In Gold We Trust!

In this week’s FinMail, we will look at that why gold has never been off the table when discussing the economy, in simpler words — Why do we go to Gold when nothing works?

Introduction

Can we get enough of Gold? The answer is always No because we loooove Gold! So much so that even after discussing Gold in at least 5 of our blogs, 4–5 Social Media posts, here we are yet again to discuss Gold and this time over a Newsletter. But this time we are not here to discuss Gold Alternatives or Investment types but to discuss Gold as the last resort for people during Economic Troubles.

The Recent Crackdown

Gold Prices have been on a free fall for the past few weeks and have fallen almost ₹9,000 from the peak of ₹57,008 per 10gm in August this year. The latest price stands at around ₹48,660 per 10gm (November 27, 2020).

So what has been the reason for this free fall and that too at a time of festival and wedding season in India?

when the demand for Gold is usually higher as compared to other months?

Another question you might be having in your mind is that why such a free fall at a time when there were reports suggesting that Gold Prices will touch the ₹70,000 marks by the year-end.

So what happened that the prediction of analysts went wrong and why are Gold Prices falling?

A Look at Gold Price Peak

Gold reached its lifetime price high in August this year. One interesting thing to note here is that gold prices have been rising and are on an upward trend since March but if we take a look at the demand data of Gold and the imports of Gold that India made is quite low, significantly low.

India imports around 800–900 tonnes of Gold every year to fulfill the demand of the Domestic Jewellery Industry which is the reason India is the world’s largest importer of gold. However, during the month of March this year, the imports of gold decreased significantly due to the corona virus-induced lockdown.

Take a look at the fall in the value of gold imported by India:

March (-62.6%) April (-99.93%) May (-98.4%) June (-77.5%)

So, while demands have been plummeting and reaching almost nil (in April), gold prices nationally and internationally were picking their upward trend. And even if India is the largest importer of gold, the rising prices did not get affected by the huge fall in demand. And, when the lockdown guidelines were eased and the festival season was nearing, the price shot up and reached a lifetime high in August and since then demand for Gold has been increasing in India but the prices are coming down.

So normally, if the demand for a scarce or a limited product is higher, the price of the product has the tendency to increase and vice versa. But here, it is inverse. The price of gold has increased when demand was low in India and prices have decreased now that demand is increasing.

So, what is the picture that we are missing? What is the one thing that we aren’t observing?

The one thing that we aren’t observing is the International Market of Gold. Gold prices aren’t just affected by the Gold demand in India but, the whole international demand for it. Yes, India’s demand can affect the price largely but not totally because even if India is the largest importer and second-largest consumer of gold, it totally doesn’t mean that India’s gold demand will decide the prices. So, overall Gold prices are internationally decided and then converted into rupees to arrive at the price of gold in INR.

What is it that everyone in the world was buying gold during March-August and then suddenly started moving away from it from August?

The answer is Corona Virus Pandemic or Covid-19 pandemic. During March and after March, most of the countries started getting affected by the pandemic and some countries started imposing lockdown to curb its further spread. And lockdown means economic activity will be put on hold and thus it will affect the economy negatively. So, people turned to Gold at that time and when the Covid-19 vaccines started showing positive results and then the economy started to expect growth in near time due to it, people started moving out of Gold. See this chart for instance:

The chart shows that when India including many countries went on an economic lockdown, the stock market experienced selling pressure. i.e. more people started exiting stock markets and started buying gold which can be seen. Gold prices rose and markets crashed.

And, since August many vaccines started showing positive results and were effective and also transitioned into the final phase of development which meant that the economy will soon start opening fully and thus move towards progress, and thus people started entering the stock market and exiting gold. And, thus again markets rose and gold started plummeting down.

So we can make a point that when there’s economic pressure people move to gold and when there’s economic progress, people move to other forms of Investment.

Why so? Because When nothing works, people believe in God, uh we mean Gold.

So what drives our unshakeable trust over gold?

Before we answer this question, we would like to have your attention on gold’s history.

Gold’s Golden History

Back in the days, the good old days we were on the barter system where we used to exchange goods against goods to keep the economy moving. But the barter system was not feasible in the long term. So we needed a common point to determine the prices of particular goods and services and then came the Coinage System. So thus Gold, Silver, and Platinum coins came into the picture where we would exchange coins against goods or services but the coins too had some limitations like the minting problem, the cost of metals, the scarcity of valuable metals, and so on. And thus we moved onto paper currency which we currently trade on. But also in paper currency, earlier we used to back up the paper currency by the amount of gold the currency carries. So, that means that printed currency used to be backed by the same amount of gold as per the value of printed money but that too was not feasible and thus we dropped the backing of currency by gold option too and stayed on with the paper currency. So, if you see that even in the past and the present, Gold carries a special place in our lives. But why only Gold?

