Islamic finance set to change gold market

The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) has made an important decision last year. This decision is about one of the most important markets in the world: the gold market, an investable market worth an estimated $2.4 trillion and is also of significance for the world of Islamic finance.

The AAOIFI, in collaboration with the World Gold Council (WGC) and Amanie Advisors, has approved what will become known as the Shariah Gold Standard. This is a set of guidelines that will expand the variety and use of gold-based products in Islamic Finance.

As many as 1.6 billion Muslims in the world, 25 per cent of the population, will have far greater access to the gold market than they have since the birth of modern finance, which has been primarily structured towards Western ideals.

We don’t have the full details of the guidelines but expect to find out more this week at the World Islamic Banking Conference. However, we do know three things that the new Shariah gold-standard will achieve: first, it will increase both the number and diversity of available Shariah-compliant gold investment products; second, it will place far greater emphasis on the role of physical gold in gold transactions; finally, it will give a greater role to Islamic finance in the setting of the gold price.

To some, this may appear to be an unnecessary formality taken by the body whose guidelines are followed by Islamic finance institutions across the world. After all, physical gold is Shariah-compliant and holds a unique status for Muslims. AAIOFI states, «From the perspective of Islamic Fiqh and the Islamic economic system, gold has its specific significance. This significance arises from the specific principles provided for gold and silver as Thaman in Shari’ah.»

According to Islamic texts, gold is a ribawi item, which means that it must be sold on weight and measure, and cannot be traded for future value or for speculation. In order for a gold instrument to be Shariah-compliant, the precious metal must be the underlying asset in related transactions.

However there has been a need for clarification for how gold bullion can be used for investment purposes by Muslims, for a long time. This uncertainty has kept Shariah-compliant offerings at a minimum and many investors restricted by the type of gold bullion transactions they are able to partake in, with most focused on jewellery and coin offerings. Daud Bakar, chairman of Amanie Advisors, agrees, «.the existing Islamic standards for gold are fragmented, hampering product development and market demand.»

Currently in the gold market, the majority of activity regarding gold financial instruments is based almost entirely on speculation. This is due to the overwhelming size of both the London and COMEX (Chicago Mercantile Exchange) gold markets, which together have the greatest influence on the spot price of gold.

Whilst Islamic investors have always had access to the gold market through jewellery and coins, this guidance could vastly increase the number and diversity of investment products available. There are very few Shari’ah-compliant gold offerings today. Using its deep sector knowledge, GoldCore, and its Islamic partners, have been working on a comprehensive solution for two years and will provide the solution to qualifying Islamic financial institutions in early 2017.

If Islamic Finance institutions were to allocate just one per cent of assets into new gold products then we would expect to see demand climb by about 500-1000 tonnes, per annum. Given that recent demand and supply figures showed a surplus of just 172 tonnes of gold in the market, we could begin to see some tightening with the increase of Shariah-compliant gold instruments, which will have a positive impact on the price.

It is not unreasonable to expect a minimum one per cent move of Islamic finance assets into gold, especially when you look at how it has performed. WGC data shows that in the last eight years the major Islamic asset classes (including REITs, the Takaful index, the Dow Jones Islamic Equities Index and the Dow Jones Sukuk Index) have all underperformed compared to gold, as have the major currencies used in the Islamic world.

Few appreciate that the launch of a Shari’ah gold standard signals a changing dynamic in the gold market. Until now, no group as influential as the AAOIFI has issued guidelines stating that gold must be the underlying asset in all gold transactions as we suspect they will do shortly. Whilst the likes of the COMEX gold market are able to grow to multiple times the size of the underlying physical market, with little impact on physical demand, this will no longer be case for all parties involved.

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