End Of Diesel Subsidy In India Bearish For Gold

| About: SPDR Gold (GLD)

The foreign investors finally did it. They successfully forced the Indian government to increase inflation in India. In the process they killed gold for 2013.

But then I get ahead of myself as always.

Reports the Times of India:

NEW DELHI: The government has finally bitten the bullet on subsidized diesel. It allowed state fuel retailers to raise the pump price of diesel by 45 paise a litre, excluding taxes, from Thursday midnight. This will be the general trend every month until the pump price reflects the market rate.

So what would be the immediate impact of this? Rising inflation. Reports the Times again:

An increase in diesel price would also mean there might be a hike in prices of goods and food stuff as transportation cost will go up.

Let's think about this for a second, or even a minute or two. India is an agriculture based country. Farmers need diesel to run the agricultural equipment, which is why diesel was forever subsidized in India. Now the farmers have to pay market prices for energy, which they will pass on in the form of higher food prices.

In addition, the domestic energy infrastructure in India is rudimentary and crumbling. Even in the major cities, people have their own diesel generators to product electricity. Manufacturing companies routinely depend on diesel generators as massive power cuts are the norm. That means manufactured goods are going to go up in prices from rising costs of energy, and home fuel budgets is now under pressure as well.

So, inflation is going to go up. That much is a given. But how did the markets respond? Reports the Times again:

The Street cheered the government's move, with the sensex rising 146 points to close a tad above 19,964 on heavy buying in oil stocks. The broad-based NSE index Nifty rose by 37.35 points to 6,039.20.

Wow, what's going on here? We are facing higher inflation and the market rallies? Well, there is a reason behind this. Hike in diesel prices is a bone thrown in the general direction of the foreign rating agencies and investors. They will now feel happy, and pour more dollars in to the country.

The market moves in strange ways.

So, what does this mean for gold? India, as many may know, is the world's largest importer and consumer of gold. Now put yourself in the form of a middle class Indian family. Your budget is now under severe pressure because of inflation, so you have less money to spend. You can no longer borrow money to buy gold, as the Indian Government has already put a stop to that early in the year. Massive foreign investment into India is strengthening the Rupee, so gold prices are falling in the local currency. Finally, the stock market is rallying.

Did I forget to mention that while you can't borrow money to buy gold, you can indeed borrow money to buy equities? So what would you do, rational investor? Buy less gold and more equities, of course.

This means gold demand in India, already under pressure in 2012, is under even more pressure from this act by the Government of India. A sad day for gold (NYSEARCA:GLD) investors, indeed. To profit from this trend, I had earlier recommended buying puts on the Direxion Daily Gold Miners Bull 3x Shares ETF (NYSEARCA:NUGT). For details on the rationale, interested readers may find my articles here.

The Jan 2014 strike 10 put on NUGT has bid/ask of 2.85/3.10. NUGT is currently at $10.02. I expect gold to drop by 5-10% in 2013, which means the miners will likely drop by 20%+, and NUGT will drop by 65%+, to less than $4. That would make for 100%+ gain on the put. More adventurous souls can go further out of money and aim 2x-3x return, however, I will be content with simply doubling my money.

The put on NUGT is flat since I recommended it last week. I continue to hold this position.

Disclaimer: This is not meant as investment advice. I do not have a crystal ball. I only have opinions, free at that. Before investing in any of the above-mentioned securities, investors should do their own research, consult their financial advisors, and make their own choices.

Disclosure: I am short NUGT. 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 am indirectly short NUGT as I hold puts on NUGT.