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.

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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 014 | Asia – is slower growth the new normal?

Delta Economics’ CEO, Rebecca Harding, and new Global Vice President, Tony Nash, discuss current opportunities in Asia and the risks facing Asian markets. In particular, there is focus on the high levels of indebtedness, dangers of deflation and the need for greater competitiveness. The discussion focuses on smaller emerging Asian economies like Myanmar and argues that even though growth is rapid, it is potentially still not enough to create ‘tiger’ like growth.

 

Webcast 014 Author  |  Rebecca Harding  |  CEO

Be wary what you wish for

Why the anti-European protest movement is missing the point | As the dust settles from last week’s European Elections one thing will be quite clear: there is a real momentum behind anti-establishment and Euro-sceptic protest parties across the continent.  From the “Alternative für Deutschland” (AfD) party promoting Germany’s exit from the Euro, through the Front Nationale in France, to UKIP (UK Independence Party) advocating the UK’s exit from Europe altogether, the mistrust in established politicians is manifest.  Beyond the clear fact that voters are frustrated with national politicians, the core of Euro-sceptic sentiment is rooted in anger, indeed frustration, at the failure of Europe’s politicians to create economic security for its voters because of the tortured recovery from the financial and sovereign debt crisis, perceived threats to job security from immigration and a failure of European institutions more generally.

As Europe and the UK’s mainstream politicians start to re-calibrate their dialogue with the electorate about Europe, they would do well to focus on trade, not least because one of the two founding principles of the European Union was free trade between Member States.

Trade is central to understanding why European Union is important.  First, take the country with the most vocal advocates of European exit, the UK.  Trade with Europe was worth an estimated £301bn to the UK economy in 2013 and the Centre for European Reform (CER) estimates that some 30% of the UK’s total trade is reliant on membership with the EU.  Second, there are signs that economic conditions in Europe are improving: our forecast for European trade has risen from a negative forecast for 2014 three months ago to a flat growth forecast (-0.08%) now reflecting an improvement in underlying drivers of trade included in Delta’s model, including lower market volatility, improved GDP and greater migration which improves the downward pressure on trade of aging populations.

Europe remains a long way from sustained growth, still less rapid growth, but there are positive signs of internal rebalancing since Mario Draghi’s commitment to “do whatever it takes” to ensure that the Euro did not collapse.  But while Mr Draghi concentrated on the need for the ECB to shore up the Euro as required, the Delta Economics view is that Europe’s longer-term solutions lie in its international competitiveness represented through its external trade balance.  Figure 1 shows why we see this as the case.

 

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Figure 1 | The Value of EU 28 and Eurozone trade (USDm) versus the USD per Euro exchange rate, Lat Price Monthly, June 2001-April 2014

 

What is remarkable about the relationship between the value of Europe’s and the Eurozone’s exports and the USD-Euro currency spot price is the strength of the correlations: 0.86 NS 0.87 respectively.  In itself, this helps to explain why, even at the depth of the sovereign-debt crisis there was never a serious or sustained run on the Euro.  The currency is a trade currency and this means that it is less vulnerable to speculative volatility.

Similarly, European markets are also highly correlated with EU28 and Eurozone trade.  Taking the DAX as a proxy, the correlations are 0.76 and 0.75 respectively, as illustrated in Figure 2.

 

 

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Figure 2 | The value of EU 28 and Eurozone Exports (USDm), June 2001-Dec 2016 versus the DAX Last Price Monthly, June 2001-April 2014

 

Figure 2 shows a weaker correlation with the value of the Euro since mid 2011 for the Eurozone reflecting the sovereign debt crisis, the relationship between  EU 28 trade and the value of the Euro has remained strong, suggesting that the DAX reflects the economic fundamentals of trade to a greater extent than does, say, the FTSE 100.

Figure 3, which shows the relationship between the value of the UK’s exports to the EU and shows that, although the relationship is weaker (correlation of 0.69) the UK’s trade relationship with Europe is an important driver of market sentiment.

 

 

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Figure 3 | Value of UK exports to the EU (USDm), June 2001-Dec 2016 vs FTSE 100 Last Price Monthly, June 2001-April 2014

 

What all this suggests is that the value of the Euro and key European stock markets are highly linked with European trade generally and UK trade with Europe in particular.  The UK’s trade with Europe is even reasonably correlated with the value of the DAX at 0.64.  In other words, markets can use trade statistics as a proxy for underlying fundamentals and react accordingly. Indeed, unlike the S&P 500, which appears to have gone in the opposite direction to trade recently, European markets seem to reflect European trade quite closely.  The conclusion? That Euro-sceptic political parties do not need to worry as much as they thought about economic mismanagement if a focus on long term growth, competitiveness and trade can supersede the shorter-term focus on austerity and rebalancing over time.

