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India Event Rocks the Gold Market

03/26/2012 12:10 pm EST


Andy Waldock

Founder, Commodity & Derivative Advisors

With India, the world’s largest gold consumer, in a controversial gold strike, demand for the yellow metal and prices have cratered, writes Andy Waldock, but this may be the buying opportunity gold bulls are waiting for.

India is the world’s largest consumer of gold. Their gold imports increased 50% in 2011 to nearly 1,000 tons while the nation produced merely two tons. This extreme imbalance between production and consumption means that Indian consumers must buy gold on the global market.

The net purchase of nearly 1,000 tons of gold over the last year has placed approximately $60 billion US dollars worth of Indian rupees on the foreign exchange market. The outflow of rupees has forced the Indian government to take action to constrain domestic gold purchases as they rebalance their foreign reserves. This has placed the Indian government at direct odds with the culture of its people.

The Indian government has raised taxes to reduce domestic consumption. First, it has placed a 1% excise tax on all gold jewelry sales. This is in addition to varying the value added tax (VAT) on a state-by-state basis.

Secondly, it has separated investment-quality gold bars and coins from non-standard gold such as jewelry while simultaneously doubling the import duties on both. Investment-quality gold is now taxed at 4%, while jewelry, ornaments, and other non-standard gold pieces are now taxed at 10%.

Gold is a primary investment vehicle in the eyes of the Indian public. This is due to the low penetration and distrust of the banking sector along with centuries of cultural coveting. Gold is given as gifts at weddings, births, and religious festivals. Gold is also held as a means of savings, a store of value, and an investment. It is estimated that the Indian public holds more than 18,000 tons of gold worth more than $800 billion US dollars. This is about twice the amount of gold in Fort Knox and about 25% of the combined holdings of all exchange traded gold funds.

The government’s implementation of these taxes has been met by a massive uproar among the people. The primary response was from the jewelry industry due to the direct financial implications these actions impose. They have implemented a strike against gold purchases over the last week. Industry estimates are that the jewelry industry is losing as much as $200 million per day during this strike.

The magnitude of this number reflects the trickle-down economics of such a major industry. Shipments are not being handled at the docks; they are not being transported to manufacturing facilities; smelting plants are not being run; jewelry is not being manufactured; and the inventory on the shelves is being sold at a premium. Meanwhile, employment hours are lost at each step in the process.

The drop in demand on the global market can be seen in the gold market’s decline over the last couple of weeks while this storm has been brewing. Gold prices have declined by over 8% in the month of March. The strike is expected to last until March 22. I believe that once the strike is halted, we will see money move back into gold as Indian demand replaces a week’s worth of lost inventory.

Most of the decline in the gold market appears to have been small speculators forced out by the market’s decline. The Commitment of Traders (COT) data shows that March’s decline has forced out 25% of the speculative position. This is telling, as commercial traders have stepped up to buy this drop in the market.

The market may continue to head lower from here, briefly. However, the typical pattern in a range-bound market—which this is—is for small speculators to get too bullish on the way up and too bearish on the way down. This manic behavior plays right into the patient hands of the commercial traders who are buying this decline in the market.

By Andy Waldock of Commodity & Derivative Advisors
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