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India’s gold imports in
August were shocking! Although reports vary on the actual amount, with many news
outlets reporting 2.5 tonnes while some are reporting 3, the difference
obviously doesn’t matter.
It’s negligible when you
consider that India represents the largest chunk of global demand and
imported an average 72 tonnes per month in 2012.
What is equally alarming
is that the Indian government finally succeeded in stifling imports after
several months of trying. They probably shouldn’t pop the cork on the victory
Champaign just yet, although it may warrant a beer? One month does not
constitute a trend.
However, it is too
important an event for the prudent to ignore. Therefore we should take
some time to read the tealeaves and determine the investment
implications.
Background
Let’s begin with some
historical context to illuminate August’s development.
In recent Weeklies, we
have extensively profiled India’s love affair with gold. We don’t want to
retell the whole tale here so we’ll just say that India and gold have been
soul mates for millennia and their affection for the yellow metal has not
diminished with time. (If you want, visit the “India” category on our Weeklies page for more on the topic.)
On the other hand, the
Indian government and their central bank, the Reserve Bank of India (RBI),
have had a love/hate relationship with gold.
The hate part comes from
the fact that it’s very difficult to maintain a paper currency regime when
your citizens prefer gold as their store of wealth.
Usually, when Indian’s
receive rupee income for their labors, they exchange a sizeable portion of it
for gold. This puts pressure on the rupee because it’s sold for dollars to buy
gold. Given the massive size of the Indian population and their strong
propensity to save, it means that a lot of rupees are sold, which exerts
downward pressure on the currency.
Our tale of the hate part
of this relationship begins in 1947, which is ironically the same year India
gained independence from the British.
Shortly thereafter, along
with many fast and furious policy initiatives, the fledgling government
passed the Foreign Exchange Regulation Act which carried the stated objective“to
wean people away from gold, to regulate supply of gold, to reduce smuggling,
to reduce the demand for gold, and to reduce the domestic price for gold.”
It doesn’t get more
explicit than that. This legislation outlawed the import and export of
gold but not the private ownership or domestic trade of the precious metal.
It held sway until 1963 when the government made additional moves to tighten
the screws.
They initiated what was
known as the Gold Control Rules and in 1968 passed the Gold Control Act. The
primary features of these new regulations were that they outlawed the
ownership of gold bars and only permitted citizens to own gold jewelry and
gold coins.
Now Indians certainly
don’t mind owning jewelry as part of their affinity for gold. However,
this new law increased its value as a store of wealth and currency on the
black market. Such unofficial markets have a bad habit of springing up
whenever and wherever this type of protectionist and isolationist legislation
rears its ugly head.
At the grave risk of
oversimplification, the madness continued until a more enlightened policy
prevailed in the early 1990’s when the Gold Control Act was finally
repealed. It’s at this time that the government began to liberalize the
Indian economy to promote growth, jobs, and wealth.
In hindsight, these moves
have proved to be prosperous for the Indian people. Much poverty and
corruption remains, but there have been substantial increases in life
expectancy, literacy, and of course economic growth and prosperity.
One way to measure the
increase in overall economic prosperity of a country over a number of years
is by GDP. And instead of writing a thousand words, I’ll just show you the
chart.
Follow the path of the
red line on the above chart from left to right. Beginning in 1990-91, when
the economy began to open up, the journey that India has taken to greater
prosperity is evident.
And what did the Indian
people spend a sizeable amount of their newfound wealth on? Yes, it’s a
rhetorical question. The answer is obviously gold.
As the chart shows, in
1990 Indian gold demand was just over 200 tonnes. By 2011, it had risen 5
times to 1,000 tonnes. And in 2012, it was still a lofty 845 tonnes. It’s
fairly evident that as the Indian people got wealthier, they bought more
gold.
Aside from their cultural
affinity for it, Indians also buy gold to maintain their purchasing power. In
the past as in the present, the Indian rupee is notorious for inflation.
For some perspective on
Indian inflation let’s look at the value of the rupee versus the US dollar
since 1991.
