India prepares for shining return of gold demand

Women purchase bangles during Teej festival at Dilli Haat in New Delhi, India.
Subrata Biswas | Hindustan Times | Getty Images
Women purchase bangles during Teej festival at Dilli Haat in New Delhi, India.

Festival season is kicking off in India – a period in which gold sales traditionally spike in the world's largest consumer market for the precious metal.

This year investors are watching the key market particularly closely, following a period of muted demand when bourses have rallied and supply has been choked.

The recently elected government of Prime Minister Narendra Modi surprised industry analysts by keeping import controls unchanged in its July maiden budget, in spite of an improvement in India's trade balance.

Read MoreIndia gold smuggling rises on import curbs

At the same time, gold demand has become subdued in India, as domestic investors favor equity markets, which have risen 25 per cent in the past six months on hopes of renewed economic growth following Mr Modi's victory in May.

"We have been saying for about a year now that gold is not what it used to be," says Swapnil Pawar, business head at Karvy Capital, the asset management and investment advisory group.

Last year duties on the precious metal were raised to 10 per cent,and an "80-20" rule was introduced. The scheme allows agencies to import gold on the condition that one-fifth of the shipment is re-exported, helping balance India's trade bill.

Read MoreIndia uncovers new gold smuggling route

The moves followed a period of heavy buying as global gold prices dropped in early 2013, boosting imports and contributing to a broader currency crisis that hit India.

The latest data from the World Gold Council, a trade body, show gold investment demand was down 62 per cent year-on-year to just 94.3 tons in the first half of 2014, while jewelry demand dipped 14 per cent year-on-year to 300 tons.

Premiums – the added price traders in India are willing to pay above the global price once duties are paid – have dropped from highs of over$150 per ounce to $30 per ounce, according to Kishore Narne, commodities analyst at Motilal Oswal, a Mumbai-based brokerage.

How Modi could boost India's gold demand
How Modi could boost India's gold demand   

"Last year was an unusual year – we had a booming April and May,which are generally low," said Ashok Minawala, former chairman of the All IndiaGems and Jewelry Trade Federation. "You can't compare this year to last year at all."

The drop has been more marked in neighboring China amid a crackdown on corruption, allowing India to regain its place as the world's largest consumer market for the yellow metal in the second quarter of 2014.

Consumer demand in China was down 52 percent year-on-year in the three-month period, compared with a 39 percent fall in India.

In the coming months, the Indian market is likely to revive as sales are boosted by the festival and wedding season. Though a poor monsoon may hold back demand in rural areas, where household income is largely reliant on the agricultural sector, consumer confidence has improved following the May elections.

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Rakshit Ranjan, at Ambit Capital in Mumbai, estimates the gold industry grew between 15 and 20 per cent year-on-year in terms of sales and footfall around Onam, a celebration of harvest that took place in the south of India on Sunday.

"Demand is definitely picking up because of the festival season approaching but we don't see a big spurt in the demand," said Surendra Mehta, secretary of the India Bullion and Jewelers' Association. "Only the people who need gold are buying now, there are no investors."

Investors in India have largely been waiting to see when the government will lift import restrictions.

In a preliminary step in May, the central bank allowed certain trading houses to import gold. That sparked a rise in imports, which grew to$7 billion in the three months ended in June from $5.3 billion in the previous quarter.

Industry analysts insist the restrictions are temporary, but that New Delhi is in no hurry to initiate reforms. They expect the import restrictions to be dismantled later this year as the new rules have also sparked a rise in smuggling.

"The government so far has been decisive, so they wouldn't like to flip-flop on this policy," says PR Somasundaram, managing director for India at the World Gold Council.