What Happens When You Tell Indians to Stop Buying Gold

What Happens When You Tell Indians to Stop Buying Gold

By Frank Holmes

CEO and Chief Investment Officer

U.S. Global Investors

India’s demand for gold during the second quarter of 2013 topped all other countries, according to the latest World Gold Council data. As noted by GoldCore, the demand for gold in India rose to its “highest in the last 10 years,” with jewelry, bars and coins demand, capping 310 tons during the period.

You can see India isn’t the only country in the East enamored with gold. I’ve discussed many times how China’s love for physical gold has endured, as gold deliveries on the Shanghai Gold Exchange climbed to record levels and jewelry stores were flooded with buyers in Beijing, Shanghai and Guangzhou.

Now the World Gold Council (WGC) confirms that in the second quarter, 60 percent of jewelry demand and almost half of all bar and coin demand came from these two countries alone!

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While financially traded gold, i.e., ETFs, experienced redemptions, physical gold was in strong demand. Besides Chindia, people in the U.S., Europe, Turkey and the Middle East purchased tons of gold jewelry, bars and coins.

This tells us that the Love Trade shines on. Like gold, the Love Trade doesn’t tarnish; it holds its luster.

In India, the Love Trade holds steady in spite of the government imposing import tax hikes on gold in an attempt to reduce the country’s current account deficit. In fact, according to the WGC, gold jewelry, bar and coin demand in India alone was 70 percent stronger in the second quarter of 2013 compared to the same quarter last year.

When the increased duties were implemented, I was skeptical that gold demand would be curtailed because of India’s affinity to the precious metal.

For decades, Indian families have celebrated weddings, births, festivals and holidays centered on gold and these traditions are passed down from generation to generation. Take the wedding industry, for example, where about half of the gold that Indians buy each year is for a wedding. With an estimated 10 million weddings taking place every year in India, the country sees a lot of gold buying out of love.

That’s according to a 60 Minutes feature on the role of gold in India’s wedding industry. If you missed it, here’s the link on our website.

India’s culture is very different from that of many Western countries. I’ve been to many Indian weddings and have witnessed this special and unique celebration as well as a very tight bond among families. I’m excited to be attending another wedding this November while I am in Delhi at a global CEO summit.

However, the record gold buying we are seeing today isn’t only out of love. I believe Indians are also buying out of fear due to its infamously poor and corrupt government policies.

I often say how government policies can be precursors to change. Good policies can drive economic growth and markets respond positively. Bad policies can have the opposite effect. At the same time Indians buy gold out of love for their family and close friends, they are also buying gold out of protection.

Take a look at the chart below, which shows gold’s return in Indian rupee compared with gold’s return in the U.S. dollar. In the U.S., where the dollar has strengthened, gold has increased only 12 percent on a cumulative basis over the past three years. But in a country with a significantly weakening currency, gold gained nearly 50 percent.

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With the government in India raising its import tax for gold to 10 percent this week, I firmly believe Indians will continue indulging in gold, even if they have to smuggle it in.

We’ll see if Delhi gets its way, especially as gold is approaching its prime seasonal time. I noticed on Business Insider today that JP Morgan expressed a similar thought: “Indian demand is quite seasonal related to events and festivals. While some might argue for less Indian buying due to tougher regulations and the weaker rupee making the metal more expensive, the WGC data suggests the opposite."

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This week, when I was on Bloomberg Radio and CNBC, the anchors were asking me about gold’s movements and if investors should follow the gold buying patterns of George Soros and John Paulson.

These hedge fund managers are making huge short-term bets, which is a very different strategy from what I’ve suggested. I have always advocated holding gold like insurance, with only a 5 to 10 percent weighting in gold and gold companies, and rebalancing annually.

Index Summary

• Major market indices finished lower this week. The Dow Jones Industrial Average fell 2.23 percent. The S&P 500 Stock Index lost 2.10 percent, while the Nasdaq Composite declined 1.57 percent. The Russell 2000 small capitalization index fell 2.30 percent this week.
• The Hang Seng Composite rose 3.26 percent; Taiwan gained 0.88 percent while the KOSPI advanced 2.09 percent.
• The 10-year Treasury bond yield rose 25 basis points this week to 2.83 percent.

