Yellow metal and rupee: The curious case of higher gold prices in India

Trade negotiations over tariffs between the US and China are underway and any movement therein will impact the currencies which in turn will have an effect on gold

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It has been commonly noted that domestic gold prices currently are at a significant high for a variety of reasons. Indian consumers are extremely price sensitive and hence, at higher prices the market witnesses a certain level of demand compression.

The following chart traces the average monthly gold prices, domestic as well as international, beginning in January 2015.

The chart below captures the month on month price changes in the domestic as well as the international gold prices.

When both these prices and their month on month movements are juxtaposed against each other, the following points become readily apparent:

a) Domestic prices generally follow international prices. This is also justified given the country’s near-total reliance on imports for meeting its demand.

b) Even as the upward movement in the international prices is captured in the domestic price, the fall in international prices is not completely reflected in the domestic prices given that the Indian rupee has depreciated against the US dollar and also due to import duties that distort the local prices as compared to international prices.

Under normal circumstances, gold and dollar share an inverse relationship, and any weakness in the dollar push up gold prices and vice versa.

The Indian, as well as the Chinese consumers, generally decide their gold purchases based on their requirements and on the local price of gold.

These local prices are different from the international price of gold due to the prevailing local demand-supply dynamics, regulations, import restrictions, seasonal factors and purity requirements.

The following chart compares the difference in the domestic gold price in India and the international price of gold along with tracing this movement with the changes in the INR/USD exchange rate.

Interestingly, we see a surprising scenario emerge that if the domestic prices in India are converted into US dollar prices and further controlled for import duties, the local gold price was broadly at a discount to the international prices during the period in the chart i.e. 2015 onwards.

a) The local rate was at a discount to the international price for more than twice the number of days the price had a premium to the international rate (745 days of a discount compared to 301 days of premium).

b) Additionally, it can be observed that the premium/discount was at opposite end of the exchange rate, i.e., when the rupee was weaker against the dollar, the local price was at a discount to the international price and vice versa.

Moving on to the larger Chinese consumer, the chart below compares the difference in the domestic gold price in China and the international price of gold along with tracing this movement with the changes in the CNY/USD exchange rate.

The above chart indicates that there seems to be a minimal correlation between the exchange rate and the domestic gold premium/discount. The local gold price was broadly at a premium to the international prices during the period in the chart, i.e., 2015 onwards.

The local rate was at a premium to the international price for more than 10 times the number of days the local price traded at a discount to the international rate (94 days of a discount compared to 962 days of premium).

The following two points can be theorised from the above data:

Higher prices in the Indian market are more a function of the exchange rate rather the inherent price of the yellow metal internationally or demand.

Simplistically, lower prices seem to indicate lower demand for a commodity. Referring to the above charts, consumer demand for gold in India seems to be trending down justifying larger share of discount in local prices, while Chinese demand seems to trend up, indicating the likely reason for the premium in local prices for the period under review.

Due to the weakness in the rupee, India has a higher effective rate for gold with record prices being quoted in the domestic market. Additionally, general elections are scheduled between April and May of 2019, and a new government would take over mid-year.

Consequently, demand may seem to be subdued with all these changes on the cards. Further, trade negotiations over tariffs between the US and China are underway and any movement therein will impact the currencies that in turn will have an effect on gold.

Disclaimer:-The views and investment tips expressed by investment experts are their own. Ripples Advisory advises users to check with certified experts before taking any investment decisions.

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