rate and not in gold it cannot control it price .
    thirdly who will bear the loss if gold prices touches new high if we suggest this idea this will create a bigger problem.
    it is better Options trading are allowed in commodity market here in India first between investor and not RBI as counter party.
    good idea will be start looking for gold reserve in India, like the one which BHP recently found a gold mine in which work currently is going on

  6. sunny
    August 31, 2011 at 7:07 am

    why my question got deleted by moderator is asking not allowed here?

    • sunny
      August 31, 2011 at 7:09 am

      oh it is still awaiting moderation after more than 16 hours thats y can’t see it kindly remove this. sorry for that

  7. December 19, 2011 at 10:41 pm

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  8. January 8, 2012 at 12:25 am

    This is a very good information. It has every strong data that could help investors to make their analysis.But i do solicit for more market information that will further strenghten the power of forecast over time. i do hope to read further and extend it to others. keep it up. i shall be expecting to get more updates

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