Domestic Equity Market

The S&P 500 fell sharply this week as quantitative easing (QE) tapering prospects regained momentum, and is now widely expected to begin in September. Economic data was mixed, but on balance was viewed as stronger than average. The potential for reduced stimulus along with the associated increase in interest rates weighed on the market.

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Strengths

• Every sector in the S&P 500 declined this week, but the technology sector was the best performer of the bunch as Apple rose by more than 10 percent on news of a prominent hedge fund manager taking a large stake in the company. The company also announced a new product release for September.
• Cyclical areas of the market were relative outperformers as rising real interest rates and a steeper yield curve potentially preclude better economic performance.
• Apple was the best performer in the S&P 500 this week as mentioned above, while Newmont Mining was the second best performer rising 9.73 percent. Gold rose sharply due to inflation concerns beginning to creep into the market.

Weaknesses

• The utilities sector was the worst performing sector this week falling 4.36 percent on rising interest rates.
• The consumer discretion sector lagged as a wide variety of companies fell by 5 percent or more. These companies include Macy’s, Expedia, Cablevision and AutoNation.
• TripAdvisor Inc. was the worst performer in the S&P 500 for the week, falling 12.29 percent. The company’s CEO stated at a conference that traffic growth was not as strong as expected and pricing was also a bit soft.

Opportunity

• The current macro environment remains positive as economic data remains robust enough to give investors confidence in an economic recovery, but not too strong as to force the Federal Reserve to change course in the near term.
• Money flows are likely to find their way into domestic U.S. equities and out of bonds and emerging markets.
• Earnings have generally been well received as earnings season continues into next week.

Threat

• A market consolidation could occur in the near term after such a strong year.
• Higher interest rates are a threat for the whole economy. The Fed must walk a fine line and the potential for policy error is large.
• With much of the significant economic data out of the way, the focus will be on the Fed and whether it will taper in September.

The Economy and Bond Market

Treasury yields moved sharply higher this week as both economic data and the Fed’s resolve appear strong enough to follow through with reducing the QE program, commonly known as tapering.

The selling of U.S. fixed income and equities was at an extreme in June, with the number of outflows not seen since August 2007. According to the U.S. Treasury, $66.9 billion of long-term U.S. securities were sold, including $40.8 billion in Treasury bonds. This is the “highest monthly sell-off [in Treasuries] on record,” according to the Financial Times. China and Japan led foreign investors in the sell-off after the Fed began talks on tapering its monetary stimulus later this year. This could be the “shot across the bow” that the “great rotation” from fixed income and into equities may be beginning.

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Strengths

• Retail sales, excluding autos, rose 0.5 percent in July, which was the fastest pace since December.
• Weekly initial jobless claims hit the lowest level since October 2007.
• The eurozone grew 0.3 percent in the second quarter, which ended a streak of six consecutive quarters of contraction.

Weaknesses

• Treasury yields headed higher as fears of Fed tapering intensified.
• Japan’s second quarter GDP fell well short of the forecast, rising only 2.6 percent.
• Wal-Mart reported disappointing results and outlook, causing some to question the strength of the economic recovery.

Opportunity

• Despite recent conflicting commentary, the Fed continues to remain committed to an accommodative policy.
• Key global central bankers are still in easing mode such as the European Central Bank (ECB), Bank of England and the Bank of Japan.
• The recent sell-off in bonds is likely an opportunity as higher yields will act as a brake on the economy and potentially become self-fulfilling, thus postponing Fed tapering.

Threat

• Inflation in some corners of the globe is getting the attention of policy makers and may be an early indicator for the rest of the world.
• Trade and/or currency wars cannot be ruled out which may cause unintended consequences and volatility in the financial markets.
• The recent bond market sell-off may be a “shot across the bow” as the markets reassess the changing macro dynamics.

Gold Market

For the week, spot gold closed at $1,376.87, up $62.47 per ounce, or 4.75 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, rose 12.51 percent. The U.S. Trade-Weighted Dollar Index rose 0.21 percent for the week.

