India stampedes into bullion

December 01, 2016

Pat Heller

Jewelry stores in India were besieged with customers seeking to spend 500- and 1,000-rupee notes to buy physical gold bullion and jewelry.

India’s prime minister Narendra Modi announced on live television Nov. 8 that the government would immediately begin withdrawing the 500- and 1,000-rupee notes from circulation. Their face values are roughly $7.50 and $15 in U.S. funds, respectively.

This was part of an explicit government crackdown on corruption and illegal cash holdings. What was not stated is that there are so many counterfeit notes of these denominations in circulation, supposedly mostly coming from Pakistan, that the government made this move to also combat that problem.

Technically, it became immediately illegal to spend such notes, which made up about 86 percent of circulating currency in that country. The exceptions were that airports, railway stations and hospitals would accept such notes through Nov. 11 and that people could exchange these notes for other denominations at their banks through Dec. 30. It was also immediately illegal to transport any such notes outside the country back into India.

Because of the ability to convert the notes at banks on a delayed basis, jewelry stores in India were quickly besieged with customers seeking to spend these notes buying physical gold bullion and jewelry. Demand for gold was so strong that many stores were completely sold out and had to close by Nov. 11. Customers were paying prices up to 65 percent above what jewelers were charging before the announcement.

There were two reasons for the surge in demand for gold by people wanting to unload these denominations of currency. The first was that the government suspects many citizens were hiding their wealth in cash to avoid paying taxes and wanted to convert to another private asset. Depositing or exchanging large quantities of these notes at a bank might attract unwanted scrutiny. Second, the government’s tinkering with the currency also increased the fear that the rupee might suddenly be devalued.

For the previous year or two the Indian government had been trying to encourage citizens to decrease their demand for physical gold and silver. Massive gold imports (India is the world’s second largest gold consuming nation after China) had pushed the central bank into a deficit on international payments. To reduce this problem, the Reserve Bank of India created paper gold “savings accounts.” Even with financial incentives being offered, this product pretty much flopped.

This sudden announcement of the recall of the 500- and 1,000-rupee notes caught the nation’s banks and financial companies without sufficient alternative denominations. To try to manage this problem, the government initially limited conversions by banks to 2,000 rupees per day per person through ATMs or 4,000 per day if done in person at a bank counter. A weekly conversion limit of 20,000 rupees was set. As you might suspect, this sudden recall resulted in long lines at banks.

The situation has gotten much worse since. To try to reduce long lines at banks, the daily limits at ATMs and bank counters were raised to 2,500 and 4,500 rupees, respectively, and the weekly cap was upped to 24,000 rupees.

An even greater problem quickly arose. The nation’s truck drivers paid almost all of their operating expenses in cash. They mostly did not have credit cards. When their cash ran out paying for food, fuel and road tolls, about half the country’s trucks were simply parked. This disrupted deliveries of raw material to factories and merchandise to retail merchants. The government quickly and temporarily suspended toll-road fees, but it was too little, too late.

India’s government was not finished creating problems. On November 11, excise tax authorities sent notices to 600 jewelers across the country asking for details about their inventories and their transactions from Nov. 7-10. Merchants were asked to provide details about the quantity and value of gold purchased from customers and the quantity and price of gold sold to other customers. The government reserved the option to then request customer details on any larger transactions.

Once the news was disseminated that the tax authorities might be checking on private citizens’ gold purchases, demand for this metal almost totally stopped. This development heightened fears that the government might try some kind of gold redemption or confiscation program. Such concerns were becoming so rampant that last week the government went out of its way to deny that any exchange or confiscation program would happen.

Throughout this fiasco, the government’s credibility has suffered. Such a reassurance that private gold holdings were safe did not have the intended effect. Instead, what has happened is that people are now focusing on buying physical silver. Since India is also one of the world’s largest silver consuming nations, I anticipate that this bump in demand will lead to significantly higher silver prices by the end of January.

There are almost daily updates on India’s currency message. Before markets opened in the country on Tuesday this week, the government announced that foreign travelers arriving in the nation could exchange up to 5,000 rupees of these notes (worth less than $75 U.S.), on a one-time basis with no questions asked, right at the airport. Further, people with accounts at an Indian bank are now allowed to convert up to 250,000 rupees on a one-time basis with no questions asked.

To recap, thus far this sudden government move has almost totally backfired because it has:

• deprived many citizens of the ability to pay for things
• inflicted financial losses on those holding such notes outside the nation’s borders
• disrupted domestic commerce
• created even more distrust of the government of India, and
• created even more demand for physical precious metals at a time when the government wanted to reduce such demand

By the time you read this, even more problems will doubtless have erupted. If any other government is considering a similar action, it should use what has happened in India as a case study of what not to do.

The surge in demand for physical silver in India is just one of three factors that could spark much higher prices by the end of January. As I discussed in my Nov. 18 column (posted at http://www.numismaticnews.net/article/buy-gold-price-dip), there is a strong prospect of another surge in demand for physical silver once a sharia-law compliant standard of how Muslims can own physical gold and silver as an investment comes out. This is expected before the end of this year.

Another potential boost in demand for physical precious metals could happen after Italy’s constitutional referendum vote coming up Dec. 4. If approved, this would be the most extensive constitutional change in the past century. Although the referendum addresses the reassignment of governmental powers, one fear is that this will lead to Italy opting to discontinue using the euro for its monetary system. If all of this happens, expect the value of all paper currencies to take a hit and for precious metals to shine. The polls since April show this to be a tight contest, with the opposition slightly ahead in the early November surveys.

Even though gold and silver prices performed poorly in the month of November, they are still up significantly over the course of 2016. How well? The Dow Jones Industrial Average at the close on Nov. 28 was near its all-time high. Still, that was only 9.6 percent higher year to date. In contrast, gold was up 12.3 percent and silver rose 20.2 percent over the same time period.

Mint switching over to 2017 bullion

The United States Mint normally starts taking orders and delivering the new year’s gold and silver Eagle and gold Buffalo bullion-priced coins by the second week of January. In order to have sufficient inventory by then, production of these coins has to start late the year before.

We have heard from wholesale suppliers that the U.S. Mint has already stopped striking the 2016-dated silver Eagles, although some inventories were still on hand. We were also told that the Mint had sold out of the tenth-ounce gold American Eagles, with no indications either way on whether any more would be struck.

As a consequence, the premiums above metal value for both of these coins have started to rise. If you are looking to purchase some for gifts for others or for yourself, you probably should buy them sooner rather than risk higher premiums in the coming weeks. Also expect the same supply exhaustion to happen with the other sizes of gold American Eagles and the gold Buffaloes.

Don’t go chasing these coins thinking that, because of tightening supplies, they will be low mintage rarities. Even though the 2016 silver Eagle didn’t set an all-time mintage record, it will still be among the top five. This end-of-year gap in supplies is almost a standard annual occurrence. Don’t be spooked into chasing 2016-dated coins at premiums well above typical levels, especially since you will be able to purchase the 2017-dated coins in January at or near standard premiums.