Part of the reason for the higher gold prices recently could be the almost insatiable demand for gold in India. People in that nation are buying so much gold that the Indian government is thinking about limiting gold imports.
The growing Indian middle class is apparently buying so much gold that it is affecting the nation's balance of trade. Huge amounts of money are pouring out of India at a time when the nation's economy is in a downturn. India's former finance minister even complained that what he called the "quantum import of gold" is dragging down investment in stocks, bonds, and other financial instruments.
Any measure to limit gold imports to India could harm gold mining stocks because India is the world's largest buyer of gold. Nearly one-third of the world's gold is shipped to India. Even a rumor of such a move could cause both gold prices and gold mining stocks to drop.
Even a modest limit on gold imports to India could hurt smaller gold producers, such as Russia's High River Gold Mines (NYSE:HRG), Paramount Gold and Silver (NYSEMKT:PZG), and Pershing Gold (NASDAQ:PGLC). These companies need a relatively high price to cover production costs. Larger miners that might be harmed by Indian restrictions on gold imports include Randgold Resources Ltd (NASDAQ:GOLD).
Diversified miners, such as Freeport-McMoRan (NYSE:FCX) and Rio Tinto (NYSE:RIO), could also be hurt because they rely heavily on gold as a hedge against the fall of other metal prices. Without added gold revenue, some of these companies may not be able to cover expenses from recent expansion plans.
The current economic uncertainty and talk of such restrictions could temporarily push up gold prices and benefit some gold stocks. If it becomes apparent that there will be restrictions, there will probably be a rush to buy gold in India that will momentarily increase demand.
It is also possible that such restrictions would boost gold mining stocks because Indians might see them as an alternative to physical gold. The current conditions in India are making the gold market vulnerable and will probably make gold-stock prices more volatile.
Gold stocks that Indians could turn to include Barrick Gold (NYSE:ABX), GoldCorp (NYSE:GG), and Newmont Mining (NYSE:NEM). Barrick, as the world's biggest producer of gold, would probably be the biggest winner if large numbers of Indians start buying gold stocks. Also benefiting would be gold exchange traded funds (ETFs), including the very popular SPDR Gold Trust (NYSEARCA:GLD).
Politics Make a Limit on Indian Gold Buying Unlikely
Serious limitations on gold buying in India are not likely because they would not be politically popular. It is doubtful that any political party that tried to restrict gold would keep its majority in the Indian parliament. That would cause the government to fall and cost the Prime Minister and the cabinet their jobs. Efforts to increase taxes on gold jewelry in India earlier this year provoked a backlash, so it is doubtful that Indian politicians will make a serious effort to limit gold imports.
Even though a limit on gold purchases would probably be good for India's economy, it would simply cost politicians there too many votes. India's leaders will probably put their chances of re-election ahead of the national good and leave the gold market alone.
This could be what cost Pranab Mukherjee, the finance minister who complained about the quantum import of gold, his job. He abruptly resigned his job on June 26 as India's currency was collapsing on the global markets.
Therefore, India's demand for gold should remain high. That should keep up gold prices and provide a steady market for small gold producers.
Dipping Indian Economy Will Help Gold Mining Stocks
The most likely outcome is that gold demand in India will grow and gold prices will increase because that nation's economy is in crisis. Things are now so bad there that the nation's Prime Minister, Manmohan Singh, took over the finance minister's job after Pranab Mukherjee resigned on June 26.
One of the major reasons Mr. Singh took that step is because India's currency, the rupee, has fallen to record lows. Reuters reported that the rupee had fallen to a record low of 57.35 U.S. dollars on June 22.
The collapse in rupee value is good for gold mining stocks because it encourage Indians to buy more gold. As the currency loses value, more and more middle class people on the subcontinent will head for the gold shop. That could drive gold demand and gold prices to record highs.
The big winners will, of course, be the large gold producers, such as Barrick Gold, Kinross Gold (NYSE:KGC), Gold Fields (NYSE:GFI), and Eldorado Gold (NYSE:EGO). Any company that could ramp up production quickly to fulfill increased Indian demand will see greatly increased profits and cash flow. That company will also see a fairly large increase in its stock value.
This could include smaller miners, such as Pershing Gold and Thompson Creek Metals Company (TC), which have new mining projects that are about to come online. Pershing owns an existing mine with large reserves in Pershing County, Nev., while Thompson Creek is scheduled to begin production at Mt. Milligan in British Columbia in 2013.
Massive Surge in Indian Gold Buying could be Underway
From Mr. Mukherjee's remarks, it is clear that the Indian government expects a massive surge in gold buying by its people. Average Indians may feel that buying the metal is the only way they can protect their wealth and their families as their currency collapses.
The major result of such a surge is that gold in other parts of the world will start flowing into India to fill the demand. As that happens, prices should start going up all over the world as traders rush to fill the demand. A strong possibility is a sell-off of gold in the United States, where the dollar remains strong.
The demand for gold is likely to hit its highest level ever this year because of the crisis in India. The ongoing collapse of the rupee is likely to spark a frenzy of gold buying that would be almost unprecedented in scope. That could bring back the record-high gold prices and boost gold stocks through the ceiling.
This could lead to a short-term boom in gold stock prices that may not be sustainable. The scope of the increase in Indian gold buying is not clear, but it must be large if it worried the former finance minister. The Indian demand could be what has been fueling recent rises in gold prices on the international market.
The surge in Indian gold buying would only help mining stocks if it is a long-term phenomena. If the frenzy abruptly stops, gold prices could collapse and drag prices of stocks like Barrick and Thompson Creek down.
If it lasts for any length of time, the Indian economic crisis should result in increased cashflow for active gold miners such as Barrick and AngloGold Ashanti Limited (NYSE:AU). These companies have the existing reserves and resources to quickly capitalize on the situation.
There is a potential downside for mining stocks here. If the Indian recession lasts for more than one or two years, it could dampen the gold market, because at some point, Indians would not be able to afford to buy gold. Another long-term problem is that desperate Indians could start selling gold in order to eat or pay bills. That could depress the price of gold and start dragging down gold stocks.
No matter what happens, India seems to hold the key to gold stocks' future profits and cash flow. Investors could be able to profit from the Indian crisis by shrewdly picking gold stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.