Until China overtook India in 2013, India had been the largest gold importer in the world when the Government implemented severe gold import controls in July 2013 as a means of reducing India's balance of payments deficit. The controls included raising the import duty to 10%, prohibiting imports by certain business segments and imposing onerous import restrictions on gold trading companies. While the move might have helped reduce India's BOP deficit, it also cost the previous Government its job. The new Government, led by newly elected prime minister Narendra Modi, announced yesterday the start of what will likely be the eventual complete removal of gold import controls. Should this occur, it could stimulate a large move up in the price of gold.
Last July, as part of its import controls, the Government barred what are known as "star trading houses," or private jewelry exporters, from importing gold. Yesterday the Government announced that it was removing those restrictions. It is likely that the Government will begin to further remove several other restrictions. The probability of this was reflected in this week's decline in the market price premium for gold in India to 17% over the world spot price of gold, as I'll explain.
Relative supply and demand for gold in India can be measured by what is called the "ex-duty" premiums. This is the market price of gold in India over and above the 10% import duty fee imposed by the Government. In late 2013, the ex-duty premiums were seen as high as $160/oz, which means that Indians were paying as much as 25% in total - the import duty plus the ex-duty premium - above the world spot price of gold (I get this information from a subscription newsletter, John Brimelow's Gold Jottings).
On the assumption that the new Government will likely lower the import duty from 10% down to the more "normalized" 6-8%, the decline in the ex-duty premiums seen this week in India thus reflects the market pricing in the expectation of substantial, if not complete, removal of the highly restrictive import controls, which will likely stimulate a huge rush to import gold.
Although India imported 825 tonnes of gold in 2013, this was down from 860 tonnes imported in 2012. India was importing gold in the first half of 2013 at a record rate and it was widely forecast that imports for the year would exceed 1,000 tonnes. However, imports dropped off significantly after July because of the import controls. Historically, the second half of year is its biggest seasonal buying period, with several important festivals which feature enormous gold buying by the public taking place between August and December.
Assuming that the newly elected Government restores the gold import duty and regulations as they were before July 2013, I believe India will resume importing gold at an annualized rate of at least 1,000 tonnes. I say "at least" because I also believe there will be a snap-back effect that will take the rate of imports temporarily well in excess of 1,000 tonnes per year.
If this is the case, I believe the normalization of India's gold imports will cause a significant upward move in the price of gold in the second half of 2014. The reason for this is that India's seasonal buying pattern is highly correlated with the seasonality of the monthly returns for the price of gold (chart source: Equityclock.com, edits are mine):
This chart above shows the 20-yr average monthly rate of return for the price of gold. As you can see, the September - December period produces the best monthly returns for gold. This is widely attributed to the huge demand for gold during India's festival season. On the assumption that the gold import regulations will normalize by August, I believe that the price of gold will significantly outperform its average monthly returns during the fourth quarter this year.
At the end of January I wrote an article in which I suggested that gold could see $2,000 this year. Admittedly, at this point in late May that forecast price target may seem completely unrealistic. However, if India's gold importation snaps-back like I think it will, $1800 is still possible. Whether my forecast proves accurate or not, I am confident that the price of gold will be a lot higher than now in December.
To participate in a big move in gold related to this recent development in India, I always first and foremost recommend buying and holding physical gold coins (gold eagles, maple leafs, etc). If you want to trade and "index" the price of gold, the easiest and most liquid security is the SPDR Gold ETF (NYSEARCA:GLD). In addition, you can make a leveraged bet on gold using the VelocityShares 3x Long Gold ETF (NASDAQ:UGLD).
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: The hedge fund I co-manage is long physical gold, silver and junior mining stocks. I am invested in the fund.