Via Nic Colas of ConvergEx,
Summary: India is known for its historically high per capita demand for gold, particularly before festivals and the wedding season, which peaks in the months of October to December. With more than ¼ of the entire global world market for the metal, the country has long been leading world demand, though fellow BRIC member China is catching up. But recent developments in India have gold bugs stirring – protests, boycotts, and a proposal for a tax on the sale on gold jewelry has severely dampened demand ahead of one of the most lucrative festivals in the country. And with global gold prices down more than 10% since their February high of $1,787.75, there seems to be good reason to worry about India’s role in the decline. But a longer-term analysis of Indian demand, global gold prices, and global GDP yield some surprising results about the country’s connection to the metal. While acceleration in gold prices and Indian GDP seem to link up as do Indian demand and global GDP growth, increases in demand have little correlation to gold price growth. Similarly, rampant inflation has almost no role in stifling demand for the metal. If these correlations hold true in 2012, gold investors might be able to sleep a little easier.
Gold trend-adjusted seasonal performance...
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Note from ZH: We did a little seasonality check (chart above - black dotted line) and noted three things: 1) 2012 (orange) so far is looking a lot like 2009 (green) - which neared its trough around this period; 2) Trend adjusted, the period from late February to early June is a weak cycle (red arrow on regression channel) which is followed by a trend-adjusted upwards bias through the summer; and 3) Trend adjusted, the period from mid-October to early December is a very strong cycle
Note from Nic: A recent article in The New Yorker about a surprising find in an ancient Indian temple got me thinking about gold, the subcontinent, and Charlie Munger’s recent comment that “Civilized people” don’t buy precious metals, but rather financial assets like stocks. Gold has, in fact, been in a bit of a freefall of late, so I asked Sarah to pick up these disparate thoughts and see where they lead. Her note, on Indian gold demand, follows here...
In the summer of 2011, while U.S. politicians were hotly debating the latest increase in the Federal debt ceiling, Indian authorities were facing quite the opposite situation: what to do with $22 billion worth of gold and rare jewels discovered under a temple in the southern state of Kerala. Rumors that the Sree Padmanabhaswamy temple sat on top of a horde of riches go back centuries, the result of millennia of donations to the gods, but the stories were only confirmed after a former Indian Police Service officer petitioned the Indian Supreme Court to order the opening of the temple to ensure “transparency in the running of the Trust” which overseas temple finances. The discovered wealth – which exceeds the annual education budget for the entire country – is now in limbo as two parties face off for ownership of the fortune. The Travancore Royal House, charged with the maintenance of the temple since the 18th century, assert that the riches belong to the gods they were offered to – and many Hindus in the region support their cause. Others think the wealth should be distributed to the poor; that $22 billion (and it could be far more once definitely valued) could potentially feed, clothe, and shelter every citizen of the region for years to come. The decision is ultimately up to the Indian Supreme Court, who have already stationed two dozen police officers around the temple for 24/7 surveillance. Just in case.
The $22 billion treasure found in Kerala is astounding, to say the least, but it represents barely half of the $46.4 billion Indians spent on gold in 2011. And while you may have read about Western central banks, Chinese citizens, and scores of other buyers for the yellow metal, India in fact outpaces every other country on the planet in gold consumption:
- In 2011, India was the clear leader in global gold demand with 27.1% of the market, according to the World Gold Council’s statistics.
- 61% of this spending went to jewelry, while 39% went to coins, bars, and other investments. This ratio has been converging for several years: in 2006 73% went to jewelry and 27% to other investments.
- China has been slowly closing in on the lead, however, with 22.3% of the global gold market last year. 67% of this went to jewelry and 33% to other investments.
- Gold ETFs got their start in India in 2007, and the seven such funds on offer to Indian citizens now have $1.9 billion in assets under management.
- The next closest country in the ranks after India and China is the US, representing a much smaller 5.7% of global demand.
Clearly, India and China together are imperative to the global gold trade, as they account for almost half of all global demand.
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In fact, as we show in the charts following above and below and the few data points below, the gold trade is a useful proxy for Indian economic growth, and demand from both of these countries is strongly connected to global GDP acceleration.
- Annual Indian GDP acceleration or deceleration has a 0.4 inverse correlation with acceleration or deceleration in gold prices. In other words, when gold prices increase by a greater amount than the year before, it’s likely that Indian GDP will decelerate that same year. We’ve used the last six years as the baseline for this comparison, encompassing both the turmoil of the Financial Crisis in western economies and India’s volatile GDP growth rates of anywhere from 6-10% over the period in question.