Because it is precious? Because it is rare? Well not exactly. Because Silver is also rare and precious too and the same goes with the case of Platinum. But Silver is a little rare and a little less precious than Gold and Platinum is a little more precious and rare than Gold. So if we were to balance Gold, it would be, Gold is the perfect balance between Rare and Common.

It is not too rare but also not too common. You see, it is perfectly balanced as all things should be. So yeah, Gold is close to our hearts. And to answer the question, “Why do we love Gold?” we have got a chemistry angle as well, yup we have got everything today to make you fall in love with Gold.

Gold is the only element in the periodic table which is edible (yes, you can eat it too), not harmful to the human body, can be given any shape, low melting and boiling point, shiny and rare. So you see Gold has got too many merits on its side. So, Gold being too much good and precious, it has a special place in our hearts and thus people just love gold. And, this is just the metal side of the gold. Let us compare Gold with some asset classes as well. Let’s see how Gold ranks against other monetary Assets.

Paper Currency

Modern Paper currency is nothing but a piece of paper that is guaranteed or backed by the regulator of the currency i.e the nation or its Central Bank. So, we can say that the value of the paper currency is largely dependant on the power of its regulator. Regulators of the currency being the government or the nation’s central bank, its value is often driven by the economic performances of the nation. If a country has significant economic power over others, it is likely to have a strong currency as compared to others. Hence the fluctuations we see in exchange rates of different currencies over a period of time are ultimately dependant on a nation’s economic performance. So, what if one day or at a certain point of time, people don’t trust the government? Will the paper currency carry the same value as before?

Other Financial Assets or Investments:

If we take a look at Financial Assets that carries a monetary value or those that can be determined in terms of money, like equity shares, debentures, bonds, real estate, fixed deposits, etc. we can say that every single asset is in a way dependant on how a nation or an economy performs or is expected to perform.

Take for instance equity shares and the stock market. The stock market is a combination of companies that work individually towards their economic progress. But what if the economy doesn’t have suitable conditions to perform. The stock market of a country moves towards progress only if the economy as a unit performs. Everyone or a major part of the economy has to perform to be able to move towards economic progress. So what if the economy doesn’t perform? People who have invested will lose their money and will be discouraged to invest more.

The same goes for other assets as well. Be it bonds or fixed deposits or debentures. They carry a monetary value and are a form of a Financial Investment that cannot be touched or felt. But that doesn’t hold true for precious metals like gold. They carry a value, they can be held onto and can be touched as well as felt. Also, Gold carries an International Value and can be exchanged for money in any part of the world. So, it is kind of an International Currency. A currency of a nation can appreciate or depreciate and one day can turn just a piece of paper too, but Gold doesn’t let that happen to itself. One day every financial asset or an economy carries the probability of vanishing into thin air but Gold and other precious metals will still remain the same and thus it carries a monetary, trustability, and appreciating factor with itself. And thus when there’s a fear, a doubt that an economy will not perform or will depreciate in the future, people move to precious metals like Gold. And this is what happened during the month of March and in the month of August. When the world economy was under the pressure due to the Corona Virus, the overall sentiment of the people was that the economy was going to suffer, and thus the assets that are dependant on the economy’s performance like stocks and bonds were meant to be affected by it and thus people started shifting from stocks and bonds to gold, to protect their capital. Similarly, when the news and progress about the vaccine started coming in, people gained trust in the economy and thus started shifting to other financial assets from gold and thus the crack in the prices.

Take any major economic distress over the past two decades, whenever the economy crashes, the yellow metal has emerged as the safer side for investors.

The same happened during the 2008 crash when the equity market crashed and interest rates of bonds were negligible, people trusted gold over these financial assets for stability, as a result, gold prices increased. Take a look at the charts:

Whenever there’s economic trouble, prices of Gold start rising and stock markets start falling.

Repeat the same in the current year, Pandemic led us all into house arrest & with economic activities halted, again gold was something to rely upon, having all the perks! Gold is the asset people like to buy and have on their side when they have less confidence in other assets. Ask a Desi Uncle and he’ll say, “In Gold we Trust!”