Gold Trade: Why high demand for gold may be a good thing for India

Much of the recent attention regarding gold trade has been directed at China. This is entirely justified; rapid gold purchases from around the globe have fomented speculation that China is preparing to float its currency. But the truth is no-one really knows what they are planning to do. Their strategy is a manifestation of Deng Xiaoping’s famous maxim “hide your brightness, bide your time”. In other words, they will not show their strength until they can ensure they will achieve their objective.

Ambiguity and speculation over what is, undoubtedly, a very important question for global markets has meant that gold trade in other, highly significant, consumer nations has slipped under the radar. India, for example, currently ranks top in terms of largest gold consumer nations and in the past few years there have been shifts in policy.

Gold is an extremely popular commodity in India; it is as much a symbol of affluence as it is a means of providing future security. Demand for the precious metal has remained high. However, in recent years, India has struggled to balance this demand with its large trade deficit.

Policy makers were so concerned with the overall trade imbalance that in August 2013 the so-called 80/20 rule was imposed. This rule restricted India’s gold imports and forced 20% of any gold shipment to be re-exported by Indian jewellers. The 80/20 rule was scrapped in November 2014 after it became apparent that the domestic jewellery sector was suffering (Figure 1). Policymakers within India instead decided to focus on boosting exports rather than curbing gold imports.


Figure 1  | India gold jewellery market, 2008 – 2015, the impact of the 80/20 rule
Source | DeltaMetrics 2015


This is potentially a very shrewd shift in strategy; Delta Economics does not expect India’s demand for gold to abate with a forecast compound annual growth of 9.5% to 2020. Therefore, instead of cutting gold imports, which was leading to an increase in smuggling, February 2015’s budget suggested a scheme to monetise Indian citizen’s private gold holdings: an estimated 20,000 tonnes. The scheme would allow Indian citizens to accrue interest on any gold deposited into the banks. This could, as a consequence, reduce volatility in the rupee and provide the average Indian household with extra spending power.

At a time when the world’s national banks seem to be realising the potential of having a gold-backed currency, India’s historically high demand for gold suddenly doesn’t seem like such a bad thing.


Gold Trade: Why high demand for gold may be a good thing for India  |  Author  |  Jack Harding  |  Analyst and Publications Manager

Webcast 026 | Trade and economic outlook 2015: the Delta Economics view

Delta Economics CEO Rebecca Harding examines some of the main trade trends and challenges expected in 2015. Looking at issues such as disinflation that continue through from 2014, this Webcast discusses how much trade may grow this year and looks at some of the key countries and sectors that will be driving trade. The impact of continuing instability from geo-political tensions in the Ukraine and Russia as well as Syria and Iraq is also outlined with a view to understanding their likely impact on the global trade environment.



Webcast 026 Author  |  Rebecca Harding  |  CEO

A dose of its own medicine

Why India has a clear way of boosting its economy through exports  |  When Mr. Modi takes office on the 21st May, his first thoughts will almost certainly not turn to US pharmaceutical imports, but maybe they should. India has been plagued by a trade deficit since 2006 which is likely to grow in double digits this year and next. Alongside this, its terms of trade (the value of its exports in relation to the value of its imports) have deteriorated substantially and although its share of world trade increased to above 2.5% in 2013 and is forecast to reach 3% by 2015, this is as much because of increases in imports as it is about increases in exports. The Rupee’s value against the US Dollar has slipped by over a third in the three years since May 2011 when confidence in emerging markets generally and India in particular was so strong but if Mr. Modi is to address some of the broader challenges he faces, then it is the link between trade, real economy and key indicators such as the value of the Rupee that he needs to tackle first.

This will not be a simple job because, at the moment, the speculative element in Indian markets and the dominance of its trade by imports means that the correlation between the currency and exports is relatively weak at 0.50. The correlation is slightly stronger between its imports and the value of its currency at 0.53, as shown in Figure 1, which illustrates something unusual about the relationship: as the currency becomes weaker, imports drop.


Figure 1  |  Indian imports (USDm value, June 2001-April 2015)
against Rupees per USD, Last Price Monthly, June 2001- April 2014
Source  |  DeltaMetrics 2014, Bloomberg


India imports predominantly crude oil, which, with an estimated value of USD 175bn in 2014, is nearly three times higher than the next largest import – gold. If the currency devalues, then exports should become more competitive and imports less competitive since they are more expensive. India has increased its imports of oil over the time since 2006 by over 350% against a backdrop of a depreciating currency making it inflation-prone.

