Why India Will Keep Buying Gold

India's government is fighting thousands of years of tradition...

LESS THAN 1% of the world's gold is mined in India, writes Douglas French for Bill Bonner's Daily Reckoning.

The rest comes from somewhere else. Still, India can't get enough. It is the largest consumer of gold in the world, buying nearly a third of production in recent years. Some estimates say that 10% of all gold is held in India.

Indians save roughly 30% of their income, as opposed Americans, who save 5%. Plus, Indians are getting richer all the time. Once a very poor country, the rich and middle classes now outnumber the poor in this nation of 1.2 billion. 

The country has the sixth-largest economy in the world.

If people are left alone, high gold demand going forward is a lock.

Yet India's policymakers are disturbed. Yellow metal purchases have widened the country's current account deficit to 5.4% of GDP.

The Reserve Bank of India (RBI) has produced a report indicating "a need to moderate gold import, as the insatiable appetite for the yellow metal could jeopardize economic stability".

So the Indian government and its central bank are trying to get people to buy other financial products. 

"There is a need for banks to introduce new gold-backed financial products that may reduce or postpone the demand for gold imports," the RBI report said.

The central banking wonks are thinking that if the Indian public can be made aware of financial paper instruments such as gold accumulation plans, gold pensions, and gold-linked accounts, it will drop its obsession with the barbarous relic.

A leading Indian trade body said country's gold imports could fall to just 550 tonnes next year, little more than half of the peak of 967 tonnes in 2011.

Well, good luck with that. The people of India have cultural, historical, and traditional reasons to buy gold. They consider it the most valuable asset there is. Indians want to own gold like Americans want to own houses.

Ganesh Rathnam related a story that explains India's gold obsession. When his father, a pediatric surgeon, wanted to buy land to build a new clinic, he mortgaged his wife's jewelry to raise the purchase money.

"Similarly, millions of people in India have capitalized their businesses or farms, or secured their basic necessities after severe business reversals, by pledging their gold jewelry," he writes.

Last year, 60 Minutes ran a segment, "India's Love Affair With Gold." Correspondent Byron Pitts was stunned that the Indian people consider gold purchases as savings. 

Indians do not believe that they are spending when they buy gold, but, instead, that they are putting their money in a savings account. 

Oftentimes, a savings account that is worn around the neck or wrist.

There are 22 official languages in India, so there are 22 ways to say gold. And nothing says gold in India like a wedding. Half the country's gold purchases are for wedding jewelry. It is said in India, "If there is no gold, there will be no wedding." 

Gold must be widely owned, because there are 10 million weddings a year. Some are extravagant affairs that last for days on end.

Parents start accumulating gold for their daughter's wedding day as soon as she is born. This gold represents some financial security that the bride brings to the union. 

It also gives the bride some economic status in the relationship. And while it provides security, gold is hardly ever sold, but instead passed on for generations. But it can be mortgaged if needed.

Gold is a symbol of purity and is considered sacred, but also signals prosperity. Jewelry does the talking and gold speaks loud and clear. Not for vanity's sake, however, as gold is considered honorable. You can't have a family without gold. The yellow metal is a way of life.

A gold analyst told Pitts that it's impossible to explain to an Indian that gold might go down in price. Indian society has been around a few thousand years. 

People learn a thing or two in that time. First, save money for the unexpected. Second, don't trust banks. And third, don't trust the government's paper money. They're not interested in mutual funds and other financial products.

Even the poorest people in India buy gold, saving a little each week to buy a gram at a time.

"Gold has a rich tradition in the Hindu epics, the Ramayana and the Mahabharata," writes Rathnam. 

"It was associated with the pomp and splendor of the gods and kings who appear in these mythological stories."

He explains that silver coins were widely used in India during the reign of the Mauryas circa 250 B.C., and the first gold coins were issued widely during the Gupta dynasty around A.D. 250. 

India has been a collection of kingdoms and fiefdoms often at odds. Gold was easily hidden, "enabling ordinary citizens to avoid being looted by marauding armies," Rathnam writes. The kings changed, as did the coins, and thus gold became the preferred medium of exchange and store of wealth.

After India's foreign reserves were decimated by its war with China, the government instituted the Gold Control Act of 1962, which forbade private ownership of gold bullion and forced all bullion to be turned into jewelry.

In the 1970s, tax rates reached 95%, and the Indian currency, the rupee, plunged in value. Indians took to not only hiding assets from the taxman, but also trying to survive inflation. 

Gold and real estate were the chosen vehicles. Rathnam also points out that bank deposit insurance in India is the equivalent of just over $2,000, making bank deposits a risky asset.

But finance minister Chidambaram Palaniappan doesn't care about tradition or prudence. He sees gold purchases as consumption that has contributed $64 billion to the country's widening current account deficit.

While the average Indian loves gold, the country's bureaucrats do not. The numbers tell the story. The Indian government owns only 360 metric tons, while private gold holdings are estimated to be 15,000 metric tons. It is, indeed, the people's money.

An Indian gold expert told 60 Minutes' Pitts, "If India sneezes, the gold industry will catch a cold."

The government is trying to make it sneeze, but the people are wise. Thousands of years of tradition will likely keep the gold market healthy, no matter how much the politicians hate it.