Strengths

• The recent price action of gold seen in the chart below was is undoubtedly the most important news in the gold sector this week. Gold broke away from its 50 day moving average in convincing fashion, while also breaking above the approximately $1,340 per ounce horizontal resistance level. The rise is even more convincing when seen in the context of 10 year Treasury rates reaching 2.84 percent, the level seen just before the U.S. debt downgrade in August 2011. Our outlook for gold is positive having seen the action and volume this week, and entering the historically best seasonality for gold.

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• The strong July import data for the Chinese economy announced on August 8 (up 10.4 percent) indicates a stronger-than-expected domestic demand recovery, which hopefully bodes well for gold demand. In fact, China July gold sales were up 41 percent. Silver is not lagging behind; if anything it is moving ahead of gold. Sales of American Eagle Silver coins by the U.S. Mint rose to 31 million ounces year to date, closing in on the 33.7 million ounces sold in 2012.
• Kip Keen of Mineweb reports on Calibre Mining Corp. recent performance: Back in March Calibre Mining released sampling results, primarily for gold, from its Montes de Oro project in Nicaragua reporting 9 meters intercept at 10.76 grams per ton gold. By early June the trench grew longer with Calibre reporting 17 meters at 17.95 grams per ton. Calibre's latest sampling results out this Thursday, trench 009 stretches to 52 meters at 7.1 grams per ton. Calibre shares flew, tripling at one point Thursday on a wave of heavy volume surpassing 5 million. The price action highlights one of Paradigm Capital’s 10 reasons to buy gold research report. Development [and exploration] stage companies are trading well below discovery cost. These companies are currently trading at $40 per ounce of estimated mineable resource; about half of what Paradigm believes the global finding cost is for economically viable projects in acceptable jurisdictions.

Weaknesses

• Gold in the second quarter of 2013 was extremely popular with retail consumers and investors, especially in Asia, but not institutional investors and central banks, the latest World Gold Council data suggests. What we learned over the quarter is that the price outlook is still very much dependent on ETF flows. The GLD ETF was responsible for 63 percent of the 671 tonnes of outflows seen in the first seven months of 2013. Macquarie reports that despite GLD seeing inflows in the last week from August 9 to August 14, the ETF flows represent a new reality that gold investors have to live with.
• The World Gold Council also reported central banks are expected to buy fewer gold bars than previously expected in 2013. Central banks are now expected to be net buyers of 300 to 350 tonnes of gold in 2013, down from an earlier forecast of 400 to 450 tonnes. In a counterintuitive rationale, central banks appear to be avoiding new purchases as policy makers fear further price declines. Regardless, central bank buying has been strong over the last ten quarters and will remain a source of demand for the foreseeable future.
• The dollar registered its biggest weekly advance in more than a month against the yen as gains in new home construction and worker productivity added to signs the world’s biggest economy is improving. The release of indicators beating expectations increases the likelihood of the Fed tapering this September. In the past, the stronger dollar has proven to be the main factor in driving commodity prices lower, while also adding downward pressure to gold.

Opportunities

• Once again gold forward offered rates (GOFO) have turned negative, which according to Euro Pacific Capital research, means banks which had lent their customers gold to obtain a positive return, and therefore increase the "paper" gold supply, are looking forward to take the gold back in exchange for the paper. This is cited as one of the main reasons for the strong performance of the yellow metal this week, as bank demand for physical gold limits the amount of gold available on the market. In addition, gold bullion ETF liquidations stopped this week, the first time since December, coinciding with the renewed strength in bullion.
• Significant operating cost savings will begin to appear in the fourth quarter for gold stocks, helping turn around the earnings per share and cash flow per share downtrend, according to Paradigm Capital. In the past, global total cash costs dropped 27 percent from 1996 to 1999 in response to a 28 percent decrease in the average gold price in those years. Paradigm estimates a $150–$200 per ounce reduction in all-in costs should be possible by the end of 2014, giving the magnitude of the price decline this year, with the first meaningful results showing in fourth quarter 2014 to first quarter 2014.
• In the same research note, Paradigm Capital explains gold exploration is imploding, which reduces the production growth outlook and decreases the certainty of the long-term future supply. Exploration budgets have been slashed by the majors by a one-third to one-half and deeper cuts cannot be ruled out. According to Paradigm, the roughly 80 gold exploration companies are trading at a median of only 11 percent of their four year highs, making it a challenge to raise debt or equity. As a result, a large portion of the explorers will go dormant. These developments will eventually transmit into scarcity of the metal which should lift prices.