But this relationship also demonstrates the fact that India’s currency is prone to speculation. The correlation is weak against commodity exports and this suggests that it is not so much measuring the economic development and growth of the Indian economy as it is measuring the capacity of the economy to soak up imports from overseas. The Indian stock market is a measure of the investment potential of the Indian economy and it too is more strongly correlated with imports (0.91) than it is with exports (0.90), as illustrated in Figure 2.


Figure 2  |  Indian imports (USDm value, June 2001-April 2015) vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg


While the difference in the correlation between the BSE and exports and imports is marginal, it points to the fact that investors are, arguably, measuring the success of the economy against their own capacity to invest in it. The post-dotcom hubris that surrounded India’s development in the early 2000’s spawned an excitement about India’s potential growth that fuelled inward investments in biotechnology, pharmaceuticals and electronics from developed world economies, particularly the United States. And yet, paradoxically perhaps, India’s trade itself has shifted markedly away from the developed world economies and towards economies in the Middle East and Asia.



Figure 3  |  Moving focus – how India’s trade is shifting from Europe to Asia and the Middle East
Source  |  DeltaMetrics 2014


For example, China was India’s twelfth largest export destination in 2001 but is its third largest now and Singapore was its eleventh but fourth largest now. The UK was India’s fourth largest export destination but is now 7th and Germany its fifth, but is now 8th. India’s fastest growing export destinations are Indonesia, Vietnam and Brazil and while the UAE has risen from second to first, much of this is because of exports of diamonds, jewellery and gold.

Its import structure has changed as well, reflecting India’s insatiable demand for oil, diamonds, gold and jewellery. In 2001 the UAE was ranked 14th and Saudia Arabia are nexus pheromones any good 18th. They are now 2nd and 3rd respectively. China is the number one importer and with import values into India of USD 71.9bn anticipated in 2014, its imports are worth more than twice those from Switzerland and the United States which ranked first and second in 2001.

Trade is normally glacial in the pace at which it changes so these shifts in the structure of India’s trade partners are worth dwelling on. The pattern that is being reflected is a shift away from the developed world towards the emerging world and while this is, in itself, not a bad thing, it pushes India’s trade structure increasingly towards that of an emerging economy. Its trade is heavily concentrated in refined oil (nearly 19% of its exports) and pearls, precious stones, precious metals and jewellery (16%). Pharmaceuticals overall account for around 3% and while this is more than its concentration ratio of 2.5% in 2001, it is modest in comparison to its commodity exports.

Exports to the emerging economies are largely commodity-based: for example, exports to Vietnam are dominated by beef and soyabean cakes, maize and fish while exports to Brazil are oil, synthetic filament thread (used to stitch car seats), carbon and coke and insecticides. Yet to Germany, its top five export sectors include aircraft parts and cars, while to the US they include medicines.

It would be a mistake for policy makers to ignore the importance of traditional areas of export strength. Precious metal, pearl and jewellery exports to the UAE, for example are strongly correlated with the value of the currency at 0.61, as shown in Figure 4.


Figure 4  |  Exports of pearls, precious stones, precious metals and jewellery (USDm) to the UAE,
June 2001-April 2015 against Rupees per USD, June 2001-April 2014, Last Price Monthly

Source  |  DeltaMetrics 2014, Bloomberg


It would also be misguided to ignore the importance of emerging markets in Asia. As Figure 5 shows, there is a very strong correlation (0.91) between the value of India’s Iron Ore exports to China and the Indian Stock Exchange.


Figure 5  |  Indian exports of ores, slag and ash to China (USDm value, June 2001-April 2015)
vs IndiaBSE, Last Price Monthly, June 2001-April 2014
Source  |  DeltaMetrics 2014, Bloomberg


Indian pharmaceutical exports to the United States, however, are almost as highly correlated with the BSE at 0.88 and this is important for policy makers. Over the period since 2001, the comparative advantage of Indian pharmaceuticals has gone from positive to negative and while the comparative disadvantage of Indian electronics exports (measured through revealed comparative advantage) has gone from -0.66 to -0.46, given the powerhouse that is India’s innovation economy, this should be reflected in its electronics exports as well. Yet the correlation between India’s trade and proxies for its innovation (the amount the government spends on R&D and business expenditure on R&D) are very high at over 0.93 as are skills, wages and foreign direct investment. More than this, the currency elasticity of trade is 0.99 correlated with trade.

