India is the #1 gold consumer in the world; it is important for gold investors to understand what is happening in this unpredictable market. The Indian physical gold market has been volatile in 2016. Strong monsoon rains suggested buying would be strong, but government regulations kept demand unexpectedly weak.
The metal was even trading below the international spot price at several points during the year.
Now, the Indian government has thrown another wrench into the physical gold market. On November 8th, the country banned 500 and 1,000 Rupee notes; this is 86% of all cash outstanding in the country. The prime minister of India, Narendra Modi, states this policy is designed to shut down currency counterfeiters and tax evaders.
Modi has taken a drastic step, and it will have consequences for the economy of India and the global gold market. There is disagreement on how this move has affected gold prices over the last eight days.
Bearish Case
Gold and crime go hand in hand in India. Because the Indian government heavily regulates the gold industry, licensed gold dealers monopolize the market and impose premiums of up to 10 percent on its sale. In response, a black-market for the metal has developed. Smugglers buy gold on the cheaper international market to sell in the more expensive Indian market.
The proceeds from this illicit activity are stored in the high-denomination bills the Indian government is now banning.
But it doesn’t stop there. Not only do gold smugglers store their profits in high-denomination bills - counterfeiters, tax-evaders, and corrupt officials launder their illegal cash by converting it to gold. On both sides of the issue gold is being used. The metal is used to launder high-denomination cash, and high-denomination cash is used to buy illegal gold.
India announced its large-denomination currency ban on the exact same day of the U.S election. It is possible that Indian selling defrayed the gold rally that should have resulted from a Trump victory.
As we can see from the chart, gold collapsed after November 8th. It is possible that the Indian government’s ban on high-denomination notes has crippled the gold market in the country. With the ‘black money’ industry gone, will Indian gold demand collapse over the long-term?
Bullish Case
On the other hand, there is a bullish argument for these developments.
Many Indians have seen their savings destroyed in an instant – such extreme government intervention does not inspire faith in a currency. Perhaps this sell-off will be followed by mass buying as Indian consumers convert their wealth into a form that cannot be arbitrarily made worthless by a government declaration.
Gold has traditionally been a better store of value than cash in India – the events of November demonstrate how important it is for investors to hold physical gold.
Conclusion It is impossible to isolate any single factor as the cause of gold’s price movements. So many variables pull the metal in different directions. Is the gold correction because of Trump, Modi, interest rate fears, inflation, who knows?
Regardless of how the developments in India play out, they have taught the gold market three things: paper money is not safe, the gold market is extremely complicated, and the Indian government is a wildcard that will make unexpected moves.
