There is an
old Sanskrit maxim from India that says, “सर्वे गुणाः काञ्चनमाश्रयन्ति”- that means all virtues lies in the person possessing gold. This
importance of gold has been very well justified in recent years.
Since January 2000, gold has given a whopping
489 % of absolute return that means money invested in gold turned almost around
5 times in just 12 year. Gold prices rose steeply since the year 2007 onwards.
Gold, once considered as an idle
asset suddenly turned into a desirable investment option for investors!
Why Gold Rates are increasing?
There are many reasons for the
soaring of the gold prices but I shall discuss the most common of these.
(1)
Demand & Supply: As per this economic principle,
price of a commodity increases when higher demand of that commodity is not
counterbalanced by its higher supply.
Demand of gold is increasing
day by day while gold mine production is declining and there has been no
significant success in discovering new mines.
so far only 1,65,000 metric
tonne of gold has been mined.
It is evident from the graphs
that demand for jewellery and bullion has been continuously increasing. Gold
buying by various governments and central banks fall under Official purchase
category.
Simply put, gold demand is
continuously increasing and the same is not matched by the supply (mining
production and resale). There has been no significant new gold discovery . Mining
costs are also increasing. Unless there is significant new gold discovery,
demand pressure shall continue to loom exerting upward pressure on gold prices.
(2) Gold as an Investment option:
(2.1) As a Hedge Against Inflation: As per the conventional wisdom, Gold is a hedge against the inflation.
This means when inflation is raising prices of gold shall also increase and the
investor shall be benefitted. Gold has tendency to soar aggressively during
inflationary environment.
(2.2)Handsome
Returns Delivered So Far: As mentioned above, investment in gold’s price
has almost quintupled in 12 years and this is why investors are tempted to buy
gold in the hope of further appreciation.
(2.3)Unattractiveness
of Other Asset Classes: Due to global economic
turmoil and events like Europe’s sovereign debt crisis, recession in USA or
slowing Chinese economy ,other asset classes -stocks, treasuries (and similar),
became unattractive and funds ended up buying gold.
(2.4)
Enhanced Buying Spree by Global Central Banks: Across
the globe central banks of various nations are voraciously pursuing their gold
buying spree. Global economic crisis forced central banks to lose faith
in the currency like US dollar and instead they started parking considerable part of their reserves in gold in a move to reduce their reliance on US dollar denominated treasuries. Such a higher reliance on gold over other
fiat currencies stems from the intrinsic value of gold which every fiat
currency lacks making them vulnerable.
When and why central banks started
hoarding gold?
After the demise of Bretton woods system which relied on gold in the year 1971, global central banks never needed to hoard the physical gold.
But in the aftermath of 2008 financial crisis, central banks realized the importance of gold owing to its underlying intrinsic value.
(3)
Weak Dollar & US Rating
Downgrade Fear: Dollar is world’s reserve currency
and gold prices are marked in dollars. This means when dollar turns weak the
prices of gold shall rise.
As evident from the above
chart dollar has significantly weakened in last 10 years.
This weakening helped gold to surge high.
Us dollar index
measures the strength of the US dollar against a basket of currencies. Investors
who were earlier investing in US treasury products
started allocating some part of their corpus in the gold territory.
Earlier Many foreign central
banks would keep a substantial part of their reserves in US treasuries to keep
their local currency competitive but weakening dollar and looming threat of US credit downgrade forced them to redeem treasuries
and instead buy gold. This move exerted upward
pressure on gold prices.
(4)
Relation with other
commodities: Gold plays an important relationship with crude oil. Rising crude prices
translates into higher inflation and to conquer this inflation more gold buying
takes places as discussed in 2.1.
(5)
Depreciation of Local
Currency: This is a country specific phenomenon.
If local currency of a nation depreciates against the USA dollar (being the reserve currency gold prices are marked in US dollar) then the price
of the gold increases in that country.This happens even if there is no substantial change in international gold price.
I have elaborated this point here.
(6) Money Printing By Various Governments:Various governments over the world are printing money in one form or other- whether it be quantitative easing in USA or issuance of oil bonds in India, these are nothing but the money printing.
Simply put, money printing means artificially (without
keeping any collateral like gold, money is created by an electronic entry) increasing
the money supply in the ailing economy in the hope of a boost in growth.
Higher money supply results in the weaker local currency.
weaker currency not only means higher gold prices but attracts higher investment
in gold thus exerting further demand pressure which consequently results in
higher gold prices.
Money printing makes the credit easy that leads into higher
inflation as a result more money flows in the gold territory to hedge against the
inflation.
(7)
Gold As A Solution To
Financial Crises:
Europe’s sovereign debt crisis fortified the
need of gold as collateral- some of PIGS countries nearly reached on the verge
of default on their bonds.
Europe is the largest holder of the gold reserves.
If gold reserves are used as collateral the same can’t be
placed on the block for sell unless the lien is lifted off – resulting in a
gold supply constraint which lasts till lien is lifted. Interrupted supply results in higher gold prices.
(8)
Excess Money in the Global
Economy: due to measures like money printing by
various economies, excess liquidity gets created.
This excess liquidity finds its way into commodities
making them dearer.
Not only gold but other metals (precious and base) too
have been multiplied globally.
A 100 dollar bill is just a paper and it has no
intrinsic value. Indiscriminate money printing by a country's government makes
this fiat currency literally meaningless.
The best example is of Zimbabwe where to buy a groceryproduct one has to carry bundles of currency notes.The countries where currencies are losing value,
investors start protecting their wealth by investing in Gold.
(10)Issuance
of Gold Coins to Resent the Government’s Policy: In few states of the UnitedStates, to resent the policies of the federal government gold coins have been circulated.
These gold coins have intrinsic value much higher than
the denomination value.
Minting gold coins reduces the availability of mined gold
and exerts upward pressure on gold prices.
This practice was implemented to mock the
deterioration of the fiat currencies as discussed in point (7).
Why gold demand in increasing
in India?
In volume terms India is
world’s largest gold market and is continuously expanding.
India and China collectively
account for around 45 % of the demand.
Demand for gold for traditional
reasons like marriage, festivals, rituals etc was always there in India and it
started rising exponentially after the country liberalized. The most overlooked
reason for higher demand of gold is black money- which can be effortlessly
employed in the gold and real estate.
Rising corruption also
enhanced the demand for gold bars (better known as Cadbury in local
parlance due to its resemblance to chocolate) is a convenient way to park black
money.Gold being portable and less bulkier, can be easily stacked in a
locker.
During raids and seizures it
is now common to find gold bars from houses and lockers of corrupt and
unscrupulous people.
Demand for gold coins and
bullions which was 25 % higher in 2011 than 2010(as evident from graphs) second this point.
Not only gold but diamond
prices have jumped significantly but diamonds are generally used in very high
value transactions.
What can bring down the gold
price?
Huge new gold discovery or
heavy gold reserve selling by official holders and big investors, could only be reasons for gold to go southwards but probability of the same is bleak.
2 Comments:
A very informative post..solved a lot of my queries..thanks a lot for the upload..
You're welcome :)
Post a Comment