Gold has seen its fair share of peaks and troughs during the past 12 months. In a year characterized by some as one of the most perilous ever in the last few decades as geopolitical tensions heightened on the back of rising nationalism and protectionism, the year 2018 has revealed several interesting trends in the gold sector, including a strong movement from West to East, fuelled partly, by an increasing demand from Islamic investors.
A confluence of factors including a weaker Indian jewellery market and a fall in investment demand for gold bars and gold-backed exchange-traded funds (ETFs) translated into tepid gold demand in the first half of 2018. According to the World Gold Council (WGC), demand during January-June 2018 stood at 1,959.9 tonnes, the weakest since 2009.
Although full-year figures are not available yet, third-quarter data painted a slightly more optimistic picture: demand hit 964.3 tonnes, 6.2 tonnes higher year-on-year driven largely by robust central bank buying and a 13% increase in consumer demand which compensated sharp ETF outflows.
As the price of gold tumbled, hitting some of its lowest levels in the July-September period, retail investors began flooding the market again, pushing bar and coin demand up by 28% to 298.1 tonnes and jewellery demand by 6%. Central banks also ramped up their purchases which culminated in the highest level of quarterly net purchases since 2015 at 148.4 tonnes (up 22% year-on-year) while technology demand continued to grow, appreciating by 1% on a yearly basis. These however were offset by strong outflows in gold-backed ETFs (mostly US-based), resulting in the sale of over 116 tonnes of physical gold.
Chart 1: Gold prices
“Most of this disinvestment has been soaked up by physical demand leading to physical gold leaving the vaults of the West and heading to the East and Far East to meet high Eastern and Islamic regional investment demand, both retail and institutional,” explained Philip Judge, CEO of Physical Gold Fund (PGF).
While India and China accounted for the bulk of this flow, Judge emphasized the growing influence of an often-overlooked market.
“Of great importance is the fast-growing and often little noticed investment demand from the Middle East where evidence suggests that demand for physical gold far exceeds many of the estimated numbers of buying in this region,” Judge noted.
Unlocking Shariah opportunities
Although gold has a long history of being widely used as a risk management tool and investment instrument by individual and institutional investors, this isn’t always the case in the Muslim world where there had been a lack of Shariah consensus or clarity over the permissibility of trading and investing in the yellow metal, making it problematic for investors and product issuers. As one of six items (the others being silver, wheat, barley, dates and salt) identified as Ribawi (staple everyday commodities), gold is subject to more stringent rules including the fact that it cannot be traded for future value or speculation.
Chart 2: Strong central bank and consumer demand offset ETF outflows
In 2016 however, a landmark development unfolded: global Shariah standard-setting body AAOIFI and WGC jointly launched the Shariah Standard on Gold (which also applies to silver), reconciling years of contrasting opinions and giving much-needed guidance on the Shariah rules and basis for the permissibility or impermissibility of gold in Islamic finance.
While gold-based Islamic finance products, albeit limited, were already available in certain markets (such as Iran and Turkey) prior to the release of the standard, and despite the existence of country-specific rules on highly specific Shariah issues on gold, it wasn’t until the release of the internationally-recognized 2016 AAOIFI standard that more market participants were comfortable enough to begin manufacturing Islamic gold instruments. For example, despite Securities Commission Malaysia already outlining Shariah parameters on gold and silver-based Islamic ETFs as early as 2014, the country only welcomed its first Islamic gold ETF in 2017 after the introduction of the AAOIFI standard.
“Given its history and reputation, the opportunity for the use of gold in Islamic finance is clear… this standard will enable the foundation of what could be the most significant event for Shariah finance in modern times,” Dr Mark Mobius, the former executive chairman of Templeton Emerging Markets Group, said at the time when the standard was launched.
Expanding the universe
The AAOIFI Shariah Standard on Gold triggered a domino effect. Within weeks of its release, financial institutions – Islamic and conventional – began rolling out, or announced intentions to introduce, Shariah compliant gold-based products.
At least 10 different types of instruments have hit the shelves since then, ranging from the more traditional gold coins and bars, the familiar gold-backed funds and ETFs, to groundbreaking gold Sukuk and exotic gold digital tokens.
