India Gold Soars

Gold denominated in Indian rupees just skyrocketed up near record highs, a far cry from recent dollar-gold action.  Much of this extraordinary rally was fueled by the near-collapse of the Indian currency to new record lows against the US dollar.  India’s deepening currency crisis has major implications for domestic gold demand and thus global gold prices.  Nothing ignites gold buying like a collapsing currency!

Indians’ deep cultural affinity for gold is legendary.  For decades it was the world’s biggest consumer of gold, although China is overtaking it now.  According to the World Gold Council, in the first half of 2013 India still accounted for a staggering 28% of global consumer gold demand!  The 566.5 metric tons of the yellow metal Indians bought in the last two quarters greatly dwarf Americans’ 83.4t purchased.

It is estimated that Indian households hold 31,000t of gold worth a breathtaking $1395b at $1400 per ounce.  A single temple alone in southern India (Tirumala near Tirupati) is believed to hold 1000t itself, worth $45b!  It gains another 3t annually in gold offerings from devout Hindu pilgrims.  More than half of Indians’ personal savings is held in hard assets including land, houses, cattle, and of course gold.

Despite this vast absolute wealth Indians have invested in gold, they still have very little per capita.  With 1210m people, India’s population is massive beyond belief.  Let’s assume just half are of working age, when they can save and invest the surplus fruits of their labors.  Dividing India’s total consumer gold hoard by 605m people equals per-capita holdings of merely 1.65 ounces!  That certainly isn’t excessive.

Nevertheless, India’s government has been waging an aggressive war on gold this year.  The country is struggling with a record current-account deficit that ran 4.8% of GDP in fiscal 2012 (ending March).  India’s two biggest imports by far are oil and gold, accounting for 70% of its trade deficit.  Of that, gold represented a quarter.  But oil is far more essential for civilization than gold, so New Delhi has targeted it.

In order to try and curb gold imports to reduce its trade deficit, the Indian government has greatly hiked the metal’s import taxes this year.  Import duties were raised by half to 6% in late January, by a third to 8% in early June, and then again by a quarter to 10% in mid-August!  In addition to gold’s duties being 2.5x higher than their 4% when 2013 dawned, New Delhi also applied the latest 10% to silver and platinum to fight substitution.

How are these steep and punitive gold import taxes working out?  Not so well from the government’s perspective.  The World Gold Council recently reported that Indian consumer gold demand soared 48% year-over-year in 2013’s first half!  So Indians are still buying gold aggressively, much to the chagrin of the government.  Instead of retarding demand, these tariffs are simply fueling a boom in gold smuggling.

The Indian government really has no one to blame but itself for these surging gold imports.  It has been seriously mismanaging economic reforms and failing to upgrade deteriorating infrastructure.  Corruption is rife, and regulation is suffocating and heavy-handed.  Vodafone is one key example.  This British telecom company was capriciously slapped with a gigantic retroactive tax bill for 50 years of mergers!

All this has led to waning confidence in the Indian government and its fiat currency, the rupee.  Both Indians and foreign investors alike have been exiting the rupee, exacerbating its slide over the past couple years or so.  The Indians trade their surplus rupees for physical gold, which must be imported, preserving their purchasing power.  The foreigners sell their rupees for other major currencies and move on.

These foreign capital outflows have mostly come from bonds, catapulting India’s benchmark 10-year yield up near 9.25% in late August.  It hadn’t been higher since August 2008 heading into the stock panic.  Stocks were hit hard too in recent weeks, with foreigners selling $1b worth of Indian shares in just 8 trading days.  They’ve dumped $3.6b in Indian stocks since early June, intensifying the rupee’s plunge.

The hypocrisy of the Indian government through this snowballing currency crisis has been epic.  India’s finance minister Palaniappan Chidambaram has spearheaded the government’s war on gold this year, often backtracking and lying.  He’d keep assuring Indians that New Delhi was done mucking around in the domestic gold market, and then within weeks he’d announce some new control on gold imports.

After this blizzard of new taxes and regulations in 2013, he addressed the parliament on August 28th.  He had the gall to say, “What we need now is not less reforms but more reforms.  What we need now is not more restrictions but less restrictions.  What we need now is not a closed economy but a more open economy.”  Is a less-restrictive more-open economy one where New Delhi arrogantly tells Indians how to invest?

The result of all this nonsense and mismanagement has been a plummeting rupee and therefore soaring gold price.  Indians are not stupid, they understand what havoc their government is wreaking.  This first chart looks at gold in rupees per ounce (blue).  These are not local price quotes, but clean forex-implied prices based on the dollar-gold level and the rupee-dollar exchange rate.  That is rendered below in red.