All of this gives Mr. Modi’s team a clear lever to stimulate the economy. First, in the short term, the currency should be kept weak – this will have the effect of closing the trade deficit simply because the responsiveness of trade to changes in the currency is so high. This will promote exports in areas where price competitiveness is key, such as oil or iron ore, or even beef, which is a fast growing export product.

Second, India’s new government needs to think about its long term growth which will only come from extending education into rural communities, building on its high level skills base in cities and innovation – building on its successes in software and business services as well as in pharmaceuticals. South-South trade between emerging economies is commodity and infrastructure focuses and Delta Economics is not positive about its pace of growth in the immediate future. Accordingly, as the developed world begins to emerge from the financial crisis, India needs to take a dose of its own medicine to re-connect with these markets as they will help it to restore its competitive advantage in the innovative sectors that were so vibrant ten years ago.

The Dog That Never Barked?

Why deflation may yet bite | Deflation has come back on to the agenda. It never really left – it is the dog that never barked in the wake of the downturn: the sheer scale of the fiscal stimulus around the world has meant that, with the notable exception of Japan, we have experienced dis-inflation, or falling price levels, rather than deflation, which is negative price levels. With recovery in Europe and North America apparently beginning to take hold, why would commentators and analysts start to fear its bite now?

The answer is that it is not just Europe that needs to worry about deflation. Chinese trend growth is falling and March’s declines in copper and iron ore prices underscore the over-capacity in the Chinese economy that are symptomatic of lower domestic demand and that raise the spectre of deflationary contagion for Asia and the rest of the world.

The similarities with Europe are striking. Lack of demand in Germany  keeps inflation low in the Eurozone. While this benefits the weaker economies in the Eurozone in terms of competitiveness, making their prices cheaper and giving their consumers some spending power, if German demand remains low, then its inflation remains low. Because it is a surplus nation, its over-production pushes down prices in peripheral countries too, putting further downward pressure on investments and increasing the cost of their debt.

The threat of deflation from China’s lack of demand is best seen through the lens of South-South trade, illustrated in Figure 1a and 1b. China’s demand is a major determinant of South-South Trade, and the two charts show clearly the inverse relationship between South-South trade and the strength or weakness of the currency.


Figure 1a (left)  |  Real-USD and Zloty-USD Last Price Monthly versus monthly USDm monthly value of South-South trade, June 2001-Feb 2014

Figure 1b (right)  |  INR-USD versus monthly USDm monthly value of South-South trade, June 2001-Feb 2014

Source  |  DeltaMetrics 2014, Bloomberg

The post-crisis recovery in trade continued until the beginning of Q2 2011 and the emerging currencies 
continued to strengthen. Since then, however, South-South trade has been volatile but with flat trend growth. The Real and the Rupee have deteriorated against the US Dollar. The Zloty has strengthened slightly, but this is because Poland is integrated into European supply chains, especially through Germany.

This points to two dangers: first, the fact that China’s trade is volatile and not increasing at the rate that it was between 2010 and the middle of 2011, meaning that South-South trade is relatively unpredictable and not as buoyant as it was either pre- or post-crisis. This will put downward pressure on prices in China and in other emerging economies. As prices fall, servicing debt becomes more difficult.

Second, the fact that emerging market currencies (here proxied by the Rupee and the Real in particular) are associated with South-South trade growth presents a further challenge for US denominated debt. Emerging market trade is slowing and the pressure on prices is downward. This puts downward pressure on the value of the currencies too, making dollar denominated debt more expensive – further exacerbating the debt challenges caused by any potential deflation.

Figure 2 looks at the problem on a global scale and shows how deflation may already be working its way into trade values and into lower metal prices.



Figure 2  |  World Trade (USDm) versus Copper, Steel, Platinum and Gold Spot Last Price Monthly (June 2001-Feb 2014)

Source  |  DeltaMetrics 2014, Bloomberg

The first point from this chart is the clear flat-lining of trade values since March 2011 and a decline from May 2013 through to February 2014 in nominal value terms. Second, through the whole period, key metal prices are highly correlated with world trade, at above 0.79 for all metals. However, since August 2008 only Copper and Gold have been highly correlated (0.71 and 0.79 respectively) with world trade.

