India Trade Requirements Limit Prospects for Gold Rally

NEW YORK (TheStreet) -- Gold prices are showing some bounce after the initial market declines that followed Federal Reserve Chairman Ben Bernanke's congressional testimony last week.

Bernanke essentially suggested that it is too early to know when the Federal Reserve will start making reductions to monetary stimulus programs. The uncertainty created by the directionless commentary generated a selloff in gold.

But the prospect of continued stimulus is ultimately bearish for the dollar and positive for gold, as the metal shows a strong history of inverse correlation relative to the U.S. currency.

The latest strength has sent gold prices through closely watched technical resistance levels at $1,330 per ounce, and this is leading to renewed speculation that this year's bear trends have bottomed out.

Short-term rallies in gold have generated highs near $1,340 per ounce, posting single-session gains of more than 3%. Daily moves of this magnitude have not been seen since June 2012, so when we look at things from a short-term perspective, it can be easy to buy into the optimism and start projecting larger runs higher.

But before we look at these moves as a new buying opportunity, we should note some of the factors that could stall any rallies that might be seen into the end of the year.

The latest example can be seen in announcements that India will place additional restrictions on gold bullion imports. India was the world's largest gold consumer last year, and these restrictions should have a bearish impact on market prices, as measures to curb demand create negative scenarios when we look at the bigger picture.

Specifically, these measures will require 20% of all imported gold lots to be made exclusively available for export, and will be applied to all forms and purities of the metal (to include everything from unrefined gold to minted coins).

Gold importers in India will be allowed to supply jewelry businesses and outlets selling to jewelers, but 20% of the initial shipment will be held in customs bonded warehouses. Those importers will not be able to make new overseas purchases until 75% of that deposit has been exported. This will likely result in declines for in-bound shipments of gold bullion for the third and fourth quarters, as these required impositions reduce incentives and limit major centers of global market demand.

The Reserve Bank of India (RBI) has chosen to implement these measures as a means for reining in the country's record current account deficit, and to help stall this year's plunge in the Indian rupee. Recent data show that the country's current account deficit has grown to $87.8 billion (or 4.8% of GDP), a factor the RBI describes as the biggest risk for India's economy. At the same time, the rupee has fallen to new record lows this month against the greenback.

Currently, India imports almost all of its gold, with consumption levels rising to almost 865 tons in 2012. But the move from the RBI has already led to massive downside revisions in expected overseas gold purchases.

Average annual gold exports in India are roughly 70 tons, but at this stage it is clear the RBI is intent on tightening supply. Earlier this year, India doubled its tax on gold imports (to 8%), and placed restrictions on financing in order to reduce the rising demand seen as gold was hitting its lows for the year. So, although these measures do not suggest moves toward an outright ban on imported gold, they clearly change the dynamics seen in local markets.

On the positive side, improving economic data in the U.S. could result in renewed expectations that the Fed will begin its quantitative easing cutbacks before the end of the year.

Improved economic activity would lead to less accommodative monetary policy settings, which would create a supportive environment for gold bulls. For those holding instruments like the SPDR Gold Trust ETF ( GLD), recent price moves are supportive as well.

A clear break of overhead resistance at 130.80 in GLD takes pressure off the downside, and suggests a range trading scenario at higher levels. But at the same time, fundamental factors are seen limiting demand prospects for the metal, and this should prevent any substantial rallies into the end of this year.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is a university teacher in international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of websites, including MarketBulls.net, Seeking Alpha, FX Street, and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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