India Ending Diesel Subsidy Which Is Bullish For Gold

Includes: BNO, GLD, PIN
by: Tom Luongo

India's government has been toying with the prospects of substantial economic reforms as its persistent budget deficits - self-inflicted wounds if ever I saw them - continue to threaten the economic stability of the country. Finally in a fit of rationality the Singh government decided to let the free market - eventually - set the price for diesel fuel. India has been running the kinds of budget deficits that make one think they were trying to become the U.S., only failing. The diesel subsidy is costing them nearly 2% of GDP per year. The stated goal was to get the budget deficit down to just (I love that!) 5.3% of GDP, mostly to satisfy Moody's who has been threatening them with a downgrade.

Over the course of the year the price of diesel fuel will rise which will allow refiners to stop hemorrhaging money and sending the bills to the government. China finally had to face the political music on this as well and Sinopec's (NYSE:SNP) bottom line is already better for it. The disconnect between the prices of diesel and gasoline were so big that it altered the entire automobile industry; artificially stimulating demand for diesel cars and SUV's. Since India imports more than 80% of the oil they use creating a functional energy market is really of paramount importance. This one simple change will have far-reaching effects as long as it remains politically-viable - no guarantee of that according to friends I have there - that make me far more bullish on the country now.

Other changes implemented last year on foreign investment will now have more effect as the economic foundation of the country is functionally more stable. An increase in foreign direct investment could easily offset the internal GDP losses and mitigate the effects of higher pump prices.

But, to address the title of the article this is bullish for gold (AMEX:GLD) simply because it will put serious pressure on the rupee to rise all across forex markets. The government is in enough trouble with the people as it is, killing off the diesel subsidy but repealing all recently passed restrictions on gold importation will keep a lid on public backlash. These changes haven't been made yet but they will.

The USD/INR cross dropped sharply on the news and has now broken down out of a two month consolidation between Rs 54.03 and Rs 55.83, closing at 53.745. This news should be enough to send the pair back to the October 2012 low of Rs 51.916 over the next couple of months.

But, what is good for gold and the rupee will be bad for Brent Crude (AMEX:BNO) in the short-term. GDP growth is going to drop and CPI inflation is going to rise. They will not be able to lower interest rates to offset this and nor should they. Marginal demand for oil will likely drop in this scenario and weigh on Brent which will already be under nominal strain from the decrease in U.S. imports.

All in all this is a very bullish long-term sign for India which is a major key in the Asian growth story. There are a number of other reforms to make, but the diesel subsidy was the linchpin to solving a number of problems the country is facing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own physical gold, silver and a good number of goats