Both Copper and gold prices have fallen over the last 14 months but for quite different reasons. Copper is a proxy for economic development and manufacturing. In this context, its price will be strongly associated with economies that have strong manufacturing components to their trade, as illustrated in Figure 3.


Figure 3  |  Copper Spot prices against the world’s largest exporters (value of exports USDm against Copper Last Price Monthly, June 2001-Feb 2014)

Source  |  DeltaMetrics 2014


The copper price is highly correlated (at above 0.85) for all these countries’ exports. However, since August 2008, China’s exports have exhibited the weakest correlation at 0.57. This may suggest that investors are already looking at stronger growth in Europe and the US in the near term while also expecting flatter manufacturing exports from China as a reflection of over-supply in Asia.

Gold prices, in contrast, are often used as a hedge against inflation and deflation. Theoretically, where deflation is a risk, gold, as a store of value during low or negative interest rates, would rise in price, although, as Figure 4 shows, the price of gold rose up to early 2008 despite sustained Japanese deflation. But Figure 4 also shows a marked decrease in the price between January 2008 and October 2008 and then from September 2012. These were periods of marked disinflation, as opposed to deflation.


Figure 4  |  Gold Spot Last Price Monthly against Export Trade values for Germany, China, the US and Japan (June 2001-Feb 2014)

Source  |  DeltaMetrics 2014, Bloomberg

For the whole period, China, Germany, the US and Japan’s export trade has been highly correlated with Gold prices at 0.85 and 0.90 for China and Germany and 0.94 for Japan. Since the crisis, the correlation with Gold for Germany, the US and Japan has remained strong at 0.75, 0.79 and 0.86 but has weakened for China to 0.48. This is purely descriptive data but it suggests that investors have potentially been more concerned about the direct effects of deflation in developed economies until recently and have not regarded falling export prices in China as anything other than a competitive correction leading to disinflation rather
than deflation itself.

How worried to we need to be about either German or Chinese surpluses? There clearly is a deflationary trend globally manifesting itself through nominal trade values. But will this spill over into either the Eurozone or more widely across Asia?




Figure 5  |  China and Germany’s Trade Ratio (exports/imports), June 2001-Dec 2014

Source  |  DeltaMetrics 2014


If the problem in either Germany or China is the balance of exports over imports, then Figure 5 is enlightening. Germany’s trade ratio has remained remarkably static since June 2001 suggesting that it is not Germany’s surplus that is causing new problems. Similarly, China’s trade ratio has tipped in favour of imports over exports since the downturn since it has declined overall since 2001. In other words, the challenges of over-production are not new for two economies that are export-driven or for their neighbours.

However, if there is an issue, it is that investors and commentators alike may yet talk themselves into a deflationary spiral based on what is, increasingly, compelling evidence that disinflation could turn into deflation.



Figure 6  |  China and Germany’s trade balance, USDm against Gold Spot, Last Price Monthly, June 2001 – Feb 2014

Source  |  DeltaMetrics 2014, Bloomberg


Figure 6 shows a high correlation between the Gold Price and Germany and China’s trade balances. It is the most recent months, where disinflation has been present, that both the trade balances and the gold price have declines most sharply. The only other time when the simultaneous decline was as strong was between July 2008 and January 2011. But while German trade is highly correlated since this point, suggesting investors have priced in European disinflation, the decline in gold prices appears to lead the Chinese trade surplus since September 2012. In other words, investors began to worry about Asian prices then but may not see this as a real issue of deflation since recent price rises are strongly associated with geo-politics rather than economics.

In the end, trade flows in nominal value terms provide evidence that disinflation is an issue in both China and Germany with obvious effects for Asia, South-South trade and Europe. Of particular concern is the size of the debt burden of peripheral countries in Europe and Dollar-denominated debt in Asian markets. Defaults alongside downward pricing pressures could make deflation really bite and this is what markets are currently nervous about. And, as Figure 7 shows, the correlation between World Trade and the S&P 500 was positive up until August 2013 but has been negative since suggesting some form of correction is perhaps overdue.



Figure 7  |  World Trade Values (USDm) against S&P 500 Last Price Monthly, June 2001-Feb 2014

Source  |  DeltaMetrics 2014, Bloomberg

However, whether or not the dog will start to bark will depend on recovery in Europe and the US. If this proves sustainable, then it is yet possible that deflation’s bark may be worse than its bite.