With the Islamic finance industry set to be worth US$3 trillion in the next decade, gold could be a catalyst for its growth with the setting of new regulations that will allow Islamic investors for access to gold-based products for the first time.
The market development body, the World Gold Council (WGC), which is based in London and the Islamic standard setting body, the Accounting and Auditing Organisation for Islamic Financial Institutions (Aaoifi), based in Bahrain, are working on a draft of the standard that would galvanise the $2n Islamic finance industry.
“Consumers more or less have been confined to investing in bars and coins because that’s the only area where the rules are clear,” says Natalie Dempster, the WGC’s managing director of central banks and public policy.
“It [the standard] could fundamentally change the way in which Islamic countries access gold.”
A final draft is expected to be published in the next few months, to be followed by a period of public consultation, says Ms Dempster. The standard could be issued in the fourth quarter, prompting its adoption and unleashing hundreds of tonnes of extra demand for gold, she adds.
“This is the most significant game-changer for the gold market since the Washington Agreement in 1999, whereby 15 central banks pledged to coordinate and limit their activities,” says Matthew Keen, the founder of the Dubai consultancy Evidens. “The price of gold has quadrupled since that agreement was formed.”
The Washington agreement limited the amount of gold that several major European central banks can collectively sell in any one year, helping to stabilise the gold market. The price of gold in 1999 was $290.25 an ounce. Now it is trading above $1,266 an ounce.
“I would expect billions of USD equivalent to be made available towards the global gold markets, keeping in mind that gold as an asset class has, anyway, a strong presence in a near zero interest rate environment,” says Gerhard Schubert, the founder of Dubai’s Schubert Commodities Consultancy.
The fact that the Aaoifi is working on the standard will speed up its adoption worldwide because the regulations issued by the body are widely accepted, analysts say.
The divisive view of gold as a commodity or currency will also be clarified in the standard, which will take into consideration both aspects of the metal.
“Gold can only be bought and sold on spot/cash basis, there can be no deferred payment for any purchase of gold, and there are specific rules on the use of gold as a commodity or currency,” says Megat Hizaini Hassan, the head of Islamic Finance Practice at Lee Hishammuddin Allen & Gledhill in Kuala Lumpur.
“Thus having a Sharia standard on gold would help contracting parties to know what specifically they can or cannot do with gold.”
Gold has had a lustrous start to the year, rising by about 20 per cent year to date on the back of the low interest rate environment and flight of investments to a haven asset.
Gold’s rally this year follows three consecutive years of losses, its longest rout in more than 30 years.
Demand for gold rose in the fourth quarter of last year 4 per cent to 1,117.7 tonnes, led by central bank purchases, the WGC says. Central banks are buying the bullion to diversify their asset portfolios amid wobbly global economic growth and plunging commodity prices.
For the full year, gold demand fell 14 tonnes to 4,212.2 tonnes, a level on par with demand for 2010, the WGC adds.
Although Islamic investors have missed the gold train, the new standard will help them channel their money into products such ad gold exchange traded funds (ETFs), gold accumulation accounts and gold savings accounts, analysts and officials say.
ETFs are funds that are listed on an exchange, tracking indices and behaving like stocks.
“[The standard] makes it easier and more cost efficient for banks and financial institutions to issue gold products,” says Ms Dempster.
“At the moment, if you want to invest in Sharia-compliant assets, the universe of assets that you have to choose from is actually quite small.”
Currently most Islamic investors funnel their money into equities, property and sukuk or Islamic bonds.
“Although the price of gold can prove to be volatile in the short term, it’s always maintained its value over the long term,” says Samina Akram, the managing director of London’s Samak Ethical Finance. “Investing in physical gold or mining stocks, I feel, will prove popular for investors in coming years. I would even argue further, values of currencies are declining as fiat money has no intrinsic value, and physical gold could be one of possible remedies to the global financial crises.”
Gold could be used as an underlying asset for a number of products, including sukuk.
Islamic banks could also use gold as a high-quality liquid asset (hqlas) to comply with more stringent Basel III banking standards that are being phased in. High-quality liquid assets can be composed of cash, or assets that can be converted into cash at little or no loss of value in private markets to meet a bank’s liquidity needs.
“Since the financial crisis, banks have been required to set aside pockets of so-called high-quality liquid assets to protect them against another systemic liquidity crisis,” says Ms Dempster.
“Basel gave national supervisors in Islamic jurisdictions the right to define high-quality liquid assets themselves. And I think gold will fit very well there. It is an extremely liquid market.”
But the adoption of the standard could face a few bumps.
Banks should be willing to adopt the standard and dedicate time and effort to create products that investors want.
“The Islamic community will only be able to take advantage of this if the banks, both Islamic banks and regular banks, are prepared to deliver products to their clients, Islamic or otherwise,” says Mr Keen.
“If the banks don’t do anything to take advantage of this, then nothing changes.”
Follow The National's Business section on Twitter