In today's Finshots we talk about the newly proposed gold exchange

Markets

The Story

You’ve probably heard about it already. SEBI wants to set up a new trading exchange for gold. It’s like this place on the internet where you can trade stocks. Only in this case, you get to trade electronic receipts that will have physical gold backing them. And while everybody’s curious to see how all this might play out, we have to address the elephant in the room.

Why?

Why do this in the first place?

You can actually buy digital gold right now, can’t you? So what’s the point of this exercise?

Well, you can buy digital gold on the internet, sure. But you can’t trade them with random strangers on the internet*. And trading stuff with random strangers on the internet brings so much joy to the community that SEBI now wants to create an institution to facilitate the process.

Actually, that’s not true. It was a joke.

SEBI wants to do this because they think it might allow for better price discovery and robust retail participation. It’s like this — When you have a large group of people buying and selling gold, haggling on a price, you’ll probably have a better estimate of the true value of gold at any given point in time. And yes, you could look at international prices for clues. But where do you think they come from? Once again, you have a large group of people buying and selling gold on some international forum, ultimately helping others discover the true price. And so if you were to extend this logic and replicate the process locally, maybe you can get a better price estimate for gold. At least, that's the hope.

So now that we understand the motive, perhaps it makes sense to look at the modus operandi of this enterprise.

And here’s how things might play out on this front.

When accredited people and institutions import gold into the country, the deposits make their way into secure vaults. Once inside these vaults, they’ll stay there, all nice and cozy, until the owners decide to retrieve them. In fact, there’s actually a bunch of gold right now within these vaults that haven’t left the vaulting infrastructure. EVER!!!

And owners of these virgin deposits could choose to convert physical gold into Electronic Gold Receipts (EGRs) if they so desire. The gold has to meet a certain standard and it’s the vault manager's job to record relevant information about the physical gold and capture it in a common digital interface. In effect, they’re the ones converting physical gold into digital receipts by documenting them on a secure network. However, you still can’t trade these receipts.

At least not until the two depositories responsible for maintaining information about tradeable financial instruments can assign a unique code to the EGRs. If you don’t know much about these depositories, know that they are the same institutions responsible for holding some of your most valuable assets. Assets like stocks and bonds. These vaunted financial instruments have to reside someplace — even if they’re digitized. And it’s the depositories that host them for you. So yeah, once they have an EGR, they’ll assign a unique code and the owners can then trade it.

But what’s the unit of each EGR?

How much gold do these receipts hold?

Well, according to the consultation paper, SEBI wants to have EGRs of 1 kilogram, 100 grams, and 50 grams. They also said they’d probably allow EGRs of smaller denominations including 10 grams and 5 grams, but maybe this is one for the future.

Anyway, at the end of each trading day, the important stakeholders will make sure all the gold is accounted for and all the traders are paid their due share. The only problem here is that gold is a commodity and you should ideally be able to exchange the EGR for physical gold. However, you can’t expect to do this, unless you have a substantial amount of receipts with you. Imagine asking vault managers to send you physical gold every time you get your hands on a 50 gm EGR. The vault manager has to extinguish the receipts, request the depository to cancel the entry from their database, and then send 50 gms of gold back to you. It would be a logistical nightmare.

So yeah, SEBI has a few good ideas on how to make sure trading goes through smoothly, but if you have any additional comments, you can actually actually write to the regulator and get your views across, since they're in the consultation phase right now.

Anyway, that’s it from us. We will see you tomorrow.

Until then don't forget to share this article on LinkedIn, WhatsApp and Twitter

*Point of Interest: You can dabble with gold futures in the commodity market right  now.