But does the sudden surge in Islamic supply translate into corresponding Islamic demand?
“It is difficult to quantify Shariah demand at the moment but based on the number of new products and requests to develop new gold-backed products, it is reasonable to say that there is a healthy demand for Islamic gold products,” said Andrew Naylor, the director of central banks and public policy, at the WGC.
Chart 3: Sanctions push Iranian bar and coin demand to a five-and-a-half year high
Muslim-majority nations are indeed demanding more gold.
As global financial markets are being riled up by the ongoing trade war between China and the US, escalating regional military conflicts as well as heightening geopolitical uncertainties, investors – particularly those from emerging markets – are finding refuge in the safe-haven asset class.
Demand for gold bars and coins in the Middle East hit a record five-year high in the third quarter of 2018. It spiked 144% on a yearly basis to 27.8 tonnes, with Iran accounting for three-quarters of the share (21.1 tonnes).
“Renewed sanctions and the plummeting rial – with expectations for it to fall further – underpinned this flight to gold. VAT-free bars and coins were preferred over jewellery, which is subject to 9% tax,” explained the WGC.
One of only two countries in the world to adopt a fully-fledged Islamic financial system, Iran boasts a rather sophisticated Islamic gold offering which includes gold futures, gold coin options and at least four gold ETFs.
Outside of the Middle East, the central banks of Russia, Kazakhstan and Turkey continued their buying spree. Central bank net purchases reached 148.4 tonnes in September 2018, up 22% year-on-year, the highest level it has been since 2015.
But in the context of Shariah gold, Turkey takes the spotlight. The Eurasian Republic has been buying more gold than ever – year-to-date, it has acquired 54.7 tonnes including 18 tonnes in the third quarter. Caught in political and economic turmoil, this rush to gold is motivated by its determination to gain independence from foreign currencies, particularly the US dollar as Turkey-US relations continue to hang precariously. To this end, the central bank in 2011 even allowed banks to hold a certain fraction of their Turkish lira reserve requirements in gold (or FX) to mitigate the adverse impact of capital flow volatility on the domestic economy.
What is impressive about Turkey is that the Republic has managed to leverage its gold-centric stabilizing policy strategy to also advance another national ambition: to be an Islamic finance hub for the region. With its sovereign gold-backed Sukuk launched in 2017, Turkey carved its name as a pioneer and demonstrated its leadership in Sukuk innovation.
The first of its kind by any government, Turkey’s gold lease certificates have been designed to mobilize 2,200 tonnes of household gold into the economy by allowing retail customers to buy the Islamic securities using gold.
The successful Sukuk program – which in December saw the expansion of its dealer network from just Ziraat Bank to include Halk and Vakiflar – is just one of many gold innovations Turkey has led. In fact, Kuveyt Turk was the first to roll out a gold ETF back in 2010. The participation bank now has 17 Islamic gold products under its belt, confirmed Selman Bayoglu, the bank’s treasury marketing manager. It is also exploring a gold-denominated Sukuk.
In recent years, the notorious bitcoin has been likened to gold for its scarcity, durability, portability and fungibility; in fact, some have argued that bitcoin is far superior to gold, even dubbing it as Gold 2.0 or the new gold.
“I would prefer having a cautious stance in naming cryptocurrencies as Gold 2.0. Though they still make headlines and are on the agenda of millennials, cryptocurrencies need to be more globally regulated and to be able to build more confidence among asset owners to topple gold from the throne,” said Selman of Kuveyt Turk.
“It is product innovation, but we need to be careful,” cautioned Naylor of the WGC. “The thing about cryptocurrencies is that it comes with a whole set of different issues – it is not to say that all cryptocurrencies are bad, but when it comes to investing in cryptocurrencies, there are additional factors you have to consider including how the product is structured.”
While digital currencies remain a deeply divisive and contentious issue among Shariah scholars, asset-backed crypto tokens – particularly gold-backed crypto tokens – have found favor among several leading scholars.
Fintech company HelloGold, whose online gold trading platform was the first digital gold product to be certified Shariah compliant according to AAOIFI rules, also had its audited gold-backed HelloGold Token, approved as Muslim-friendly.