Threats

• The Indian government continues to ignore the fact that its war against gold imports continues to be unsuccessful. This week, the government announced that it is to raise the import duty on gold yet again, this time from 8 percent to 10 percent. The news follow the release of gold import data showing import figures of 383 tonnes from April to July; a sharp increase on the 205 tonnes it imported in the same period in 2012. Duties on silver imports were also increased from 6 percent to 10 percent to try and control the growing imports of physical silver. But not content with these, the government also raised duties on platinum imports from 8 percent to 10 percent. To top the week, the Reserve Bank of India followed, almost immediately, with one more ridiculous flip flop by outright banning the import of gold coins. The only question in bullion traders’ minds is how long the government will last before it eventually gives up.
• The recent U.S. jobs numbers paint too bright a picture. Looking at independent surveys, it could be said the markets are too focused on jobs headline numbers only. This Friday’s Gallup poll for U.S. underemployed workforce shows the number of respondents employed part time, but looking for a full time job increased to 17.6 percent, while the percentage of unemployed respondents increased to 8.4 percent, a full 1 percent above the official number of 7.4 percent. It is evident to us that independent surveys tell a different story in which the macroeconomic indicators are either worsening or improving only sluggishly.
• Some of the world's top money managers revealed their holdings in quarterly filings with the Securities and Exchange Commission on Wednesday, giving investors a glimpse at the moves they made during the second quarter. Hedge fund manager John Paulson, famous for making a fortune betting against subprime mortgages, reduced his holdings in a gold bullion ETF from $3.4 billion at the end of the first quarter to $1.2 billion. In addition, George Soros also disposed of his gold ETF holdings, which were worth nearly $82 million as of the end of the first quarter. It is impossible to know if these moguls reinvested their capital in another form of a gold investment vehicle, which would not be unlikely of Paulson, however the size of ETF liquidations resulting from their rebalancing is unlikely to repeat and should take downward pressure off of bullion.

Energy and Natural Resources Market

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Strengths

• The price of copper gained 1.6 percent this week to $3.37 per pound. This is the highest level since May on declining inventories and stronger import data into China, the world’s largest consumer of the metal.
• Iron ore prices have been rising since early July, recently reaching $138 per metric ton, according to The Steel Index (TSI).
• Power consumption in China experienced a sharp rebound in July, reaching 495 billion kilowatt hours (kWh), according to the latest National Energy Administration (NEA) data. This could potentially signal a rebound in industrial production in the region.
• India’s gold imports more than doubled in the second quarter of 2013. India’s gold imports rose to 338 metric tons (mt), up 121 percent year-over-year in 3 months ended June 2013. Total demand rose 71 percent year-over-year to 310 mt during the same period, according to the World Gold Council, after a slump in prices in April spurred consumer demand.

Weaknesses

• Gold demand hit a four-year low of 856.3 mt in the second quarter of 2013, down 12 percent year-over-year on ETF liquidation and lower central bank demand, despite surging appetite for jewelry, coins and bars, according to the World Gold Council. Consumer gold demand rose by 376.4 mt, while gold ETFs and central bank buying fell by 402.2 mt and 93.4 mt, respectively. Separately, India and China’s gold demand may hit 1,000 mt each in 2013, reads data from Reuters.
• Despite gains of 22 percent year-to-date, midstream master limited partnerships (MLPs) fell for the fifth consecutive week as rising interest rates weigh on high dividend yield investments.