We all view prices through the lens of whatever currency we’ve used most of our lives, so this is how Indians see the gold price.  Far from languishing near relatively low levels like dollar gold, rupee gold has skyrocketed 35.1% in the past couple months!  It is now back up near record highs.  This was driven partially by the strong dollar-gold action in July and August, but mostly by the rupee’s plunge versus the US dollar.

The horribly-inept Indian government has squandered so much domestic and international confidence in its ability to run the country that the rupee plummeted 22.0% in less than 4 months!  This dragged it down to deep new record lows against the US dollar.  That same day in late August when that hypocrite finance minister lied to parliament, the rupee witnessed its biggest daily plunge against the US dollar in 18 years.

The rupee hasn’t always looked so frightening.  It had plunged in 2008 thanks to flight capital flooding into the US dollar during the American stock panic, which drove the biggest and fastest dollar rally ever witnessed.  But after the dollar reversed, so did the rupee.  This currency strengthened nicely in 2009 before stabilizing through 2010 and the first half of 2011.  But then the rupee started breaking down.

The US dollar was strengthening then too, but it had enjoyed a far larger rally in early 2010 yet the rupee barely budged.  Provocatively that was when the Indian government started making noise about its trade deficit and how to fight it.  Despite high and rising crude-oil prices being the dominant culprit, the seeds were being sown in government circles to instead take the fight to the far-smaller gold imports.

And rupee gold soared as the rupee itself started breaking down and plunging in mid-2011.  This vertical rally was aided greatly by soaring dollar-gold prices in response to the US debt-ceiling fight that summer, which also weighed on the US dollar.  But by mid-2012 the rupee had stabilized again, albeit at lower levels than before India’s government started making a mess of things.  The rupee held its own for nearly a year.

But then it started falling again rather precipitously in May 2013.  Provocatively one of the main catalysts was QE3-tapering fears.  The American Federal Reserve started to condition traders to expect it to reduce the pace of its third quantitative-easing campaign’s huge debt monetizations.  With the Fed about to slow its manipulation of long interest rates, benchmark US 10-year Treasury yields started a record surge.

Since Treasuries are considered the world’s least-risky bonds (the US can print infinite fiat dollars to honor them), the rest of the world’s bond markets had to dramatically reprice as well.  So India experienced a bond rout like America and the rest of the world, heavy selling in response to the Fed.  As capital fled from Indian bonds, it subsequently exited the rupee too.  And this currency started to plunge to record lows.

I suspect the Indian government’s ill-fated and foolish war on gold was a major factor too.  Even less so than the average American, the average Indian doesn’t follow the Fed or long-bond yields.  Naturally they care about prices that affect their everyday lives.  And the weakening rupee was driving those higher.  The lower it went, the more expensive everything became.  Inflation makes gold much more attractive.

But just when Indians most needed gold to protect their hard-earned savings from accelerating inflation, the government was falling all over itself telling them not to buy anymore.  It started taxing and regulating the heck out of the domestic gold market.  Indians saw this and figured their government and currency were in big trouble.  This made them desire gold and fear the rupee all the more, exacerbating its decline.

People hate being told what to do.  The more a government tells its people not to do something, the more they want to do it.  No one will walk on your beautiful front yard until you put a “Keep off the grass!” sign on it.  They hadn’t even thought about it before.  The Indian government’s attacks on gold kept this metal prominent in the news, bringing great attention to it and the rupee that otherwise wouldn’t have existed.

This catapulted domestic inflation into the forefront too.  A weaker rupee of course means anything that India imports is more expensive.  And because India imports something like 70% of its total oil demand (and it is the world’s fourth-largest consumer), a weaker rupee makes everything that uses energy more expensive.  This runs the gamut from growing crops to transporting all physical goods to consumers.

New Delhi’s war on gold left Indians very suspicious about their government’s motives.  Rather than attacking inflation directly by shrinking its money supply to sop up the excess rupees sold, the government was trying to tamper with inflation’s key barometer.  Indians wisely responded by greatly stepping up their gold purchases, which soared 71% year-over-year in the second quarter!  Weak gold prices compounded this.

Indians’ deep cultural affinity for gold leads them to view every gold selloff as a welcome buying opportunity.  So when American stock traders’ mass exodus from the flagship GLD gold ETF sparked an ultra-rare futures forced liquidation in April, gold plummeted in wildly-unprecedented fashion.  Indians love a bargain, so they rushed to buy the wildly-oversold yellow metal.  These dynamics fed on themselves.

This next chart indexes both rupee gold and dollar gold from the first trading day of 2011 to highlight the vast differences in their trajectories.  While dollar gold is flat over this span, rupee gold is about 50% higher!  Thus gold looks vastly more bullish to the average Indian investor than it does to the average American one.  How this will affect Indian psychology and near-future gold demand is a critical question.

