Western countries are still struggling to see the benefits of owning gold in physical form, at least on a large scale. If we want a taste of the coming gold mania in the West, we could look at the East, where people have been rushing into physical gold, especially in India and China. Ironically, just at the time when Indian rush for gold to protect themselves against the damaging effects of the (central) banking system, their very central bank tries to seduce the people to transfer their physical gold into the banks and slow the import of physical gold.
India has traditionally been the largest consumer and importer of gold. Some 20,000 tonnes of gold is held by households currently. To put that figure into perspective, the largest central bank reserve worldwide is held by the US and totals slightly more than 7,000 tonnes. Total above the ground gold existing on the world is some 165,000 tonnes.
The real objective of the Reserve Bank of India (RBI) is to profit from the gold rush in an attempt to decrease their current account deficits. Reuters reported today that the Reserve Bank of India (RBI) plans to:
- moderate the demand for gold imports
- introduce several gold-based investment products, in order to transfer household’s gold into the banking system
- implement measures to increase the monetisation of (the stock of) gold, mainly by setting up some sort of gold bank / institution.
RBI published a report on their website which presents in a detailed way the proposed measures from their internal working group. Several interesting charts show the magnitude of the gold market in India … and the potential profits for the central bank and banking system were they to implement their measures. Interestingly, the Indian gold imports as a ratio to their GDP stands at 3% approximately.
The report provides details about the limitations of gold imports, as summarized in the following quote:
Indians’ obsession for large investment in physical gold is the outcome of the convergence of numerous and divergent factors. The Working Group is conscious that some of the steps suggested by them may temporarily reduce the gold imports through organised channels, but, does not squarely address the root cause for excessive demand for gold imports. In this context, it is necessary to recognise that a necessary pre-condition for reducing the demand for the precious metal is to ensure benign inflationary environment along with achieving and maintaining macroeconomic stability. We need to recognise that gold trade had always flourished under conditions of economic and political instability worldwide for centuries. Keeping this global experience in mind, the Working Group firmly believes that providing real effective rate of return that matches the return on investment in physical gold to investors through alternative instruments holds the key to reducing the excessive clamor for gold.
The chart (also from the report) shows how gold has significantly outperformed other asset classes over the past four years in India.
Logically, as seen on the next chart, people hedge with gold against inflation. In years of inflation, gold imports have been rising in a consistent way. Is it any surprise that the RBI aims to implement their measures given their expectations of inflation as explicitly stated in the above quote?
Furthermore, the report mentions a need to monetize the gold stock for “productive purpose” (read: interest yielding).
There is also a critical need to increase monetisation of idle gold stocks in the economy for productive purposes. It needs to be recognised that the issue of ever rising demand for gold in India is indeed very complex. Gold has been playing a key role in the Indian economy, but many practices followed in the gold market are still primitive and unorganised. There is an essential need for transforming this critical segment into an organised sector in all respects through strengthening the related institutional infrastructure structure. After all, over a billion population of India spends almost Three Trillion Rupees a year on gold imports. Viewed from this sheer magnitude, creating an institution that may focus on organised gold related transactions with undivided attention assumes vital importance.
The report, however, does not provide any detail about the “need” for a restructuring in the gold market. The only real need is in the following chart.
Holding physical gold is a conscious choice to stay outside the banking system. The key question is if the Indian people will resist the seduction to mix up their gold with paper based investments. According to expert Philip Klapwijk, head of Thomson Reuters GFMS, the government attempts will result in an increased smuggling of gold, which would be much worse for their deficits!