Assume you have gold worth 1 lakh rupees.
1. Goto the NBFC ask for a loan of 95,000 rupees, they advertise 95% loan against gold.
2. Give fake details, 15 minutes processing will ensure you are not getting caught here.
3. A year later if gold prices rise, get your gold back by paying the NBFC. Else enjoy the rip off, complete protection against fall in gold prices.
And that is probably why you should be skeptic of bonds/FDs of these companies, when the gold prices fall, the defaults will rise exponentially.
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Few issues in the analysis. This works in theory not in practice (Even in theory, gold needs to rise in value >~15% for you to breakeven)
ReplyDelete1) 95% LTV is only in advertisement. In reality its rarely greater than 80%
2) The max tenure of the loan is 1 yr (avg tenure is < 180 days and median is < 90 days)
3) Company makes you sign a waiver allowing them to liquidate your gold, the moment the loan touches 100% LTV
4) Company can liquidate your collateral the when you miss a payment, so you cant easily skimp on the interest payment
5) The company charges you rates ~15%+
So the point is, the operational reality of the gold NBFCs is different. They know that they cannot do customer credit worthiness due diligence. Hence they build a buffer in terms of LTV and terms & conditions loaded in their favor, which protects them against a major drop in gold prices (LTV buffer + small tenure of loan + 0 value assigned to any precious stones in the jewellery). The 15+% interest rate on the loan makes the type of arbitrage you articulate difficult. If you want to hedge against gold, or benefit from rise in value, use a simple Gold ETF. Its less costly and gives higher return than playing with Gold loan NBFCs.
These companies do have risk, operational & fraud risk remains high, hence their 12-13% cost of capital. Interest is taxable, so post tax return in lower based on your tax bracket. That said, they still offer attractive yield for short term instruments (1-2 yr NCDs offer 16% pre tax YTM)
All this only means one must invest with eyes open if risk tolerance is high and then too only a small part of your portfolio in these instruments.