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This Little Event Triggered A Storm In The Gold Markets

Thursday, April 24, 2014 - 12:00pm

You might call it the "golden butterfly effect."

That, of course, is a reference to the famous example of how complex systems work, wherein a butterfly flapping its wings could set off a chain of events that eventually results in a major storm on the other side of the world.

The point is that even small and seemingly unimportant events can end up having major consequences -- such as what's been going on in the gold market of late.

By now, the story on bullion is familiar to commodities investors. Gold prices have fallen rapidly and substantially over the past year.

Starting in April 2013, the price of gold began to fall. By May 2013, bullion had dipped below $1,200 -- a 25% drop in a matter of weeks.

What happened? What caused gold to see such a sudden and deep loss of value?

Some speculate that the stabilization of global markets reduced demand for gold as a safe-haven investment. Others argue that there was collaborative manipulation of the gold price by the central banks of the world.

But some recent data -- from a relatively obscure part of the globe -- have led me to a different conclusion, one that powerfully and simply explains what happened to gold.

As readers of my premium commodities newsletter Scarcity & Real Wealth already know, the gold market moves fast. And those who recognize this development early on stand to benefit immensely from the spike in prices we're likely to see.

As with the original metaphor, the trail of the Golden Butterfly starts halfway around the world from North American markets, in India.

A little over a year ago, something happened there. It was an event that seemed fairly insignificant in global context, but like the flap of butterfly wings, it may have set the wheels in motion for bullion's sudden fall.

The Indian rupee depreciated against the U.S. dollar.

For years, the Indian rupee had been relatively stable against the U.S. dollar, but in mid-2011 that stability was about to be broken.

Around that time, investors began to lose confidence in emerging markets and started pulling money out. This meant foreign investment soon retreated back to the U.S. dollar, putting downward pressure on the value of these currencies.

The rupee was hit particularly hard. By mid-2012, its value against the dollar had plunged by nearly 20%. You can see in the chart below the notable strengthening in the dollar relative to the rupee since 2011.

This fall in the value of the rupee made purchases of critical imports like coal and oil notably more expensive -- and it widened the country's current account deficit.

Authorities set out to stop the bleeding. And one of the places they focused on was the gold market.

India is one of the largest gold-consuming nations in the world. Last year, Indian buyers snapped up 975 metric tons of gold -- putting the country firmly in the number two spot for global demand, just behind China. As you can see from the chart below, Indian gold consumption is greater than that of Europe and the Middle East combined.

The majority of the gold bought by consumers in India is imported. This put even more pressure on the country's current account deficit, which could push the rupee to even lower levels.

So officials came up with a plan to curb imports of gold to prevent money from flowing out of India. They introduced higher tariffs on gold coming into the country. And they also encouraged banks to reduce their intake of foreign bullion.

This had an immediate effect on demand.

Since the introduction of the import restrictions, flows of gold into India have slowed to a trickle. In the fourth quarter of 2013, buyers purchased just 51 metric tons of gold, compared to the 300 metric tons of gold that was purchased in just 60 days leading up to the implementation of the new tariffs. That's a huge drop in demand.

Some of that decrease is due to lower gold prices. But most of the change is simply a result of less gold entering the country -- exactly as Indian officials had planned.

All That Might Be About to Change
The thing that's most interesting about India's retreat from the global gold market is how it coincides with movements in bullion prices.

You can see in the chart below that India's move to curb gold imports coincide almost exactly with gold's declining price. The first notable plunge came in April 2013, just a few weeks before the anti-gold rule changes came into force. The slide continued once higher tariffs started in May.

The timing suggests that changes in India's buying may have been largely responsible for the 25% loss of value in bullion.

This is also consistent with the price action over the past year. Remember how I said that India's gold demand during the fourth quarter of 2013 was some of the lowest in years? The price chart shows a notable decline in prices during that exact period.

It thus appears that India's gold buying (or lack of it) has become one of the dominant forces driving prices in this market. And that could mean a major opportunity in the making.

This month, news began to emerge that I have not seen reported in the mainstream financial press at all. But it may be the most important development for the gold market in years.

Word on the street in Mumbai is that Indian officials are looking at relaxing gold import rules.

In fact, the governor of the Reserve Bank of India recently hinted that gold import restrictions will be reduced or dropped entirely.

Remember the notable effect that India's flight from the market had on gold prices a year ago? I believe the return of gold buyers there could have an equally quick and notable result in terms of pushing gold prices higher.

And it could happen soon.

I say that because India's monetary officials are under somewhat of a deadline to act. And that deadline is May 2.

That's the date this year for the Hindu holy day of Akshaya Tritiya, a day considered one of the most auspicious of all holidays. Many celebrate by buying gold.

Purchasing gold jewelry and bullion on Akshaya Tritiya has been a tradition for a long time. Undoubtedly there's immense pressure on officials to lower gold tariffs in time for this event.

In fact, there have been numerous recent stories of smugglers being caught bringing in illegal gold to meet demand. One smuggler even tried to flush his gold bricks down an airplane toilet, fearing he would be caught with the goods.

With such a push building for increased gold purchases, I wouldn't be surprised to see India return to more import-friendly policies within the next couple of weeks.

If that happens, watch out. The effect on bullion prices could be quick and significant. This would be great for holders of physical gold -- but as my Scarcity & Real Wealth readers know, it will likely be even better for owners of quality gold stocks.

P.S. -- This recent news from India isn't the only reason I'm excited for the future of gold. In fact, it's only a fraction of the story. It turns out that China -- the largest consumer of gold -- has been stockpiling the precious metal at unprecedented rates... and it's not being reported. That's why I've put together a special report detailing exactly how my boots-on-the-ground approach can give early investors a jump on gold stocks that could return up to 218% in the next 12 months. You can learn the details of these opportunities by following this link.

Dave Forest does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.