Opportunities

• Massoud Amin, an electrical engineering professor at the University of Minnesota in Minneapolis, who has also been a supporter of better electrical grid technology, says the benefit to improving grid far outweighs the cost of investment. He estimates that a modern national grid would cost $21 billion per year for twenty years, and calculates that the cost savings would amount between $79 billion and $94 billion.
• Despite the skeptical response by industry pundits and investors, Mexico’s proposed energy reform could be the beginning of philosophical and political change that would infuse much needed investment into the country’s rapidly declining oil production. If this reform is enacted, it would mark the biggest private sector opening in decades for Mexico, which was nationalized in 1938. Under the proposal, profit-sharing contracts would be given to private contractors that would allow for the control of current oil production, but the state would retain ownership of the oil and gas reserves in the ground. However, some analysts believe that significant investment would not be realized until oil companies are also given private ownership rights to the reserves.
• Iron ore inventory at Chinese ports has fallen back to the lowest level since February 2009. Current inventories represent just one month of cover and compares to an average stocks and imports ratio of 1.7. Even if this is just a restocking rally, low levels of inventory at mills and ports suggest there is room for further upside.

Threats

• Workers at BHP Billiton’s Escondida mine in Chile, with 1.1mt of copper in 2012, have halted their strike. However, these workers left the door open for further action. They went on a surprise, twenty-four hour strike on August 14 demanding an annual bonus, which they say has not been given this year, according to Reuters.
• South Africa’s gold producers raised their offer for wages by 50 basis points to 5.5 percent, with additional compensation linked to a gain-share scheme to resolve an impasse in negotiations with workers. However, Bloomberg Finance LP says that NUM, which demanded a 60 percent hike, and UASA, rejected the offer.

Emerging Markets

Strengths

• In the first seven months of 2013, net flows into emerging market funds were positive at $21.8 billion, according to Morningstar. Since 2002, flows into emerging market funds have been positive every year, including 2008 and 2011. More importantly, actively managed emerging market stock funds have seen positive net flows every month in 2013. This suggests that the trend driving these flows has been a wholesale shift towards permanent allocations to the asset class, and not solely based on performance chasing. Furthermore, emerging market stock funds have come a long way in the past ten years, evolving from a 1 percent holding, to a core holding in many investors' portfolios.

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• Eurostat, the European Union’s statistics office, announced that the seventeen countries that use the euro as currency grew their gross domestic product (GDP) by 0.3 percent during the second quarter of 2013. This reading marks the first quarterly growth since 2011, thus ending the six-quarter recession. Eastern Europe is set to benefit from growth throughout the euro area, its main trading partner, as it seeks to reignite its own growth. Within this region, the Czech Republic’s GDP rose 0.7 percent in the second quarter, while Poland, the European Union’s largest eastern economy, expanded 0.8 percent from a year earlier.
• Chinese media reported that local governments are initiating a new round of urban rail construction, with approved project investment amounting to Rmb 4 trillion by 2020. The operating mileage of China’s urban rail transit systems will increase by 6,000 kilometers in 2013 and reach more than 8,000 kilometers by the end of 2020. After the National Development and Reform Commission (NDRC) delegated the administration of urban rail projects to provincial authorities in May 2013, local governments have been showing strong motivation to accelerate approvals, with a total of fourteen projects given the “green light” year-to-date. Also in the news, the Agriculture Bank of China lent Rmb 250 billion to the Shanghai municipal government. The market believes that the mainland government is quietly offering financial stimulus to key cities to help them maintain local economic growth.
• The People’s Bank of China (PBOC), the central bank, continued reverse repo operations for Rmb 11 billion this week, which indicates that the government is facilitating liquidity needs for the banks.
• The Hang Seng Index crossed the 200-day moving average this week, driven by cyclical stocks and after Premier Li Keqiang showed policy support for a 7.5 percent GDP growth floor this year and a 7 percent growth floor for the foreseeable future, with targeted stimulus in chosen industrial sectors such as environmental protection, information technology, and urban and railway infrastructures.
• China Merchants Bank announced a rights offer to raise HK$35 billion last Friday, which indicates that the Chinese government has realized a need to strengthen the banks’ balance sheet. Although dilutive, more banks will be allowed to raise funds to replenish tier-one capital.
• The manufacturing sector in the Philippines grew slower in June at 9.9 percent, and 13.5 percent for the second quarter. Net sales index expanded by 22.2 percent in June and 21.5 percent for the second quarter, which suggests a lower risk of inventory overhang amid a strong output signal.

