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| N Chandra Mohan: Bullish on all that glitters |
| N Chandra Mohan / Dec 19, 2011, 00:41 IST |
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What determines India’s growing appetite for gold?.
Through the ages, gold has been a hedge against uncertain times besides being a store of value. This metal is again in the spotlight as the world is passing through turbulent times that unnerve investors. The travails of the debt-ridden countries of the euro zone and prospects of a double-dip recession in the US threaten another global recession as in 2008-09. West Asia is in political turmoil, which could adversely impact global oil prices. Stock markets are on the edge the world over. With such worries, is it surprising that gold prices are headed only upwards globally as well as in countries like India?
India, of course, is no ordinary country as far as gold is concerned. The country, in fact, is the world’s largest consumer of this precious metal, accounting for 20 per cent of global demand. To meet this growing requirement, imports touched 753 tonnes in the first nine months of 2011 and might hit a record level of 1,034 tonnes for the year, up from 960 tonnes in 2010, according to the World Gold Council. The proximate cause is inflation and the absence of profitable investment opportunities. An investment in gold is perceived as a superior hedge against inflation and is preferred for that very reason
Global gold prices have zoomed by 20 per cent to touch $1,743 an ounce this year. Although it is currently trading at slightly lower levels, the outlook is bullish with expectations that it might breach the $2,000 level early next year. The chart of spot gold prices since 1971 indicates a spike in 1980 followed by a long stretch – mid-1980s to the late 1990s – when prices hovered around $400 an ounce. They started to zoom from 2008 onwards, the year when the global recession kicked in. As these global worries have persisted since then, this precious metal’s price has hit an uptrend.
India’s appetite for this yellow metal appears insatiable now that the bad times have arrived. Rising global prices, together with seasonal demand, have taken year-on-year gold prices up by 41 per cent to record highs of Rs 29,000 per 10 grams of 24-carat gold this year! Currently, the season for festivals and marriages is underway when purchases are heavy. This season hits its peak in November with Diwali. Demand is also buoyant in the rural countryside, thanks to a normal monsoon this year. Higher farm incomes, in turn, translate into spending decisions on gold from December-January onwards.
What are the determinants of this boom in gold imports? Dr A Vaidyanathan, Emeritus Professor at the Madras Institute for Development Studies, has updated his earlier work on “Consumption of Gold in India: Trends and Determinants” from the 1970s to the present. In this paper, he outlined several explanatory factors that affect demand for gold. One is real GDP as a proxy for rising agricultural and non-agricultural incomes. The other is household savings in financial assets. For any given level of GDP, higher the household savings in financial assets, higher will be the demand for gold.
Demand also depends on the relative price of gold and other financial assets, which can be proxied by the index of share prices like the BSE Index with 1983-84 as base. This is an important variable, especially since the turmoil in the global financial and commodity markets has become a significant factor depressing stock market sentiment. It is a no-brainer that a rapid rise in gold prices when stocks are tanking is bound to favourably influence decisions of households to invest in gold. The last variable is the differential between domestic and international gold prices as a factor influencing imports.
The statistical results of his study are noteworthy. From 1970 to the present, the bulk (as much as 89 per cent) of the variations in gold imports were accounted for by the above explanatory variables. The larger the real GDP, the higher the ratio of household financial savings to GDP at market prices, the larger were gold imports. The explanatory variable that has not really affected demand of late is the gold price differential; it has narrowed since the 1990s due to liberalisation of gold imports. But the variable that has been the most explanatory is the ratio of domestic gold prices to the index of share prices. The higher the ratio of domestic gold prices to share prices, higher indeed were gold imports.
More such studies are necessary. India’s appetite for gold is growing, the reasons for which are dimly known. We currently own 18,000 tonnes or 11 per cent of the worldwide stock of gold, which is worth over $950 billion. And every year, we are buying more and more of this precious metal — especially as the global turmoil has now appeared on the horizon. This movement to gold has accelerated as a hedge or safe haven against uncertainties. As its price has risen much faster than share prices from 2007-08 onwards and general price level, India bids fair to be bullish on bullion for a long time to come!
From the Ivory Tower will make research from the academic world accessible to all our readers.
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