Thursday 23 July 2015

Fall in Gold Prices Explained.

Why gold prices went up so much in the first place?

  • Long term view - World gold prices barely rose for almost three decades, even more so when adjusted for inflation. Proof - some faltoo data
    • The $ 850 per ounce price at London reached on January 21, 1980, was surpassed only on January 3, 2008
    • In India, too, prices of standard 24-carat gold in Mumbai touched a record Rs 33,265 per 10 g on August 28, 2013. On Wednesday, they fell to Rs 24,820, the lowest since August 6, 2011

Source Indian Express
Where’s the underlying explanation?

  • Bull runs in gold have been episodic and rare, and largely a response to currency crises. 
    • The last rally, for instance, came in the aftermath of the global financial crisis that led to unconventional monetary policies in industrialised countries — from near-zero interest rates and forward guidance to quantitative easing. 
    • The perceived debasement of fiat currencies by the printing presses of the world’s leading central banks — including the US Federal Reserve — prompted investors to put money in gold and other ‘solid’ assets. 
    • The pessimism over fiat currencies extended to even interest in Bitcoin and other such krypto-currency experiments. 
  • Gold’s high coincided with the US debt ceiling crisis of 2011, that saw the federal government almost running out of cash before a last-minute deal stitched with Republican congressmen allowed the Treasury to raise its borrowing limit before the deadline ran out.
  • Simply put, gold prices have gone up whenever public confidence in the dollar — the world’s reserve currency — has suffered erosion
    • This is hardly the case today, with the US economy recovering from a recession even with low inflation — defying dire predictions of an imminent dollar collapse. 
      • The best proof of it is the US dollar index which has shown that dollar is growing stronger. 
      • A strong dollar has made the world somewhat less pessimistic about fiat currencies, while reducing the allure of gold as a safe haven asset. The dollar index and gold prices generally move in opposite directions.

What about India? Why are prices falling here?
  • India imports the bulk of its gold requirement. So, a decline in world prices automatically translates into lower prices here. The rupee’s value also plays an important part. The day gold prices in Mumbai hit a record high of Rs 33,265/10 g — on August 28, 2013 — was also when the rupee crashed to an intra-day low of 68.85 to the dollar. 
  • Again, the demand for gold in India as an investment option peaked when the rupee was viewed as a weak currency, both externally as well as in terms of domestic purchasing power. 
  • It is the opposite today, with a strong rupee in combination with relatively low inflation making the yellow metal not a very good investment. (The huge outflows from gold exchange-traded funds would testify to this.) Gold ultimately has very little utility other than being raw material for jewellery and a store of value (though perhaps not over the long run). Nor does it generate any income — unlike rentals from land, dividends from shares or interest from bonds.

But can the shiny metal rally again?

  • Unlikely, at least in the immediate future. 
  • A strong dollar, reinforced by a hike in interest rates by the US Fed which seems increasingly inevitable, could well force gold to test the $ 1,000/ounce floor levels. 
  • Add to this Greece’s avoiding a messy default on its payment obligations or an exit from the Euro zone for now, and a landmark nuclear deal between the world’s major powers and Iran, there is no ‘safe haven’ support for gold either. 
  • And as far as India goes, a big negative for gold is diminished rural purchasing power.
  • Given that an estimated two-thirds of India’s gold demand comes from rural areas, lower crop prices and a not-so-good monsoon so far is not good news for bullion traders and jewellers. 
  • But it isn’t bad for the country’s balance of payments. Gold imports peaked at $ 55-56 billion in 2011-12 and 2012-13 and, along with oil, were the primary source of current account deficits, before falling to $ 29-34 billion in the last two years. And they could fall further this year.

Reference: The Indian Express


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