That’s not a comforting
chart for anyone that holds rupees!
Now, let’s look at why Indians
buy gold.
That’s much better!
The above chart shows
that both the rupee and the dollar are losing purchasing power against gold,
but the rupee is winning the race to the bottom by a large margin.
The Problem
India’s two major imports
are oil and gold. Unfortunately for India, they must pay for both on
international markets with US dollars. And when your currency is in
free-fall, as the rupee has been since April (see chart below), dropping
approximately 20%, these imports get really expensive!
One of the primary
catalysts for the Rupee’s plunge has been India’s surging appetite for
gold. In order to feed the country’s insatiable appetite for the yellow
metal, importers must sell rupees for dollars in massive quantities putting
strong downward pressure on the currency. This in turn depletes the
central banks US dollar reserves.
This is a serious issue
because without US dollars, how do you pay your enormous oil bill, or other
critical commodity bills, on the international market?
When you combine the
factors of a falling rupee, rapidly declining US dollar currency reserves,
and the substantial imports of oil and gold by India, they equal the third
largest current account deficit in the world. At the end of August, the
deficit was approaching US$90 billion. This is what you might call a problem.
In the desperate search
for a solution the Indian government has beat a panicky retreat to their
protectionist roots and decided to aggressively suppress gold
imports…again.
The Solution in
Action
It all started on Jan
21st of this year with a meager 200% increase in gold import duties and a
disingenuous message from the Finance Minister stating that there were no
further plans for additional taxes on gold imports.
A month later, he was
pleading with the Indian people to stop buying so much gold. His plea
fell on deaf ears. In April, coinciding with the mysterious gold price swan
dive ignited on the US futures exchange, India imported an eye-watering 141
tonnes of gold. They then followed that performance with a dizzying 162
tonnes in May!
It’s hard to overstate
the sheer scale of this wave of demand over the course of just two short
months, but the imagery of a Tsunami comes to mind. It must have set
off alarm bells in the halls of the central bank!
Realizing that the Indian
people mistook his admonishment not to buy gold as a secret signal that they
should buy gold in record amounts, he promptly raised the gold import duty
another 2%, to a total of 8%. Then, in July, the RBI tried a new tactic
issuing a rule requiring importers to re-export 20% of what they import; the
so-called 80/20 rule.
In August, the Finance
Minister made a declaration that India will hold gold imports to under 845
tonnes for the year. Backing up this proclamation he raised the import duty
yet again, by another 2% (now at 10%), banned the import of coins, and cut
off domestic buyers’ ability to buy gold on credit.
“There…that outta do
it!” - The Finance Minister said while stroking his hairless cat.
The Outcome
August Imports = 2.5
tonnes.
Several reports have
indicated that the reason imports were so low is that importers did not
understand the restrictions, and therefore were uncertain how to comply or
whether it was profitable to do so.
Regardless of the reason,
the fact remains that imports dropped 95% from the previous month! Or perhaps
the right way to say this is that they were effectively shut-off. Anyway we
phrase it, we have to acknowledge that the government’s efforts to suppress
imports were successful in August.
There has been plenty of
news since mid-August suggesting that the confusion over the new rules has
been resolved and that imports will resume again soon. However, we have
yet to see any confirmation that this has happened.
As prudent market
observers, these developments in the world’s top gold consumer require our
attention. This is because, if the central bank can succeed in August, they
could potentially extend the blockade through September, and then the month
after, and perhaps for many months to come.
Although discouraging, we
shouldn’t lose sight of their history with such things.
The Gold Miners
Crystal Ball
We know that our message
this week is tough medicine to swallow but investment success requires
regular reality checks and sober-minded judgment. Therefore, we’ve done
our homework and put a lot of thought into this week’s missive. And
now, we’re prepared to tell you what we honestly think.
There is no denying that
the RBI has declared war on gold. Our recap outlining the restrictions put in
place since January demonstrates that they are committed to controlling gold
demand by suppressing imports. They have also publically stated their
intention to limit the amount of gold imports for the year to less than 845
tonnes.
