Market Maniac

Continuing foolishness on gold
Nov 19, 2014

The October trade figures show a sharp increase in gold imports. Divali was in October. So, what’s the issue?
Indians buy gold. Indians have always bought gold and Indians will always buy gold for ornamentation – thank God for that – and savings. It has been variously estimated that about 40% of India’s gold consumption (usually between 800 and 1,000 tonnes a year) goes to jewelry; the balance is for savings and, I suppose, an inflation hedge. As growth climbs into a higher gear, personal demand for gold will certainly increase. So, gold demand can ONLY be brought down by providing Indians more effective channels for savings – period.

Higher import duties will only lead to smuggling – the World Gold Council estimates that 200 tonnes of gold were smuggled since the import duty hikes in August last year – which means (a) remittances will fall by an equivalent amount with no net impact on the current account, and (b) the underworld, which had been nicely tucked away for many years, will come back to life. There is already anecdotal evidence of this – talk to Mahesh Bhatt and company.

So, why is the government looking at trying to curb imports?

In point of fact, higher gold imports would push the current account further into the red, signaling the fact that India is not competitive at current exchange rates. Many models, including our own, suggest the rupee is about 5 rupees (around 8%) overvalued currently. Export growth is, unsurprisingly, down, and we need to recognize that in a soft global market our currency needs to be under- rather than overvalued to push exports.

Perhaps, the trauma of 2013 is still fresh in RBI’s and the government’s minds and they fear another runaway rupee. And, indeed, there is – and will always be – a threat of some global drama triggering a rush for the exits. But, as Dr. Rajan has often said, the only protection against a global financial catastrophe is internal strength. Very clearly, gold import curbs would not be seen a sign of internal strength – most investors would see this as a major weakness. So, if the intent was to “fake” the CAD by preventing free imports of gold, my sense is that it would be highly counterproductive, particularly if/when global winds pick up.

Coincidentally, the international gold market itself is signaling that something may be cooking. I have been monitoring the volatility of gold for a long time now and, almost on cue – I was targeting October 23 – it has spiked higher from a low of just under 11% (close to the all time low from which it shot up in two previous episodes) to over 14% in just three weeks.

The immediate cause for the spike was the announcement that Switzerland will be running a referendum on November 30 which, if passed, would require the Swiss National Bank to hold 20% of its reserves in gold; this would trigger huge buying since the current holding is much lower than that. Of course, few people expect the referendum to be passed – over the past two years, the SNB has been building its reserves hugely to prevent the Swiss franc from appreciating beyond 1.20 to the Euro, and for it to now divest these reserves into gold would be costly and would undermine its careful policy of protecting Swiss export competitiveness. Given that global markets are soft, in any case, this would be patently foolish.

The key question though, is whether this is just a short-term spike and volatility will again subside to recent norms? Or, will it reflect the past two patterns [graph on left, overleaf] and screech higher towards 30%? The right hand graph suggests it could go either way.

Market Maniac Gold - Mecklai Financial


But irrespective of whether gold volatility subsides – and we go back to a relatively boring, but safer, world where equity markets continue upwards, global interest rates remain subdued, hopefully supporting growth and the dollar corrects – or gets into another another grotesque upward spiral – which could result in another round of mayhem in financial markets – India’s gold import policy should be driven by the continuing need to strengthen our underlying economy.

As is well known, Indians own 25,000 to 35,000 tonnes of gold. Importantly, these are assets, and foreign currency assets, at that; they form part of the core strength of the Indian economy.

RBI and the government need to unwind every constraint keeping these assets from the market. Many people have spoken/written on this. Back in August last year, I wrote a column suggesting the government, as an easy starting point, approach temples which may well be “wholesale” holders of gold and enable them to get a better return on their holdings while bringing blocked gold into the market. That column got more response than any other I had written, including a call from the VHP, offended that I was suggesting that Hindu gold should be used to bail out the UPA government.

With the change in the political scenario, perhaps the now is the right time.




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