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By Stuart Burns

Hedge funds and private investors have been burned in gold price falls this year, down 23% for the second quarter -- its biggest decline since at least 1968, according to Reuters data -- while since the beginning of the year it is down 29.5%. In April, a dedicated gold fund managed by John Paulson was down about 27%, bringing the year-to-date decline to 47%. Since then, it has slipped further. But the hedge funds' pain is the small buyers' gain, it would seem, as falls in the gold price have encouraged buyers in the world's largest jewelery market (India) to see falls as buying opportunities.

According to a Financial Times article, gold imports in April and May surged to about 300 tons, about a third of the quantity imported in the whole of 2012. Rising gold prices had been eating into jewelry consumption; demand was down 30% from 2005 as the price rose inexorably in the intervening years, but the fall has made the metal more accessible and perceived by many as a bargain to be snapped up.

The surge in imports has come at a most unfortunate time for India, and as a result, for the prospects of a recovery in the gold price. With economic liberalization stalled in India, the currency falling and the balance of payment worsening, the last thing the Indian government needs is a surge in imports sending much-needed dollars overseas.

For any other country, gold imports would not be a significant issue in a country's balance of payments, but in India it is huge. According to the FT, gold imports increased 80% between 2002 and 2011, when they peaked at 969 tons, before weakening slightly to 860 tons in 2012. Gold accounted for 11.5% of total imports in value terms during India's 2011-12 financial year, up from just 7% in 2008-09.

As a result, the government has moved to stem the tide since January 2012. New Delhi has raised import taxes on the precious metal four times, taking it from 2% to 8%. This month, the Reserve Bank of India banned banks from providing credit for jewelery stores, which can now buy gold only on a cash basis, but as the price has fallen the rise in import duty has been masked by lower metal prices and has failed to impact demand.

To be continued in Part Two.

Source: Gold Hedge Funds Hurting, India Buying: Will Prices Recover?