Following the unprecedented Fatwa issued to HelloGold, Islamic scholars out of Bahrain this year gave their stamp of approval to Swiss-based X8Currency, a virtual currency backed by gold and eight major fiat currencies.
Gold may have been lackluster in 2018 due to a strong US dollar but analysts are generally bullish about 2019.
“We see gold likely repricing lower through the middle of next year, at which point the Fed’s policy will move into restrictive territory. The [Treasury yield] curve will invert, the expansion will slow and expectations of Fed easing will build. At this juncture, we would expect real rates to move lower and gold’s fortunes to reverse, as gold tends to benefit from a consistent drop in real yields during the lead up to recessions and thereafter,” according to Natasha Kaneva, the head of metals research and strategy at JPMorgan.
Volatility in the Middle East is also a potential uptick signal.
“Sweeping US economic sanctions and financial transaction restrictions against Iran will lead Tehran to forge new economic and financial alliances with non-US-aligned trading partners including Russia, China, Turkey and North Korea. It will also lead to non-US-dollar settlement in trade with the increasing likelihood of physical gold being used as a medium of exchange between Iran and its trading partners,” opined Judge of PGF.
An expanding middle class in China and India, stronger economic growth, and the utilization of gold in technology, healthcare and energy would also likely lend strength to gold demand.
In the Islamic finance space where the universe of investable assets is limited due to the confines of Shariah, the importance of being able to diversify into a new asset class – especially one that is well established and liquid – cannot be overstated.
Not only is this an opportunity to improve the overall risk-return profile of one’s investment portfolio, but it could also assist Islamic banks in meeting regulatory requirements, particularly Basel III which requires banks to hold a higher amount of high quality liquid assets as buffers against systemic liquidity crisis – a role the precious metal can play.
The Shariah gold momentum over the last two years has been stellar and the horizon is looking even brighter as market players continue to bolster their product suite and investors polish their knowledge on the asset class. It is understood that the International Islamic Financial Market is looking at engaging other international standard-setters such as the WGC and London Bullion Market Association on potentially co-developing a standardized Shariah compliant gold allocation agreement.
“Moving forward in 2019, we will continue to focus on product development,” assured Naylor. There are a number of products under development that will be launched next year so the pipeline is looking healthy.”
|Islamic gold products launched since introduction of the AAOIFI Shariah Standard on Gold|
Singapore Exchange had its Kilobar Gold Contract certified as Shariah compliant according to the AAOIFI standard in January 2017, claiming to be the world’s first Islamic gold futures.
However, the Islamic Republic of Iran had already been using gold to hedge risks through Shariah gold derivatives such as futures and options even before the standard. Nonetheless, being isolated from the rest of the world because of sanctions, and due to varying interpretations of Shariah compliance between the Iranian model and the rest of the world, the Islamic gold finance arsenal that Iran has built remains mainly within its borders.
Launched by the Dubai Gold and Commodities Exchange on the 29th March 2018. In the three months since its launched, it traded over 520kg of gold worth US$22 million.
The Turkish treasury began issuing gold-backed retail Sukuk in 2017 to diversify its borrowings and broaden the investor pool as well as attract idle gold.
At least seven in the market including the world’s largest physical gold-backed ETF, SPDR Gold Trust, which was issued a Fatwa in 2017. In the same year, Iran welcomed four while Malaysia launched its first Islamic gold ETF.
The Royal Mint became the first mint to achieve compliance with AAOIFI’s gold standard in 2017, followed by The Perth Mint in 2018.
A number of gold-backed cryptocurrencies positioning themselves as Shariah compliant have emerged in the last two years (including Noorcoin and OneGram), however, only two have been formally approved as conforming to Islamic principles: HelloGold’s HelloGold Tokens and GOLDX and Swiss-based X8Currency.
|Digital gold trading platform
Malaysia’s HelloGold and Indonesia’s Tamasia
Physical Gold Fund certified Shariah compliant in 2018.
First AAOIFI-compliant one offered by National Bank of Fujairah to Malabar Gold in 2017
Offered by a number of Islamic banks prior the AAOIFI standard including Kuwaiti Finance House and Al Rajhi Bank. French Takaful provider SAAFI in 2017 launched a gold savings plan.