India's tax increases another reason gold is weak (for now)

03/21/2012 3:33 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

For the second time this year, India, the world’s biggest buyer of physical gold, has increased its tax on gold imports. On January 17 the Indian government doubled the tax on gold and silver. The newest move will raise the tax from the 2% rate set in January to 4%. (The most recent tax increase covers gold bars and coins and platinum. The tax on silver remains at 2%.)

In 2011 Indian purchases of gold bullion hit a new record at 969 metric tons. Gold futures in India climbed 32% in 2011, far exceeding the 10% increase in global gold prices.

Indian gold importers anticipated the tax increases and the slump in buying that higher prices would create by cutting their imports of gold in the fourth quarter of 2011. Imports fell by 44% in the fourth quarter as jewelry and investment demand fell by 44% and 38%, respectively, according to the World Gold Council.

The announcement of an increase in the tax on gold came in a speech announcing the government’s proposed budget for the fiscal year that begins on April 1. The 50% rise in gold imports, Finance Minister Pranab Mukherjee said, was one reason for the sharp deterioration in India’s current account deficit. (India, unlike China, runs a current account deficit and is dependent on inflows of overseas capital to keep its accounts in balance.)

Indians have a history of slowing gold buying when prices rise—for a time. But since much of the country’s demand for gold is driven by its use in Indian culture, especially in Indian weddings, demand is likely to pick up again as India gets closer to its big season for weddings from September through December. In the meantime Indian families are likely to delay their purchases of gold to see if prices will fall.

In the short run the tax increase in India is one more reason for the current weakness in gold—and for thinking that this might be a decent time for building long-term positions in gold to hedge the risks of 2013.

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