During the course of the next year, however, Europe’s politicians need to worry about the consequences of a potential UK exit from Europe, following the proposed referendum should the Conservatives win the next election.  The debate will focus around the benefits to the UK of European membership and a cursory look at the correlations between the USD-Euro, Sterling-Euro and Sterling-Dollar spot prices confirms that the value that the UK extracts from its EU in currency terms is far less than the value that the EU gets from its trade with the UK.

 

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Figure 4 | Why Europe matters to the UK
Source | Delta Economics (Estimated proportion of trade dependant on EU – Centre for European Reform)

 

The correlations are much stronger between UK trade with Europe and the value of the Euro than they are for the value of Sterling, particularly against the Euro where the correlation is minimal.

This is hardly likely to have an impact on the average British voter, however, and, far from suggesting that the UK’s trade with Europe is valueless in currency terms, the fact that the correlations are weaker simply illustrates how the value of Sterling is more volatile in response to market sentiment rather than economic fundamentals.  Actually, as Figure 4 suggests, the value to the UK economy of trade with Europe is significant and, if the UK were to exit from the EU then the country would lose some £425bn, or over £6,000 per head of population in lost export trade value by 2022.

More than this: our forecasting model suggests that trade is highly correlated with skills, at some 0.98 across key countries in the European Union, the US and India.  In other words, across the developed and the emerging world, higher skills lead to more trade.  Here the UK has a gap with its European competitors: the skills component of trade is actually mildly negatively correlated with trade itself at -0.30 where it is 0.98 in other European countries.  In other words, the bulk of UK trade is currently not skills dependent and on the face of it may actually benefit from having lower skills (and hence lower costs) associated with it. Similarly innovation is only mildly positively correlated with UK trade at 0.35.

Two other countries with skills and innovation correlations like this are Brazil and China suggesting that the UK could easily lose out to lower cost nations if the bulk of its trade remains at this lower value end unless it can find cheaper ways of producing the same goods. Reports in May suggested that migration may actually have a positive effect on trade by reducing costs.

But there are two significant issues with assuming a low cost-low skill trade base for the UK is adequate. The first is one of principle: the UK should remain competitive at the higher value end of goods trade where innovation and skills are highly correlated with trade and where cost is less important. It is imperative that it increases the innovation component of its trade and recruits people with the skills to work in an innovative and international environment.  The second is one of practicality: if the UK is to find the people to take these roles, then it will have to compete with the rest of Europe as well as emerging economies like India which have high correlations of trade with skills and innovation. Accessing wider skills and innovative capacity through immigration is a central pillar of a strategy to build high-end competitive.  For example, Germany, having identified skills shortages in its productive and exporting base a decade or longer ago, now has its highest net-migration since 1993.

If Europe’s economy is improving, the benefits of trade to individual member states so great and the benefits of migration in skills and innovation terms so clear, Eurosceptics would do well to remember to be wary what they wish for.

 

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.

 

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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.

 

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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.

 

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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.

 

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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.

 

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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.

Shoring-up growth

The trade messages for the UK Chancellor’s budget | The UK Chancellor of the Exchequer, George Osborne, will stand up to make his budget speech against a backdrop of fragile growth and geo-political and economic risk. He can celebrate the fact that the UK has the fastest growth rate in the G7, that there is some evidence of businesses starting to invest and that the Purchasing Manager Index surveys for the UK have suggested that output is remaining in positive territory. But he should also be wary: the crisis in the Ukraine has unsettled markets and Russian investors in London alike; despite efforts to promote long term competitiveness and growth through exports, UK export growth has remained stubbornly low and apparently resilient to the near 25% devaluation of Sterling against the Euro and against the Dollar. And the UK’s output overall still remains below its pre-crisis levels according to the Bank of England.

Promoting trade is one of the UK government’s policy tools for securing long-term growth. UK Trade and Investment supports exporters and there is an export guarantee scheme that runs in partnership with the commercial banks to allow exporters access to trade finance when entering new markets. There is some evidence that the Trade Ratio (exports divided by imports) is improving slightly (Figure 1) but this is as much due to falling imports as it is to do with any marked improvement in exports.

 

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Figure 1 | UK Exports, Imports and Trade Ratio (X/M), June 2001-January 2014

Source | DeltaMetrics 2014

 

Two things are noticeable from this chart, which is shows trade in nominal value US dollar terms up to the end of January 2014. First, export and import trade growth has been very flat since the end of 2011 which marked the end of the post-crisis trade recovery. Second, the UK trade ratio has declined from 0.84 in June 2001 to 0.71 in January 2014, which explains the deterioration in the UK’s trade deficit over that time. The most marked declines in the ratio were pre-crisis with a trough reached in April 2007. The crisis appeared to hit exports less than imports up to the end of Q1 2011 but the ratio fell sharply between February 2011 and March 2012 caused largely by a slower decline over that period in imports relative to exports.

This does not appear to have much to with the value of Sterling, however, as Figures 2a and 2b demonstrate. Over the whole period, the value of Sterling weakened slightly against the US Dollar and the Euro but arguably insufficiently to explain the size of the change in the trade ratio.

