India Rates Rise Is Worrying for Gold

Higher inflation and slower growth constrain investors' ability to buy gold...

ANALYSTS AND TRADERS believe rising inflation in China and India's tenth interest rate rise since March 2010 are set to dent consumer demand for gold, writes Shivom Seth at MineWeb.

"Gold and silver will surely get pummeled in the near term with signs of a stronger US Dollar and yet another rate hike in India. Investors have very little savings these days and prefer not to invest in gold,'' said Manoj Maheswari, bullion analyst at a brokerage firm here.

On Thursday, June 16, the Reserve Bank of India raised its benchmark rates by 25 basis points to 7.50%. It also hiked the reverse repo rates by 25 bps to 6.50% in a move meant to arrest surging inflation.

Weekly inflation data for June showed India's food price index had risen 8.96%, while the fuel price index climbed 12.84% in the year to June 4. What has worried economists is that inflation rose higher than expected in the month of May, leaving the common man with very little savings.

Analysts have said that though the price of gold is sensitive to several factors, a mix of international events like the crises that continue to loom over the economies of the US and Eurozone, the housing debt crisis in the US, and the second round of quantitative easing that is set to continue till the end of this month have all contributed to the volatility in Gold Price.

"Dampening expectations for global growth has led many Indian investors to scale back on stocks, forgo equities and bullion,'' said S K Sharma, senior analyst at a broking firm here. A similar situation can be witnessed in neighboring China, he added.

China's May inflation rate of 5.5% was the highest since July 2008. On Tuesday, China's central bank lifted the ratio of funds banks must set aside as reserves by a half point. Analysts have said that this action in itself may further dampen investor appetite.

"Immediately, the benchmark Shanghai Composite Index lost 0.9% to 2,705.43, while the Shenzhen Composite Index of China also fell 0.9% to 1,118.17. In India too, the policy tone indicates that its central bank has more rate hikes in the offing. This is evident from the central bank's guidance that it will persist with its anti-inflationary stance, especially since it feels that growth has not been adversely affected so far,'' said Sharma.

Analysts maintain that the high cost of living in India is also playing spoilsport and will affect the demand for gold. Triggered by rising food and commodity prices and higher fuel costs, the Indian diaspora would prefer to defer purchases of gold and silver items.

Analysts have said that India could see some slowdown in capital inflows going forward as advanced economies exit from the easy monetary policy, making it tougher to fund a widening current account deficit. If oil and commodity prices remain elevated, as is expected, the current account deficit will remain significant, they said.

Incidentally, Chinese inflation which climbed to 5.5% in May, has topped the government's 4% target. Inflation is expected to reach 6% this month, according to several bankers. Traders have also pointed to the fact that gold futures were up for the first time in three days on Tuesday, June 14, after official data showed that Chinese inflation accelerated in May.

"Credit has got much tighter, unemployment has increased and overall credit worthiness has declined. This has kept money on the sidelines of the economy. At this time, investors are averse to putting money on gold. Though investors often Buy Gold and silver as refuges against economic uncertainty and as a hedge against inflation, sometimes it doesn't work that way,'' said S Goswami, bullion investor and trader.

Generally though, gold is seen as the ultimate hedge against inflation. While the Dollar may lose value, depending on the fortunes of the economy, gold historically goes up in value when inflation gathers pace. Weakness in the Dollar is set to contribute to gold's strength. Gold prices often move inversely to the US Dollar, as gold becomes less expensive for buyers using other currencies.

India's trade deficit has risen 67% in May from a month ago to $15 billion, the highest since September 2008. Exports in May provisionally rose an annual 56.9% to $25.9 billion, while imports for the month rose 54.1% to $40.9 billion.

"The slackening of global recovery, high oil and commodity prices, deceleration in domestic industrial growth, uncertainty about continuation of strong growth in the agricultural sector and the impact of the monetary policy pose downside risks to India's GDP growth during 2011-12. Investors will not want to invest on precious metals,'' said Shekar Kandhar, bullion analyst with a foreign bank.

Though India's economy expanded 8.5% in the fiscal year ended March, the central bank has forecast growth to moderate to about 8% in the current fiscal year.

Despite this, the country's growth story remains intact. But, the negative headlines have nourished anxieties that weak governance will undermine India's success in the short-term. 

During May-June, India's stock market corrected amid a challenging macroeconomic environment and volatility in foreign investment outflows. The Bombay Stock Exchange declined by 2.56% in Rupee terms, as Foreign Institutional Investment outflows jumped to $ 1.48 billion, the highest monthly outflow year-to-date.

Buy Gold through BullionVault and get direct access to live markets 24 hours a day...