So far in 2013, by compiling
World Gold Council statistics, India has imported 616.5 tonnes of gold.
This is a record amount of demand, even for India. In order for
the RBI to achieve their stated goal of keeping imports under their stated
target of 845 tonnes, they would have to limit imports to 228.5 tonnes for
the remaining 4 months of the year.
And not just any 4
months, but the 4 months of the year that usually see the largest aggregate
buying from arguably the world’s biggest gold buyer. Typically 40% of India’s
annual gold demand is bought during the festival season that has just begun.
(For more on gold’s seasonality see last week’s commentary)
Given India’s reliable
seasonal gold buying history, limiting imports during this time is a pretty
tall order for the RBI to execute. But given their success in August we
can’t rule out the possibility that the government could achieve some or all
of their stated goal.
Now before you grow
despondent dear reader, hear us out.
There is a saying, often
uttered by contrarian investors, that you should always assume the opposite
of what a central bank says they are going to do or how they view the
economy. This makes good sense.
It’s not as if a central
bank could announce to its citizens, “we’re broke, sell our currency, our
bonds, and buy as much gold as you can, while you can”, even if it were true.
This statement would foreseeably cause a fair amount of panic.
Therefore, we must assess
what a central bank is saying and discern whether they really do intend to
carry out their publicly stated strategy or are just posturing.
In this case, it’s
reasonable to conclude, given their history and recent success, that the RBI
is committed to limiting gold imports. They must believe that they can
reverse their current account deficit by suppressing gold imports.
For these reasons, we
think that it is prudent to acknowledge the possibility that there could be a
potential drop in the demand for gold in the short term if the Indian
government were to successfully extend the current import embargo into the
fall buying season.
By how much might gold
demand fall as a result? Oops! Our crystal ball just fogged up.
What a terrible time for that to happen.
Don’t misunderstand; we
remain steadfast gold bulls because historic Indian demand is very real
despite the central banks efforts and the massive global supply and demand
imbalance that continues to exist in the gold market.
However, in light of the
August import data out of India as a result of RBI gold policies, we think
one should proceed with caution and remain observant over the short-term from
a risk mitigation standpoint.
We actually see this as a
potential buying opportunity should this thesis play out and the price of
gold falls due to the absence of India’s demand from the market.
Further, we think that if
there is another decline in the gold price, China will be happy to step in
and buy in-size on the cheap. As our readers are well aware, they are
also reporting unprecedented demand this year. There is no knowing for
sure just how much of India’s demand they could absorb but it’s a safe bet
they’ll take some of it.
Moreover, when you
suppress something, especially if it is desirable, people will do whatever is
necessary to obtain it. Should Indian imports remain suppressed, we
think the domestic gold price and gold premiums will skyrocket in rupee
terms, as they have in the past under such circumstances.
This will also cause the
black market to mushroom once again and ignite larger-scale gold smuggling,
as it will be an extremely profitable proposition. This is
well-traveled ground for Indian gold buyers and smugglers.
And when the government
is forced, likely by their gold thirsty citizens, to open gold imports up
again, the Indian appetite will be enormous, and demand could be similar to
the buying trend of 1990.
However this situation
resolves itself, we will be monitoring it closely for our readers in future
posts.
To sum up this sordid
tale, in the short term anything could happen. And in the short term, we see
the potential, although hardly an absolute certainty, for the RBI to
successfully stifle gold imports. If so, it may cause the price of gold to
ease. If this happens, it sets up an excellent opportunity to buy on
short-term weakness and hold for large future gains.
This is where our
Comparative Analysis Table comes in handy. It provides many important metrics
critical to evaluating and comparing gold mining companies (see below).
Its purpose is to help
discerning investors separate the wheat from the chaff and thereby profit
from strong producers that are poised to leverage a rising gold price.
In this context, we also publish a Model Portfolio for subscribers to the
newsletter.
(Click the image to enlarge)
That’s it for this week
and thanks for reading.
Regards,
RJ Wilcox
Jeremy@goldminersreport.com
www.goldminersreport.com
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