- China’s acceleration, on the other hand, is virtually unconnected to gold prices with a 0.03 R² over the same period. Clearly India is significantly more dependent on gold’s price appreciation than their neighbors to the East.
- When this same correlation is lagged by one year – 2011 gold price acceleration matched up with 2010 GDP acceleration, for example – the correlation is essentially perfect: 0.9965. So if the Indian economy accelerated in 2011, you can probably expect gold prices to follow suit in 2012, and vice versa. In China, this correlation is much weaker at 0.53, but still significant for a one variable economic analysis.
- Annual acceleration and deceleration in Indian and Chinese gold demand also have an almost perfect correlation to annual global GDP growth: 0.94 and 0.95, respectively. Essentially, when demand in these two countries drops, based on this correlation you might see global GDP fall as well.
Given this data, it is understandably concerning to fans of the yellow metal that Indian gold demand has not been as robust as expected so far this year. Part of the slowdown is due to a series of shutdowns by gold merchants, who closed shop for 20 days at the end of March to protest a rise on an excise tax on gold jewelry sales and a doubling of the import duty on the metal to 4%. And though the excise tax is now off the table, by one estimate (from the Bombay Bullion Association) gold merchants were seeing 50% less volume than the year ago period just before the Akshay Tritiya festival in late April, a traditionally strong period for gold sales. Some of the decline can also be attributed to rising inflation, according to some analysts: at 7.18% year-over-year so far in 2012, the rupee is down 8% in dollar terms and therefore represents a diminished source of gold purchases which are dollar-based.
But there are several reasons not to be pessimistic about gold prices even with the recent relative decline in Indian demand:
- Gold prices are heavily correlated to the U.S. dollar – a strong greenback hurts gold demand around the world by lifting local prices. The Indian Rupee has fallen victim to the global “Risk off” trade in recent weeks, falling below 54/dollar for the first time since last December. At the same time, the Reserve Bank of India has reportedly launched aggressive interventions in the currency market to support the local currency. And while we’re reluctant to base any investment analysis on the counter-market moves of any central bank’s activities, there is a lot at stake for the RBI in this case. India, you see, has very little in the way of energy reserves and must import most of its oil – 80% by some counts – from overseas. And those products are also priced in dollars, just like gold. A stronger Rupee is therefore critical to continued economic growth, with gold demand in India an incidental beneficiary of this dynamic.
- China is more than making up for the loss. Indian demand dropped by -7.2% in 2011, from 1,006.3 total tons in 2010 to 933.4. Chinese demand increased 21.7%, from 666.8 to 811.2. That’s a net gain of 71.5 tons. And with an annualized demand increase of 22.9% since 2006, it’s likely that China may surpass India as the largest gold consumer in the world in the next few years.
There is even cause to be bullish, if our Indian GDP correlation can be believed. The IMF projects that the Indian economy will decelerate by -0.9% this year, to 6.9% from 7.8% in 2011. If we plug in this -0.9% deceleration into the formula derived from “Change in annual Indian GDP growth vs. change in annual gold price growth”, we find that gold prices may actually accelerate by 2.8% in 2012 – meaning they will grow an additional 2.8% to the 27.2% appreciation from last year, resulting in a 30% increase. Based on yesterday’s closing prices, that puts the metal at $2,022.15 – just above the $2,000 mark some analysts have forecast.
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The thought that a decline in the rate of Indian economic output would cause an increase in local demand is not as tortured as it might seem. The appeal of gold is largely based on its long-proven value as a store of wealth. The vaults at the Indian temple where we started this note weren’t filled with IOUs from Roman traders or shares of stock from the old East India Company. That’s good news for the Hindu gods that first received these gifts, as well as their modern adherents who may benefit from the centuries of donations. Gold does hold its value over long periods of time, and no country has a better case study of that fact at the moment than India. So even if the economy there does slowdown in 2012, the resultant uncertainty doesn’t preordain a decline in gold demand. It may even help.
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While none of this guarantees that gold will experience some kind of meteoric rise to $2k, especially given all the other factors that contribute to prices, I think it’s safe to say that the supposed softening demand in India shouldn’t be too concerning. China is emerging as a critical consumer of gold on the world stage, and may even surpass India this year if trends continue. The country has more than offset declines in demand from their southeastern BRIC partner, and has helped drive up world consumption at a time when many other countries – particularly our own – are dropping out. The US has bought 42% less gold than it did in 2006. So when it comes to declining gold prices, don’t jump to blame India. After all, it isn’t even wedding season yet...