India accounts for a sizable share of the global gold market. A well established supply chain has evolved over the years to cater to this large market which is dispersed across the length and breadth of the country. Most of the gold is imported in the country largely through banks and nominated agencies authorised by RBI to import gold in India. Then we have the bullion dealers who act as wholesalers who buy from bank and onward lend it to retailers, jewellers etc.
Although some discrepancies do exists at the retail gold market with different premiums, making charges, mark ups charged to the end user the wholesale market is highly efficient with tighter bid ask spreads and thin margins.
But things are fast changing. We are going back to the pre reform days i.e the period prior to the 1990s when it was a highly restricted market. With government introducing a variety of measures including raising duties from close to 1% to 10% and then restricting the supply by mandating an export obligation for all the gold imported in the country.
The resulting shortage of gold in the market has created an impending supply shortage leading to gold trading at a premium over and above the landed cost. This means buyers have to shell out more for their gold purchases as compared to what they would have paid had these gold restrictive policies not been introduced. Also, this premium on account of a limited potential supply tends to vary depending on the acuteness of demand and supply.
Premiums tend to increase during times of increased demand especially during festivities and occasions when traditional / cultural demand is high. Reduced imports have resulted in lower volumes for the industry making the supply chain more opportunistic who are seeking to enhance margins when the demand is high and buyers desperate. It’s the demand supply imbalance and price becomes the balancing factor. With limited supplies, they will sell to the ones willing to bid at a premium.
As seen in the chart below, the price differential paid by the buyer in India had significantly narrowed down since the onset of reforms in the 1990s until they have been reversed over the past two years by the government in order to control the burgeoning current account deficit. The differential paid by the buyer of gold in India is largely composed of Import duty which is 10% + VAT which is 1% + the premium prevailing at that point of time. Since the onset of quasi supply restrictions, the premiums have ranged between 2-12% approximately.
The Spread as shown above looks low as seen from a long term perspective. But, as seen over the last few years, it really reflects how an efficient market has turned distorted. As seen in the chart below, the spread prevailing in India which includes duties, taxes and any premium was very low until 2011. However, as governments started imposing tariffs and policies, it has truly been a distorted market with buyers having to bear the brunt in form of high prices.
The festival of Akshaya Tritiya which is the second largest gold buying day in India is just around the corner. With the demand expected to increase, so would the premiums on gold likely increase. So would the supply chain squeeze this opportunity to make a quick buck. As a buyer, be aware of what you are paying and how much you are comfortable paying. With you spilling an extra 11% in duties and taxes plus the premiums which may be high on account of increase in demand and limited potential supply on account of restrictive policies in place. As a buyer, you need to understand that these distortions mean that Gold prices need to move up that much before you just break even.
We understand the emotions to buy gold on this auspicious day. If indeed compulsive, adjust your quantity based on the premiums you are comfortable paying.