- Date : 11/05/2020
- Read: 5 mins
See what are the factors that dictate gold price in India.
Gold is a precious metal and one of the most favoured forms of investment in India. The price of gold doesn’t respond to demand and supply alone; in fact, there are a host of other factors that make it difficult to predict the price of gold at any given time.
Globally, some of the factors that influence the cost of gold are inflation, the supply of gold, the central bank’s decision to buy or sell gold, the bullion business done by exchange-traded funds (ETFs), economic conditions, and so on.
Most of these factors do dictate gold price in India; but there are some other local peculiarities that affect both the offline and online gold rate in the country. Let’s consider them one by one:
It is generally noted that gold prices react to inflation. As the Indian economy experiences inflation and the local currency weakens, people prefer to invest in gold, which in turn leads to a rise in its demand.
However, it would be wrong to claim that both of these are exclusively related. Gold prices were rising even before the great recession of the early 2000s and peaked after the situation improved. However, the gold price did respond to the inflation resulting from the recession.
Related: Will India lose interest in Gold?
2. The central bank’s decision
The decision of the central bank (the Reserve Bank of India, in India’s case) to buy or sell gold can affect its price due to the sheer volume of the transactions. Central banks hold a significant amount of gold reserve, which they must sell off when the economy is booming. The gold is sold in the market though other institutional buyers are not that keen to buy it. This leads to a slide in the gold price almost every time the central bank begins to reduce its gold reserve.
Such high-volume gold sales and purchases are also done by exchange-traded funds (e.g. gold trusts and gold shares) and are influential drivers too; transactions done this way eventually impact gold’s demand and supply.
3. Interest rates
Gold and interest rates have a simple inverse relationship. Once the interest rates increase, people sell off their gold and try to use the money to earn high interest. When interest rates fall, they see more sense in buying gold, thus increasing its demand. However, this is more of a short-term observation as over a long period, it is seen that gold price and interest rates both have risen, thus indicating a long-term positive correlation. For example, during the 1970s gold boom, prices rose in spite of a steady rise in interest rates.
4. The jewellery market
Indians traditionally buy a lot of gold for ornamental purposes. Buying gold jewellery is a popular custom across India during festivals and weddings. As a result, the demand for gold rises during festival and wedding seasons (generally October to December), irrespective of the prevailing price. Thanks to the demand, India often ends up importing gold, particularly during this season.
5. The monsoon
While urban India has other interesting investment options other than gold (real estate, stock market etc.) rural India has traditionally gravitated towards the yellow metal. This is substantiated by the fact that 60% of the demand for gold in India comes from the rural market. A good monsoon results in a good harvest and the income earned is used to invest in gold, which is then saved for the proverbial rainy day. In case of a bad monsoon, the income falls drastically and gold comes to the rescue.
6. Rupee strength
It must be noted that a major portion of India’s gold demand is met through imports. The reduced purchasing power of a weak rupee leads to a fall in imports and subsequently the demand for gold. Of course, this is characteristic of India alone, as the global gold market is not affected by domestic currencies.
7. Portfolio diversification
Gold is often seen as a welcome change from the stress and risk associated with conventional assets. It is also observed that gold generally doesn’t have any significant relationship with other popular assets. Even when a particular asset is under market stress, gold doesn’t seem to be particularly affected. So, one’s penchant for investing in gold could depend on the volatility or stability of another asset (or assets).
In India, love for gold has been passed on from generation to generation, which in hindsight seems a very good choice. Economists Claude B Erb (of the National Bureau of Economic Research) and Campbell Harvey (from Duke University’s Fuqua School of Business) compared the value of gold thousands of years ago with what it is today, and noted that it has managed to retain its value, more or less.
In other words, the purchasing power of gold has remained uniform over the ages, whether it’s the latest gold price in India or what the going rate was a few thousand years ago. But that’s not all; unlike most other assets, gold is rare – its supply is limited to what the Earth holds. And it lasts forever!