 

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Figure 2a | UK Trade Ratio (X/M) vs GBP per USD June 2001-January 2014

Source | DeltaMetrics 2014, Bloomberg

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Figure 2b | UK Trade Ratio (X/M) vs Euro per GBP June 2001-January 2014

Source | DeltaMetrics 2014, Bloomberg

Mark Carney, who was widely expected to preside over further currency devaluation has actually seen the currency increase, but the impact appears to have been the opposite of what might have been expected: the trade ratio has improved: exports have become slightly stronger despite a strengthening currency.

As noted in a previous Trade View, the UK does seem to be A Case Apart in terms of the relationship between its trade and its currency. Some of this is because of the role UK corporates play in global supply chains and this is evidenced by our trade with China and Brazil in particular, illustrated in Figure 3.

 

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Figure 3 | UK Exports to BRICs, June 2001-January 2014 USDm

Source | DeltaMetrics 2014

 

UK automotive exports to China, Brazil and India have been increasing since June 2012. This was the date when BMW invested in its UK production facilities and this has been further supported by subsequent investment from Jaguar Land Rover as well. Alongside this, UK exports to Germany of cars have declined suggesting that the BMW investment, in particular, was deliberate policy to export the Mini from the UK to China. The UK’s automotive trade with China was less than its automotive trade with Germany up until 2013 but has now taken over as the largest partner for this sector.

There is a danger in over-promoting both exports to China and the car sector as models of how the UK is driving export-led growth, however. Figure 4 shows that UK car exports are forecast to fall over the next year and while this is part of a wider global forecast downturn, it is likely to have an impact on our trade ratio as one of three major export sectors which may struggle during 2014.

 

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Figure 4 | Exports and Forecast Export Growth for Key Products

Source | DeltaMetrics 2014

 

Gone are the days when UK Chancellors stand up to give their budget speeches with a glass of whisky in their hands, yet the Chancellor may want to celebrate the growth in exports of the UK liqueur and spirits sector. But as he ponders what to do to support UK PLC, it is clear that he needs to support UK exporters generally and productivity and competitiveness in particular as trade across the world fails to deliver growth in the way that it has done in the past.

 

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Figure 5 | UK Imports and Exports vs FTSE 100 Last Price Monthly, June 2001-January 2014

Source | DeltaMetrics 2014, Bloomberg

He may also like to ponder this: the government was elected on the basis of a promise to maintain the UK’s triple A rating by bringing down its budget deficit. While short-term financial stringency is important, the only long-term route to bring down a budget deficit is to ensure long-term growth through competitiveness and exports are a key part of this.

The service sector is growing and yet merchandise trade remains highly correlated with the FTSE 100 index, as shown in Figure 5. With exceptions at the beginning of the time series and in September 2011, trade and the FTSE have largely moved together. Financial markets are entering into Q2 2014 in a febrile state, wary of geo-politics, deflation in Europe and of Dollar denominated debt in Asia, all of which will dampen the UK trade growth forecast for this year. Against this backdrop, the UK Chancellor has no option but to support long term growth through competitiveness and trade. Measures to extend Export Finance Guarantees and promote innovation, especially in engineering and pharmaceuticals can only help to shore up aerospace, automotive and pharmaceutical exports and the role of UK exporters in global supply chains. It may even further help strengthen the UK’s equity markets.

Webcast 009 | Crouching Tiger, Hidden Dragon

Delta Economics is more negative now than it was about Asian growth. Our forecast for Asia’s export growth in 2014 has slowed from 6.1% growth last quarter to 5.3% growth now. This is part of a downward trend in Asia’s trade growth that we have been seeing take hold gradually over the past year. Holger Wessling, General Manager of DZ Bank AG (London), argues that this downward trend is due to a slow down in commodity growth and a decline in prices, negatively impacting trade finance. With the majority of trade finance centered within Asia, growth rates won’t be as positive as in previous years. Yet, with a lot of risks and a lot of potential volatility there is some light at the end of the tunnel. Growth and employment rates in North America and Europe are expected to pick up and growth in North-North trade will continue to strengthen.

Webcast 009 Author  |  Rebecca Harding  |  CEO

Webcast 005 | Europe’s re-discovered growth

Dr Rebecca Harding argues in this webcast that Europe’s long term growth will be driven by its global supply chains and it is time for policy makers to focus policy on competitiveness as this is critical to Europe’s future. Europe’s car sector exports, for example, accounts for nearly 50% of world exports and the supply chain that supports this is woven into the fabric of intra-European trade as well as its trade with emerging economies. Through its key sector supply chains, cars, pharmaceuticals and hi-tech electronic products for example, Europe’s industrial strength will help to correct internal balances as well as drive trade globally. Exports to Brazil will grow by 5.2% in 2014, to China by 7% and to India by 3% despite relatively flat growth within Europe in 2014. This will ensure that recovery is sustained.

 

Webcast 005 Author  |  Rebecca Harding  |  CEO