In the previous instalment, we talked about all the ways gold is slowly and steadily coming out to be a more stable store of value than ever before. Now, its time to get into the nitty gritty of all the factors which in the end, result in the factors influencing the price of gold and its overarching role in the economy.
Demand/Consumption of Gold
According to the latest report by World Gold Council, the lockdown that succeeded the Coronavirus pandemic slashed the gold demand in India by 35% in 2020 to 464.4 tones, which is the lowest since 1994. Since majority of the gold in India is imported from other countries and the fact that the value of a nation’s currency is strongly tied to its imports and exports leads us to a clear understanding that Indian economy was to a certain extent affected by the drop in demand/consumption of gold.
It can now be concluded that there is a direct relation between demand of gold and its prices. Hence, demand of gold affects both price of gold and the economy.
Impact of Inflation
As the value of a currency drops with a rise in inflation, this leads to less money in the hands of people to spend. With limited money in the market, gold becomes a tool to hedge against inflationary conditions. Due to this hedging, the prices of gold soar high in the market with rise in inflation. This again leads us to a correlation between changes in gold prices and dwindling of the economy.
Good Monsoon
Majority of the gold demand throughout the country, i.e., around 60% comes from rural India. Gold forms a major part of the traditions and customs of rural India. We know that monsoon plays a significant role in smooth functioning of the rural economy, this is the reason why deficient rainfall leads to decline in the demand of gold by farmers thereby leading farmers to sell their gold in order to generate funds. On the contrary, good rainfall will give farmers more money to spend and hence encourage them to buy more gold.
Rupee-Dollar Equation
The Rupee-Dollar equation, though does not affect the price of gold throughout the world, has a significant role to play in deciding the price of gold in India. As already mentioned, majority of gold in India is imported from other countries to meet its demand here. Rupee-Dollar equation shares an inverse relation with the price of gold. If the rupee weakens against the dollar, price of gold will increase in rupee terms. On the other hand, if rupee appreciates against dollar, the price of gold will decrease.
Interest Rates
Interest rates play a major role in determining the economic conditions of a nation. These fluctuations in the interest rates affect the gold prices also. Going with the popular opinion, interest rates and price of gold share a negative or inverse relation. According to many investors and analysts, a hike in interest rates makes other fixed income investment attractive, so the money will flow into higher yielding investment and out of gold when rates soar higher. Thus, a rise in interest rate should follow a fall in gold prices.
Geopolitical Conditions
It is a known fact that geopolitical events can affect the views of the investors and can lead to either encouragement or discouragement in a certain investment. This affects the stock market and hence, the economy. Now, how does geopolitical conditions affect the gold prices should be your next question. For this, we first need to understand that at the time of geopolitical uncertainty, investment is considered a safe haven by the investors, resulting in an appreciation in the demand of gold and subsequently its price. However, other asset classes will witness a fall in their demand at times of such crisis.
Notes To End On-
Since its abolishment in 1971, the gold standard has almost wiped out the importance of gold in determining the value of a currency. To bridge the gap created by the abolishment of gold standard, governments, after 1971 created new ways of deciding the value of their currencies which no more includes gold as a major indicator of fixing the currency value.
Nonetheless, this does not mean that gold has lost its control over the economic influences and financial ups and downs in an economy. Though, the control may not be that strong, we are still affected by the moving prices of gold. This is the scenario as of now, let’s see what the future holds for gold !