Many finance experts and market analysts have been scratching their heads in the days following the U.S. presidential election. As quickly as gold prices rose, they fell even further than where they started the week. Rather than marching toward $1,400/oz as many had predicted, gold is now threatening to fall to $1,200/oz. Why?

PM Narendra Modi [CC BY-SA 2.0] via Wikimedia Commons

One explanation focuses on one of the largest sources of gold demand in the world, India. Changes to the country’s currency regime supported by Prime Minister Narendra Modi have caused a cash scramble, making it harder to buy gold.

Demonetization

As a measure to cut down on the use of cash in the black market, the Modi government made a surprise announcement that 500- and 1,000-rupee banknotes would be demonetized. (For reference, these notes are equivalent to $7.38 and $14.75, respectively. They were still the country’s highest-denomination banknotes, however.)

Although the state is issuing new 500 Rs and 2,000 Rs rupees notes, the old cash is useless in everyday transactions. Indians will have until December 30th to exchange or deposit their old notes. The new paper money will still feature the image of national icon Mahatma Gandhi but will use different colors and have other new features.

Therein lies the problem: Most rural Indians don’t deal with banks or even have a bank account, choosing instead to store their wealth in gold and cash. This is part of what has contributed to the country’s strong cultural affinity to gold jewelry.

Copyright: snowwhiteimages / 123RF Stock Photo

This policy change has led to long lines at automatic teller machines as well as daily and weekly withdrawal limits that amount to about $35 per day. In order to alleviate the backlog and assist cash-strapped citizens, vans and buses with mobile ATMs have been deployed in parts of the country. Overall, the measure has been extremely unpopular, causing social unrest and making it more difficult for consumers to complete everyday purchases.

That includes gold.

Copyright: anandkrish16 / 123RF Stock Photo

Amid the currency chaos that is disrupting normal business in India, gold-buying has been severely limited since Modi implemented the demonetization scheme. In order to avoid extra taxes and fees related to the government’s tactics to curb gold imports, most gold purchases are settled in cash. Not only did the 500 Rs and 1,000 Rs notes make up about 20% of circulating cash in India, but it is also estimated that “black money” could account for as much as a quarter of the Indian economy.

Considering Modi announced this surprise policy on November 8th, around the same time as Election Night in the U.S., the plunge in gold prices correlates more closely with events in India than Donald Trump becoming the president-elect. Though it is probably not the only cause, it is clearly a major contributing factor.

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.

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