Economics of Gold

@Musingsbysonalkatyal

All that Glitters is not always Good . This is true in case of Gold which happens to be the most loved commodity . How does Gold market works?

Price of gold is determined by:

  1. Supply of gold
  2. Demand for use in goods such as jewellery.
  3. Speculative demand to hedge against inflation and economic uncertainty.

Gold in India

Gold is an investment which people make for three reasons.

Transaction: Traders purchase gold for trade purposes. During festival season and marriage season gold sale goes up so they keep adequate stock to meet high demand.Precautionary: People invest in gold for precautionary reasons such as for  marriage. 

Precautionary : People Invest in gold for precautionary reasons such as marriage.

Speculative: Those who have extra wealth invest in gold for making extra gain. Some people also convert their wealth to gold to avoid high taxation.

In India , Gold is the second commodity after oil which contributes significantly to the widening of the current account deficit . India is one of the largest importers of gold globally. As much as 90% of the country’s gold demand is met from import as indigenous production of gold as a proportion of India’s total demand is very limited.

 

In fact , to reduce the high import demand for gold which resulted in bloated India’s current account deficit to a record 4.8% of gross domestic product in 2012-13, the Union government had raised the import duty on gold from 2 to 10% .

Why Gold prices were at an all time high despite Global Economic Slowdown in 2020?

Gold is a safe haven and continues to be a rare commodity as its supply has not increased significantly over the years. Thus, gold prices doesn’t fluctuate as much as equities or money markets do and it is a safe bet, even in tumultuous times.

Due to economic slowdown, high inflation, weakening currencies, a fall in stock markets and other investment options, investors are known to flock to gold to use it as a hedge against inflation. As per last Monetary policy report by RBI , gold prices move in tandem with heightened economic policy uncertainty.

Goldman Sachs said in a report that fear-driven investment demand in developed countries has contributed about 18% increase in gold prices and 8% in emerging countries.

Historically, when the global recession hit in 2008, gold prices more than doubled from 2008 to September 2011.

Over the years, experts have noted that gold has positive price elasticity, which means that as more people buy gold and demand increases, the price also increases.

Low interest rates too, increase the demand for gold. Currently central banks of most countries are cutting interest rates in a bid to put more money into the hands of people. Analysts believe that liquidity in markets always helps gold prices. Also, lower interest rates usually mean lower return on investments, thus making investors turn to gold.

However, it is pertinent to note that investors flocking to gold doesn’t necessarily mean that consumers too, are buying more gold.

Gold is considered an investment, especially in a country like India, because it a commodity whose value can be preserved over time and doesn’t deteriorate much, even physically. It is also very liquid and doesn’t carry a credit risk.  

However, the economic slowdown in the country has led to massive job losses and the coronavirus pandemic-induced lockdown restrictions have also meant smaller weddings, and jewellery stores being closed for a prolonged time. This has led to the demand for buying physical gold and gold ornaments falling in India.

These factors, along with rising prices, only means that the demand to buy gold in India is likely to be muted at least for the next year.

 

Why sudden drop in Gold Prices?

Reduction in custom duty to 7.5 per cent from 12 per cent.

Increase in investors appetite

Gold tends to drop when the rupee gains since the US dollar to buy it from abroad is lower.The appreciation of the rupee has lowered the prices of gold by ₹700-800 (per 10 gm)

 

To Conclude , India’s Obsession with Gold is actually a weakness and not a strength .

 

The above information is taken from various blogs , newspaper articles and reports.

 

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