2012-11-28

Dematerialized gold in India—it's about the rupee, not gold

Gold bugs are reading this situation wrong, as they did before with regards to Indian gold taxes.
'Demat gold to arrest rising demand'

In India, the high price of gold fails to make a significant dent in massive consumer demand, where gold is used as savings and doubles as wedding jewelry. This leads to massive imports of gold, which causes a current account deficit for India, which weakens the currency, which then makes gold more attractive as an investment. In a normal economic cycle, rising prices would eventually kill demand, but in financial markets there is a positive feedback loop. Rising prices make the asset more attractive, leading to more buying and higher prices, until everyone is involved in the bubble and prices collapse. (I don't think Indian gold demand is a speculative bubble, but the effects of rising prices are the same because one component of demand is speculative.)

Many gold bugs are pointing to this story as evidence of a lack of physical gold. The reality is much simpler: India is trying to defend its currency and cut imports. The aim is to redirect speculative and financial demand into a paper market, with the goal of reducing imports. There's not really a conspiracy here, at least not the one the gold bugs are looking for. If there's a "real" reason behind the move, it is to protect the value of the rupee. As the chart below shows, gold has been a steady winner in rupees and is already back near a new nominal high. If this is smoke, the fire is a slowly unfolding run on the rupee.



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