When you think of gold you tend to think of it as an asset to protect against financial, economic and geopolitical Armageddon. Unbeknownst to many gold investors, one of the largest drivers of gold demand and the overall price level are Indian households. Demand depends on three key factors: demand for crop insurance, the Diwali shopping season and end of year wedding parties.
Around one-third of Indian gold demand comes from rural farmers, who have traditionally spent a percentage of their crop revenue on gold. The precious metal is held as a type of insurance and sold in times of dire need.
This insurance becomes essential when you start to realise how crucial the monsoon season is to India’s agriculture sector. During an average year, the Indian subcontinent can receive close to 80% of its total annual precipitation during the summer monsoon season.
When the rains fails to materialise (as we saw in 2014 and 2015) farmers suffer, gold purchasing drops or even reverses as farmers offload some or all of their gold (insurance) to pay for food and other necessities.
Diwali (also known as the Festival of Lights) is a major shopping season in late October or early November. Families typically splash out on gold jewellery. Merchants and jewellers purchase gold during the third quarter of the year in anticipation of a surge in demand .
Finally, Indian weddings are held in the fourth quarter (after mid-November more specifically) due to Hindu tradition. Although there is some movement towards other precious metals, gold remains the dominant metal of choice for a bride to be. As in other cultures, the wedding ring acts as a form of financial security for the bride.
With so much gold buying activity concentrated in such a short time period, recent economic activity and expectations for the future matter a great deal. And the factor that matters most is the monsoon season. A bad monsoon results in a poor harvest requiring a farmer to buy less gold or even sell some. A bad monsoon reduces the spare cash to treat their family to gold jewellery. A bad monsoon reduces the likelihood of weddings taking place and the potential money available for their guests to spend as a gift.
According to the Indian Meteorological Department (IMD), August 2020 saw the country receive 25% more rain than average (the highest August rainfall since 1976). This comes after recording 10% less rainfall than average in July. The IMD forecast that the monsoon may slow down in September.
Despite being hit badly by coronavirus, plentiful rain helped prompt Indian crop plantings to hit record levels. All things considered its been a good monsoon. With the rural economy accounting for 45% of India’s GDP that should be very positive for Indian gold demand.
It’s not necessarily a one-way bet. Long term holders of gold may be tempted to sell gold trinkets and coins in order to profit from the surge in gold prices that has taken the yellow metal to record levels. In past periods in which gold prices have surged, holders of gold have taken the opportunity to pocket some of the rise in prices before buying when the price fell back.
The decision to sell or not, will as ever be determined by expectations over the future value of gold and the need to hold it as an insurance. However, it could be argued that things are different this time. Gold’s role in the Indian economy and financial system has changed since the past gold peak in 2011-12.
First, young consumers have an increasing range of products to purchase or to receive other than gold jewellery. That might mean they are less willing to pay recent ‘high’ prices for gold and gold jewellery once Diwali and the wedding seasons approach.
Second, Indian consumers have been encouraged to open bank accounts. This might potentially reduce the opportunity cost of holding physical gold versus the convenience of a bank account.
Both of those factors are negative for gold demand. The third factor I believe will be an overwhelmingly positive driver of gold demand.
And so third and finally, gold can increasingly be used as collateral for relatively inexpensive loans. So instead of having to sell gold to release funds, farmers and other gold holders can borrow using their gold as security. This reduces the incentive to offload their gold to release cash.
Cash strapped families would often pawn their gold to informal lenders. With interest rates ranging from 25-50% this was viewed as a last recourse by many. The sky high rates would often cripple families not able to pay back the loan resulting in them forgoing their gold.
Now banks and other financial institutions are rushing in to lend money secured on the $1.5 trillion of gold owned by Indian households. The extra competition should result in much lower interest rates and provide an additional reason for households not to part with their gold.
Gold is intrinsic to the Indian economy and its culture and has been so for hundreds of years. That relationship is unlikely to disappear in the period since the last boom in gold prices a decade ago. Indeed, gold’s role as security is arguably becoming more important to the Indian economy than ever.
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