Last year, the price of gold on MCX surged by 25%. Gold finally came out of a six-year trading range and delivered strong gains. This bullish rise in gold prices is expected to continue in 2020, with some experts even quoting specifics like a 12% — 13% increase. Before we address the real causes behind this surge, here are a few factors that affect the price of gold.
- Consumer Demand: India has been diagnosed with ‘gold fever’ for being heavily biased towards gold as a secure investment for the long term. Consumer demand for gold in India is high.
- Inflation: Gold acts as a hedge against inflation. So whenever costs increase in any way whatsoever, people turn to gold jewellery, gold bonds or gold ETF as a form of ‘pure’ investments that will not be subjected to inflation.
- Economic Uncertainty: Physical gold, gold ETFs and gold bonds can diversify one’s portfolio. While market uncertainty can affect equity investments, investors flock towards gold as their safe haven.
- Interest Rates: Higher interest rates can also push investors towards keeping a section of their portfolio in gold bonds. The rising yield from higher interest ultimately leads to the expectation of a stronger economy. A strong economy results in inflation and gold can be used as a hedge during this time.
- Rupee-Dollar Exchange Rate: If rupee weakens against the US dollar, gold prices will also depreciate in rupee terms. A depreciating rupee has the potential to reduce the demand for gold in India. However, this change will not be for the gold outside India, denominated in dollars.
There are other factors like geopolitical tension, weakening of the dollar, and monsoon season, all of which contribute to the price of gold in India. However, the core factors that contributed to the surge in gold prices in the last year have been the fall in equities due to the COVID-19 pandemic in addition to rupee depreciating in value, and India’s increased import levied on gold.
Firstly, it seems like no investment portfolio is immune to the coronavirus. Global oil prices have fallen, and so have equities. Stock market crashes in March were seen in India and internationally. However, gold seems to be on a rising spree for the last few months. Investors with exposure to gold are sitting on a profit of more than 12% so far in 2020. Experts expect gold to go as high as ₹54,000 to ₹55,000, a 25% surge from the current levels. The reason for gold outshining the rest during this time is that it is negatively correlated to equities. In fact, in the 2008 financial crash gold prices surged, as they are now that there is a pandemic ravaging.
Whenever the rupee depreciates, gold follows suit. The rupee has also had to cope with an unexpected coronavirus outbreak. With COVID-19 threatening to derail economic growth, an already weak Indian economy is giving forex dealers some jitters about its value. As it disrupts supply and trade chains between countries, the nearly 3% fall of the rupee from Jan 1st to March 3rd seems warranted.
To import gold into India, there is a 12.5% duty with added goods and service tax of 3%. There is also a negative feedback loop that has been created by gold prices increasing. With every 1% increase in the price of gold, experts claim that the demand for it drops by 0.9%. This further increases the prices people are shifting away from gold. In fact, in 2019 the Indian demand for gold witnessed a sharp drop when gold hit its record high on MCX.
According to the World Gold Council, the demand for physical gold in the form of jewelry dropped by 40% between Q2 and Q3 in 2019 alone. Moreover, one can annually expect an average drop in the demand for gold by 32%. People tend to prefer paper gold due to its lower maintenance costs and fewer risks in terms of security and value depreciation. However, the surge in prices is preventing many from buying it.
In conclusion, gold prices have increased from a combination of the COVID-19’s economic impact, India increasing gold import duty, and the depreciation of the Indian rupee against USD. As coronavirus grips the global stock markets, and India’s GDP lags, investors seem to be choosing to return to paper gold for its protective purposes. As their demand for paper gold grows in the form of gold bonds and gold ETFs, some speculate that gold prices may see a decline in 2020.
Consider Tata Capital for all your investment needs. From wealth management services to help you perfectly allocate your portfolio based on your needs, to commercial loans to jumpstart your next business idea, Tata Capital is among the top service providers in India. Visit the website here to learn more.