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Why are Gold prices increasing in India?

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On July 27, 2020, gold prices hit an all-time high and reached Rs. 52,000 per 10 grams. From being priced at Rs. 35,660 on August 1, 2019, gold prices have risen steadily through the year. In fact, apart from a minor downward movement in March 2020, when the coronavirus pandemic first hit, gold has not faltered from its upward trend.

During to COVID-19, the unemployment rate has increased by more than 20% in India alone. Billions of people across the world have lost their jobs in the span of a few months and are struggling to make ends meet. The global financial markets too, are echoing the uncertainties and vicissitudes in the hearts of investors. Apart from a few sectors which are benefitting from the “new normal”, most industries are feeling the effects of the coronavirus led lockdown.

Why, then, are gold prices increasing so much? If there is no money in the hands of people, then who is buying this gold? Where is the demand coming from?

GOLD AS AN INVESTMENT

Throughout history, precious metals like gold and silver have been used as forms of investment. In India, for instance, gold is considered to be one of the most auspicious forms of gifting to mark special occasions. According to the figures from the Confederation of All India Traders (CAIT), about 6,000 kg of gold was sold on Dhanteras, 2019.

Here, it is important to distinguish the purchase of gold for consumption purposes and for investment purposes. 

Consumption of gold takes the form of gold jewellery. This demand is the highest in places like India and China. In the last decade, the consumption of gold jewellery made up about half of the total gold demand. Most recently, however, the consumption of gold has decreased steadily. 

Following the peak in jewellery consumption during the slump in gold prices in 2013, demand for gold jewellery has declined.

gold prices high

Most of the gold demand originating from North America and Europe are based on investment purposes.

As an investment, the popularity of gold is based on its liquidity and the fact that it provides long term protection from inflationary pressure in the economy. Apart from that, gold provides diversification from conventional investment avenues. In fact, analysts recommend that retail investors allot 5% of their portfolio to alternative investments such as gold. Gold investments have been gaining traction over the past few years.

Investment in gold can take several forms.

  1. Physical gold

Physical gold does not refer to jewellery; it refers to the physical purchase of gold bars, gold coins, etc, for investment purposes. Because the value of gold does not decline or depreciate much, it is ideal to hold ones money in the form of gold rather than in currency. Here, the main challenges faced are in terms of storage and safety.

  1. Sovereign gold bonds

These bonds are issued by the government of India and are based on gold. SGBs offer a substitute to holding physical gold. Here, at the time of purchasing the bond, the investor has to pay the market rate of gold for the specific amount. At the time of maturity, the amount paid out also depends on the going market rate of gold along with periodic interest. SGBs can be held for a period of 8 years, and they offer an average interest rate of 2.5%.

  1. Gold exchange-traded funds

A gold ETF is a fund that invests in physical gold. Almost 90% of the entire fund amount is held in that form, while the remaining 10% is held in other debt instruments. These funds are generally transacted in the stock markets, and the units are held in demat accounts.

  1. Gold mutual funds

Gold mutual funds are those which invest in gold ETFs. It is very similar to the above option. The only difference is the method of investment.

INVESTMENT DURING CRISIS

Investment during the crisis is based on a simple premise — keep your money safe from the volatilities of the financial markets.

Under normal circumstances, investments in the stock market and mutual funds are extremely attractive. The risk associated with these instruments is offset by a good rate of return, especially when held for longer periods. 

However, all of this changes when the circumstances change. The reason why stock markets are so popular is that they reflect the moods of the investors and the events that occur in the global financial markets. In times of crisis, this works against stock markets and mutual funds. 

For instance, right now, most industries and most companies are taking a hit owing to the rising tensions about health and safety, the disruption of global supply chains as well as the lockdown and the restriction on physical activity. 

This is why, during pandemics, it is a normal instinct to look for safe options where one can invest one’s money. In this case, gold offers a safe haven like no other. Debt instruments like bonds can offer some respite. However, due to the falling interest rates in the economy, the yield amount offered by bonds have reduced.

“Enormous liquidity push by central banks across the world is going to be underpinning fundamental support for the continuation of gold strength,” said Navneet Damani, Motilal Oswal Financial Services.

Gold has proved its mettle as one of the safest forms of investment during crisis times. As uncertainties increase in the global financial markets, gold gets more and more attractive.

INCREASING PRICE OF GOLD

For most commodities, the price is determined by the interaction of the forces of demand and supply. The equilibrium price is generally the price at which the demand for the commodity equals its supply.

Gold, however, works in a slightly different manner. 

For instance, if we consider the supply of gold, then the fact remains that gold does not get destroyed once it is consumed. This means, as more and more gold is mined every year, the supply of gold has been increasing steadily over time. The demand for gold, however, depends on the disposable income in the hands of investors, the rate of inflation, the prevailing interest rate and several other factors.

The graph below shows the increase in gold prices over the years.

gold price

Based on this premise, during times of uncertainty, much like the present coronavirus crisis, the price of gold should drop instead of rising.

Why is this not the case?

One of the primary reasons why gold prices have been rising since last year is the depreciation in the exchange value of the Indian rupee. In the past few months alone, the Indian rupee has declined by more than 7% against the US dollar. As gold is primarily imported into India, this decline in the global value of the Indian rupee means the same amount of gold will cost a greater amount.

Another reason is the fact that gold is often used, not for its individual benefits, but as a hedging instrument. 

There has been a shift in the global demand patterns for gold, especially during the COVID-19 pandemic. Even though the demand for gold has declined among retail investors in Asia, the demand for gold as an investment instrument has increased steeply in North America and Europe. 

The reason why the demand for gold has fallen in India and China is largely due to the fact the usual stream of import of physical gold has fallen, and the lockdown has restricted buyers in malls and physical stores. In India, the import of gold fell by over 90% in May. According to a forecast by Metal Forecasts Ltd, the Indian demand for gold consumption will probably fall by about 36%, while the Chinese demand is expected to fall by about 23%.

The western demand for gold is based on the search for a safe haven amidst the volatilities in the global financial markets. Here, the demand is not for physical gold, but for exchange-traded funds based on gold bullion, or gold ETFs.

gold

According to DWS Investment Management Americas Inc, “We expect the US and European investors to remain interested in gold regardless of Asian demand. If the buying pattern were to go up as well for China and India at the same time as what you see in the ETF market, then the price would have come up even further.”

According to Steve Dunn at Aberdeen Standard Investments, “The demand for gold in 2020 has been almost exclusively supported by investment demand.”

THE ROAD AHEAD

The current bull run for gold is expected to continue in the medium term, even after things have normalised. According to the Bank of America, gold prices could increase by 75% in India by 2021.

So as an investment avenue, gold is quite attractive indeed. 

However, it is important to remember that low-risk investments such as gold offer the highest returns when held for long periods of time. Apart from that, just like all other asset classes, the price of gold does not follow a linear trajectory. Following this immense bull run, there will be a period of consolidation when gold prices will fall. 

In order to obtain consistent and meaningful returns, it is important to continue investing in gold during lull periods. 

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Adrija