During festivals such as Diwali, the demand for gold in India increases because it is considered auspicious. Traditionally, people invested in physical gold bars, coins and jewelry. However, after the introduction of the gold ETF, the option to invest in gold also became popular. There was a huge growth in the assets under management for gold ETFs compared with ETFs in other asset classes.
Investors purchased gold as a way to preserve value and hedge against inflation and recession. Gold was in a bull run until the year 2012, and the average asset under management in gold ETFs peaked at INR 119 billion in Q1 2013, but since then it has declined.
Exhibit 1: Average Assets in Gold ETF’s in India
Source: Association of Mutual Funds of India. Data as of Sept. 30, 2014
The Federal Reserve introduced tapering after confidence of the sustained improvement in the U.S. economy was restored. Tapering led to the strengthening of the U.S. dollar, which exerted downward pressure on the price of gold. The import restrictions in India, the second largest consumer of gold, exacerbated the situation.
The Indian government and the Reserve Bank of India introduced a series of measures in 2013 in an effort to curb the import of gold and improve the current account balance of payments of India. The introduction of the 80:20 rule, under which 20% of the imports must be re-exported, and an increase in import tariffs has reduced the amount of gold imported, and it has increased gold’s premium in the local market compared with that of the global market.