Don’t poke the gold elephant in the room

January 24, 2014 09:07 AM
Anti-gold rules getting hot for Congress, and prices, as BJP's Modi declares victory...

BIG though China is for gold these days, India has remained the elephant shut out of the room.

Hence Thursday morning's pop in London prices. Quickly up $10 per ounce, and then another $10 on top, gold gained after news broke that Sonia Gandhi, leader of India's Congress Party, apparently wrote to the government, asking to ease its anti-import rules.

Gandhi's party, the Indian National Congress, is actually in charge, leading New Delhi's coalition. But Gandhi heads the party, not the government. The prime minister's job went to 81-year old Manmohan Singh (who's stepping down this spring). And the anti-gold policy...aimed at cutting India's huge balance of trade deficit...belongs to finance minister Palaniappan Chidambaram, enforced by the Reserve Bank.

That policy is "working," says the government. Which is true, if by "working" you mean a huge surge in illegal gold, forcing ever-more Indian businesses and households to deal with the black market. Official imports collapsed in the second-half of 2013. So the trade deficit is down on the official data.

But India continues to pull in huge quantities of metal, as ever-more businesses and households are forced to deal with smuggled gold. The legal industry, employing perhaps 2.5 million people, is suffering. And with national elections coming in May, gold has become a hot topic.

So finance minister Chidambaram finds himself in a corner. He has repeatedly said there is zero chance of a change to the anti-import rules until at least end-February's budget. Now, with opposition leader Narendra Modi of the BJP already claiming victory for May, Gandhi is asking the government to try and catch up, easing restrictions before voters head to the polls.

Too little, too late for Congress? Put aside the threat of a nuclear power being led by an international pariah (seen as being "soaked in blood," Modi is barred from the United States). The re-entry of India to the world's gold market, everyone says, would see pent-up demand drive or at least buoy prices. (Just check the references in this week's otherwise bearish LBMA 2014 forecasts.)

Maybe. Since last summer, 20% of all new gold imports to India must be re-exported before the other 80% can be sold to domestic buyers. On top of strict financing rules (plus an outright ban on imports of gold coins for investment, as well as tax-advantages for India's now-growing refinery industry) this has effectively shut India out of the global gold market.

Yet the gold price crash of 2013 was all done by end-June. Up to that point, India was on track for record-high imports of legal metal. Illegal flows have jumped since, but they're unlikely to match the quantities bought during the first-half's 30% price drop. So the fact remains that Indian gold consumption, like China's record year of 2013, failed to stem or reverse the crash sparked by Western funds selling.

Here now in 2014, the finance minister has again denied any move before next month's budget. But this May's national elections, when Gandhi's Congress Party is expected to lose (badly), will only make gold in India more political still. BJP challenger Modi has repeatedly played gold as a theme, appealing both to India's deep love for and commerce in bullion. So in a way, the election will pit 2.5 million jewellery workers against New Delhi's bureaucrats.

Getting elected and being in power are very different things, however. The finance ministry wants to fix the trade deficit (and weak Rupee) by blocking trade (instead of raising interest rates). If Modi repeals the gold bans as promised, but doesn't reform India's broader economic problems, expect a lot of fresh Indian demand as a financial escape.

Unlike consumer jewelry buying, that's just the kind of demand which really does move prices.

About the Author

Adrian Ash runs the research desk at BullionVault.