Growing Appetite for Gold

In brief:

Gold standard was a monetary system that was used before 1930 to define the value of currency in
terms of gold. Under this system the currency printing was backed by gold. However, the gold
standard was completely abandoned in 1973 and all the countries started to shed off their gold. As a
result the global central banks had reduced the gold reserves drastically between the time horizons
of 1990-2008. However, the countries gradually reversed their trajectory and started to buy gold
with rush. By 2018, the central banks globally held 1.064 billion ounces of gold (33200 tons) that is
about 1/5th of all the gold ever mined and by 2019 they purchased even more.

Consumer phycology amidst the crisis:

Usually during the crisis, the demand for gold increases. Under Covid-19 crisis situation there has
been a nationwide lockdown that forced the economic activities to come to a standstill to control
the pandemic. During the lockdown time, the consumers are finding ways to save their money for
future which looks uncertain. They are trying to save money by restricting themselves from spending
on luxury and stick just to the basic essentials that is the need of the hour and cutting down on their
investments. The prices of products and services in the market are rising and the value of the money
has gone down. In this period of crisis, investing in real estate is a bad choice unless we consider
buying property at a low cost. Equity indices have been slashed by 40% in India, debt market is
under acute liquidity pressure and investors are taking an exit from their positions. Therefore,
people are switching to gold as a safe haven, a hedge against the rising prices and more liquid than
other assets. Since people cannot buy physical gold during the shutdown time hence they are
inclined towards buying sovereign gold bonds issued by the government.

Checkpoint:

To control the excess demand, the government has to increase the prices of gold so as to discourage
people from buying excessive gold bonds. After all, the central banks also need to add up more gold
to diversify their foreign reserves to pay for the import bill. Gold is also needed for international
transactions since the foreign currency fluctuates and hence it is very unreliable asset compared to
gold. The prices of gold remains moreover same across the world and hence gold is reliable.

General reasons for rise in gold prices:

 When global prices increase, the prices of gold in domestic country also rise up.
 When government starts accumulating gold as their reserves, the prices of gold rise up.
 When interest rates go down, the cost of borrowing also decrease. This leads to excess
money in circulation, hence people demand more for gold and the prices of gold rise up.
 When inflation rises, people spend more due to rise in demand for products and services
hence consumption increases and the prices of gold rise up.
 When the demand for gold surge during festivals, the import bill also rise leading to rise in
gold prices too.

Looking back at history:

 In 2008, after the collapse of Lehman Brothers, the gold prices were at $700 per ounce and
soared to $ 1200 per ounce in 2011. It gradually declined and stood at $1000 per ounce in
2015 since the impact of global crisis faded with time. Between 2015 and 2019, the gold
hovered within the range of $1000 - $1350 per ounce. Since May 2019, following the rupee
 depreciation, the gold prices have gained momentum and soared at new highs of over $1700
per ounce. The gold has been on a potential upside months before COVID-19 started in
2020.

Reasons why gold prices are potentially moving upwards during Covid-19 crisis:

 There are recession fear amongst people as they cannot predict whether the pandemic is
going to gain momentum or fade away in the near term. Also, COVID-19 impact might drop
US economy into recession once again since the global financial crisis in 2008.
 Depreciating rupee Vis a Vis US Dollar may give support to rising gold prices. Since India
imports gold heavily, the weakening rupee (around Rs76 to a dollar) would make imports
expensive and the prices would have to pass on to the home country to pay.
 The central bank of India is adding up gold to be a significant part of India’s foreign exchange
reserves to pay import bills, deal with international transactions and a hedge against the
economic uncertainty.
 China and Russia are adding up more gold to diversify their forex reserves and to break the
stranglehold of US dominated financial market. They intend to insulate themselves from
dependency over US dollar reserves in the longer run. Currently, China has 2.9% of gold to
reserve ratio and Russia has increased its gold to reserve percentage to 20% from 2.5% in
2007. If Russia and China continue to show up a great appetite for gold disproportionately
and represent it as a significant portion of their foreign exchange reserves, then gold prices
in medium to long term would soar to unbeatable levels.

Concluding thoughts:

As the economic recovery picks up, gradually the consumers should gain confidence and switch the
preference from gold to equity and other risk asset classes once again. Liquidity injection, stimulus
and several bond buying steps have been taken by the government to revive the economy and spur
the demand and growth. Eventually we shall also see the gold prices falling back similar to the
correction in gold prices we saw in the year 2015 post the global financial crisis.