Expectations for higher gold prices are getting baked into India's huge jewelry market

11/08/2010 5:28 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

A minor sign that inflation expectations are starting to become embedded in economies and markets.

Minor but important. Especially for investors in gold.

Typically, when gold prices rise, the demand for physical gold from the jewelry market falls. Buyers of gold for jewelry and the buyers of gold jewelry itself are traditionally very price sensitive. This is particularly true in India, the world’s largest market for gold jewelry and the source of one-eighth of global gold demand. Buyers there simply postpone purchases or buy less when prices rise.

Except they’re not doing any such thing right now.

Even though gold prices are at or near all time highs at $1,400 an ounce (not adjusting for inflation), India buyers haven’t pulled back.

Reports from Mumbai and London put gold buying for the Diwali festival at 25% above last year’s level. Hindus believe that buying gold on Diwali attracts business and prosperity during the year.

So the question is Why?

One theory, and this makes sense to me, is that Indian buyers have become convinced that gold is just headed higher so there’s no reason to put off buying at what will be, in retrospect, today’s low prices. This is a very good description of inflationary expectations at work: Expecting higher prices tomorrow, you buy today, just about guaranteeing the higher prices tomorrow that you expected.

Gold investors outside India should note that Diwali is followed by wedding season in India. During those months gold buying is strong as parents buy gold jewelry as part of a daughter’s marriage dowry.

If demand for physical gold isn’t dropping with higher prices, that removes one traditional restraint on rallies in the shiny metal.

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