Weaknesses

• Russia’s industrial production fell more than anticipated in July, while manufacturing contracted for a third consecutive month, stressing the severity of the country’s economic slowdown. Industrial output shrank 0.7 percent from a year earlier, compared to the forecast of a 0.2 percent decline. Industry accounts for about a quarter of gross GDP, increasing the concern about the economy growing less than the official forecast of 2.4 percent.
• Once again, economists lowered their 2013 and 2014 growth forecasts for Brazil as the government struggles to revive expansion in the world’s second-largest emerging economy. New estimates signal that GDP will expand 2.21 percent this year and 2.5 percent next year.
• Bank Indonesia (BI) left the policy rate unchanged at 6.5 percent, which is in line with the consensus. Nevertheless, BI is introducing measures to reduce excessive liquidity to contain inflationary pressures. These measures include a higher secondary reserve requirement of 4 percent from 2.5 percent, stricter loan-to-deposit ratios reduced to 92 percent from 100 percent; and the issue of BI deposit certificates within the next few months.
• Singapore’s retail sales declined 4 percent in June, versus the consensus of a 2.5 percent gain, as car sales plunged.
• On the front page commentary in China Securities Journal, reporter Ren Xiao wrote that it is still too early to conclude whether China’s economy will rebound after recently announcing its stimulus measures.

Opportunities

• It is evident in the chart below that emerging markets were quick to recover from the 2008 financial crisis, even without a significant rise in Chinese stocks. The story for Eastern Europe has been radically different. Countries like Poland and the Czech Republic have been dragged down into periods of recession due to their export dependence on Western Europe, while Russia has continued to struggle in a weak commodity-price environment. This “guilt by association” is set to change now that recent macroeconomic indicators have turned positive and Europe appears to be on its path to sustainable growth. Eastern Europe could benefit handsomely from a European recovery and is set to close the five-year gap with global emerging markets.

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• A key point to take from the tax reform that is in place in Colombia as of this year, is that the payroll taxes and other non-wage costs paid by the companies decreased from around 29.5 percent to 16 percent. Francisco Schumacher, Andean Strategist at HSBC, believes this is likely to accelerate formalization and job creation in Colombia, which has one of the highest urban unemployment rates in the continent at 11.2 percent. Companies with a high number of employees should see a relief in their labor costs from this tax reform.

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• As shown in the graph above, mobile internet users grew at a double-digit speed in the first half of this year alone, which has driven an e-commerce boom in China. Most profitable from mobile internet users is online games, followed by advertising and online shopping. It is predicted that online shopping companies will be making profits next year as more and more people conduct shopping through smart phones.

Threats

• Turkey’s current account deficit is the eastern economy’s biggest area of vulnerability, even as it reduced the shortfall to about 6 percent of GDP last year, from 10 percent in 2011. The consensus is that the current account deficit will likely be lower than the initial market consensus of $55 billion to $60 billion, however, it will still be very high nominally and difficult to finance. On the news front, the most recent reading shows the nation’s current account deficit narrowed to a seven-month low in June. The news coincided with a sharp increase in output in the services industry, demonstrating the headwinds are short term and that the European nation is on its path to recovery.
• Argentine President Cristina Fernandez de Kirchner continues to accelerate fiscal spending in order to boost her party’s chances in the October elections. She pushed the fiscal deficit closer to the 2001 default level and drained foreign reserves that are plummeting at the fastest rate within a decade. The fiscal shortfall widened by 40 percent in the first five months of this year, prompting Fernandez to draw billions of reserves to make foreign debt payments. The government is partly unable and partly unwilling to issue debt, leaving the only alternative as the monetization of its deficit through reserves, which fuels inflation.
• China’s NDRC launched sector-wide investigations in the healthcare industry, continuing bribery crackdowns after finding sales misconduct of GlaxoSmithKline in China. Although it is a short-term event, market sentiment was affected with the news.

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