Substitution Effect: Many Indians Shift from Gold to Silver

Social policies impacts the incentives which drives people’s action.

From Mineweb.com 

It is not just gold that caught the eye of Indian consumers celebrating Diwali. Brisk business in silver was also seen in select parts of the country.

Given the high price of gold and the Indian government’s new regulation on buying gold and tax deductions at source, the sale of silver items at jewellery shops soared to a new high.

The average Indian’s response to new regulations and higher taxes on gold buying has been to substitute gold for silver. On most occasions, the typical substitution effect has been anchored on pricing.

Given that India remains the leader in the world’s gold consumption, which materially declined from  record highs in the third quarter, then the shift to silver may have altered the balance of relative price performance between gold and silver.

The chart above gold: silver ratio depicts that gold outclassed silver from May until August. However, silver bested gold in August to September which may have reflected on India’s pre-Diwali celebrations silver buying spree. But gold, despite the recent declines, seems to have regained the leadership.

Nonetheless the above exhibits demand for gold in terms of jewelry, coin and bar by the top two world consumers, India and China, from 2009 until the second quarter (charts from AdvisorAnalysts.com).

Bottom line: The Indian government’s war on gold, which has been an attempt to camouflage the government’s profligacy, has hardly altered the traditional demand for precious metals nor have the government persuaded the average Indians to shift to non-gold assets. 

However, the shift to silver implies that India’s authorities may expand taxes and regulations to cover silver.