The disconnect between the blue line that shows how Indians see gold and the red line that shows how Americans see it is massive.  Despite the unprecedented gold weakness in 2013’s first half, rupee gold is doing fantastic on balance.  It is back up into a major uptrend established over a year and a half starting in late 2011.  I certainly know American investors would be flocking to gold with performance like this!

American investors love to buy high, getting the most greedy and excited after a long run higher.  They are quick to pounce on momentum, pouring their capital into any hot asset no matter how overbought it happens to be.  But Indians are smarter and more contrarian in their approach.  They would rather buy low than buy high, so record highs aren’t as big of draw in their culture as they are over here in ours.

Everything else being equal, Indian investors’ lower-price preference would likely retard gold demand in higher-price quarters.  And that may indeed happen in the third quarter, only time will tell.  But a currency crisis is an extraordinary situation that probably overrides everything else.  When a currency is plunging so prices of essential goods and services are surging, gold becomes almost overpoweringly attractive.

With the rupee languishing near all-time lows versus the US dollar, inflation is a huge concern that is only going to grow.  Higher prices for life’s necessities hit the poor particularly hard, and India remains a poor country.  Its per-capita GDP is only around $1600, ranked 140th in the world.  In purchasing-power-parity terms Indians’ per-capita buying power grows to $3850 a year, but that still isn’t very much to live on.

In response to the inflation concerns the plunging rupee is spawning, India’s lower house of parliament recently approved a $20b plan to provide cheap grains to the poor.  Odds are the costs will spiral a lot higher, as 2/3rds of India’s population is eligible for this subsidized rice and wheat.  The ruling party hopes this program will help it win re-election, with general elections due by next May at the latest.

With growing inflation dominating newsflow and consciousness in India, gold should prove exceptionally attractive despite higher prices.  As Indians see their hard-earned rupees buying less and less in terms of real goods and services as the currency crisis deepens, their demand for gold to preserve their purchasing power should soar.  Gold is always the easiest of the inflation-proof hard assets to buy.

And this deepening currency crisis ought to amplify normal autumn festival-season buying.  India always sees a huge gold-demand spike between August and November or so.  Much of this is due to weddings, as that season is the most auspicious time to tie the knot.  Families of Indian brides spend fortunes to outfit them with extensive gold dowries.  These gifts are always incredibly important within Indian culture.

The combination of New Delhi’s war on gold and the plunging-rupee-driven inflation is likely to make Indian parents want to spend even more on their kids getting married than they normally would.  They will fear buying more gold to give to their kids later will be more difficult or costly.  They will also want to dig deeper to help their kids start out with a secure nest egg since inflation is so hard on young families.

And the rupee crisis isn’t going away anytime soon.  Foreign investors aren’t likely to flock back into Indian bonds and stocks as American interest rates rise and the American stock markets roll over.  India’s oil imports can’t slow much without the whole country grinding to a halt.  And with elections looming, there is no way the Indian government will start tightening and reduce the excessive rupee supply.

So I suspect we may be in for some of the biggest Indian gold demand ever seen in this year’s third and fourth quarters!  To have the world’s long-time biggest gold consumer faced with a currency crisis deep in a secular gold bull is something never before witnessed.  Add in the government’s foolish war on gold to keep it on the forefront of Indians’ minds and make them really want to buy it, and demand should be incredible.

And if Indians buy more gold, their collective footprint is so massive that global gold prices simply have to rise faster.  The highly-likely outsized Indian buying on top of the mean reversions in American gold futures and the American gold ETF should help drive one of gold’s biggest uplegs of its entire secular bull.  The higher gold goes, the more Western investors will want to buy it.  Gold buying begets more gold buying!

We’re sure ready for this at Zeal.  We’ve been aggressively buying the best of the deeply-out-of-favor gold and silver miners, which are due to really multiply the underlying gains in gold.  There is no sector in the entire stock markets with more potential to soar in the coming year!  We’ve spent many years deeply researching the universe of these companies, painstakingly uncovering the elites with the best fundamentals.

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The bottom line is gold denominated in Indian rupees just rocketed back up near record highs.  This was largely due to India’s currency plunging in global markets thanks to its government’s terrible performance and policies.  Foreign investors and Indians alike are quickly losing confidence in the government and its rupee.  While the foreigners sell to buy other currencies, the Indians are converting their rupees to gold.

The rapidly-falling rupee hitting record lows is spawning accelerating inflation in India.  This is almost certain to seriously ramp already-high gold demand this time of year.  There is nothing like a currency crisis to ignite big new gold buying, and seeing one in the world’s long-time top gold consumer is unprecedented.  If Indian gold demand continues surging to records, global gold prices will be driven much higher.

Adam Hamilton, CPA

September 6, 2013

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