By Dr. Martin Patrick*
Gold witnessed a slump hitting a five-year low this week; it’s down more than 40 per cent from its 2011 peak. At one stage the price was 19 years low. Traders and investors are worried about the fall in prices of gold where as consumers are happy with the current development but still waiting for new opportunities of further fall in the price. Analysts forecast that there will be further fall in the price of gold and in the immediate future it will touch Rs 18,000 for 8 grams (22 carat sovereign). It may go up to Rs 15000 in the near future, some analysts predict. The peculiarity of gold as a safe haven is getting lost these days.
Factors determining the price of gold
There are several factors that determine the price of gold. Like any other commodity demand and supply factors influence the trade in gold. Since the supply being limited the factors that determine the demand are greatly influencing the trade in gold. Total supply in the international market for gold is steady for number of years, but demand is going up every year till recently. Now the trend is reversed; the demand is coming down these days. The supply – demand mismatch was often cited as the major reason for volatility in the prices of gold. The other factors influencing the trade in gold are discussed below.
- Demand for crude oil
- Exchange rate of dollar
- Equity market movements
- Speculative activity
Gold as an investment Vehicle
- Commodity trading
- Geopolitics and broader market concerns ( the actions of Fed in the US)
- Jewellery demand
In the international market the price of gold is determined by the price of Crude oil. In normal situation it shows a positive relationship between the price of crude and that of gold, where if the price of crude increase they tend to switch to gold and vice versa. But during the last one or two years we have not been witnessing this positive relationship between the price of gold and that of crude. On many occasions the price of gold increased in the midst of fall in the price of crude oil, may be due to abnormal situation. Moreover, this trend may get changed when we consider a sufficient long period of time and thereby positive relation between the price of gold and crude may hold true in the long run.
In respect of dollar value we find an inverse relation between the price of gold and the exchange value of dollar. As dollar gets strengthened, the price of gold comes down and vice versa. The investors will turn from gold to dollar when its value in the international market gets strengthened. Dollar is traded like a commodity and hence it is an investment vehicle.
In the equity market Gold shows a negative correlation for”reasonable long period of time”, Where stock market shows an upward trend for a sufficient long period of time, investors will be attracted to this field and thereby the demand for gold will come down. This will push down the prices to a lower level.
Speculative activity, gold as an investment vehicle, commodity trading, geopolitics and broader market concerns, and jewellery demand are other reasons that determine the price of gold.
Multiple reasons account for the continuous fall in the price of gold. The immediate reason is the selling of gold by China due to the crash in stock market in that country and strengthening of dollar in the US. The major reason is strengthening of the dollar. The good US economy data has really resulted in the strengthening of exchange value of the dollar. The expectation that Fed would go for a hike in interest rate in the coming months is another reason that accentuated the gold price fall. In short, dtronger dollar index and fear of interest rates hike in US are keeping Gold prices under pressure.
Chinese factor is cited by many as a major reason for the gold price slump. It is argued from all corners that there occurred heavy loss for investors in China due to the recent stock market crash. In order to compensate this Chinese investors sold a part of the gold they acquired. A five tonnes of gold being sold through the Shanghai gold exchange is a clear sentiment on the fall in prices. The expectation about the gold reserves to be kept by People’s bank of India was a major reason for the price change of gold. Earlier the gold witnessed rise in prices due to the expectation that the Chinese central bank would acquire more gold in their reserves. There was speculative activity in gold trading due to this aspect. But in reality, the bank didn’t acquire gold up to the expectation level. The numbers showed the world’s largest gold producer has been stockpiling gold reserves at a slower pace than previously thought. Realizing this, investors downsized the demand for gold and hence the fall in price is accentuated.
The fall in inflation is another reason for the gold price slump. “Over the last 5,000 years gold has been a store of value that will be there for a time when there is inflation. There is no inflation now,” said George Gero, vice president of global futures at RBC Capital Markets. Precious metal is supposed to be a hedge against inflation. No doubt the recent collapse in the gold price is only lowering inflation and inflation expectations.
Truly speaking, the strengthening of dollar has fuelled the process of fall in gold prices .Other reasons have just supported it. Ultimately there is a fall in demand. To sum up the demand for gold has come down due to one or other reasons. As for instance, physical demand for gold in China is down by 9 percent. Worldwide, demand for gold coins, gold bars have come down by 17 percent this year.
Optimistic or Pessimistic Future
The prospect of gold is very grim as per various analyses. It is expected that gold price will face a downward trend in the coming weeks too. Currently the gold is being traded below $ 1100 per troy ounce. If gold were to finish the year at its current level, it would mark the first time it has posted three straight years of losses since 1996. It is expressed from some corner that the price of gold in the international market may touch$1000 per troy ounce. Goldman Sachs commodities Chief Jeffrey Currie warned that gold could dip below $1,000 an ounce for the first time since 2009. If it touches that level, it can be stated without much doubt that it would be a golden opportunity for investors to invest in this safe haven. No doubt, gold will be cheap at $1000 per troy ounce.
The possibility may be a different one. Economic uncertainty is still persisting in the world, at least in some parts of the world. The situation of Greece is very evident to everyone. The reflection of Greece on Europe is also adverse. Investors are no longer speculating about a Greek exit or the long-term implication for the currency union. Very happy notes are not coming from Asian countries; China may create some problems in the world economy. Recognizing all these aspects, there is a chance for revival, barring the recovery of the US economy, at least in the short run. Expecting a collapse in the trading of gold does not tally with current developments in the economic front of the world. One has to go with this quotation: “Should the conditions change and the risk of contagion or the unintended consequences of a Greek exit increase, we would expect to see a stronger reaction from the gold price. As a high quality, liquid asset, it is likely that many investors would use gold to protect wealth. A more substantial market correction in China, however, could spill over to other economies, increase uncertainty worldwide and make gold a more relevant hedge”.
* The Author is the Chief Economist of CPPR. His views are personal and does not anyway represent that of CPPR.