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All that Glitters is Not Gold

Gold has for long been the favoured investment of investors, but it has seemed to have lost its sheen of late

For as long as one can remember, gold has been one of the most favoured medium of investment for the Indian investor. There would hardly be any Indian family that wouldn't have invested in physical gold. Gold is considered to be a safe and sure-to-generate-returns kind of investment, so much so that when a husband buys gold jewellery for his wife, he invariably thinks of it as an investment. Invest money and make the wife happy at the same time, seems like a golden deal, doesn't it? Maybe in the past it was, but somehow, not anymore.

India is the world's largest market for gold. The country accounts for 10 per cent of the above-the-ground gold stock of the world. But of late, it seems like gold is losing its long-held sheen for the Indian consumers. And any drastic change in demand in India would be reverberated in the bullish markets the world over.

The price of gold, like that of any other commodity, is determined by demand and supply factors. In the short run, demand for gold has a dual component — 'use' demand and 'asset' demand. The use demand for gold comprises the demand for manufacturing jewellery, medals, electrical components, etc. This demand is inversely related to the price of gold, i.e. as gold prices go up, the use demand for gold goes down. On the other hand, the asset demand is made up of factors like dollar exchange rate expectations, inflationary expectations and fears, returns on other assets, lack of correlation with other assets, etc. Hence, in the short run, the price of gold depends on a number of factors other than the intrinsic demand and supply. This explains the wide variations we see in the day-to-day prices of gold in the spot markets.

However, in the long run, the price of gold had to get aligned with global supply and demand. In this perspective, the fall in demand in India is highly significant. Another interesting fact is that the demand, in terms of amount of gold bought by retail customers, has gone down not only in India, but all over the world. A report by the World Gold Council reveals this fact, which is interesting because the value of investment in gold has gone up because of uncertainties in the global economic and political arenas. Globally, the demand for gold has been down by 21 per cent while in India, the use demand and asset demand for the yellow metal is down by 50 and 49 per cent respectively. Even though the demand has suffered in other regions like the Middle East, US and UK, nowhere has it fallen as low as it has in India. One of the factors behind this steep fall in demand is the high price rise. Worldwide, gold prices has risen by 11 per cent in the past six months, while in India, the depreciating rupee has led to an increase of 20 per cent. And apparently, this is just too much for the Indian consumers, resulting in them losing their appetite for gold.

The main drivers for gold in the global markets have been the ETFs and institutional investors. Currently, ETFs account for 50 per cent of the total investment demand for gold, which is quite a remarkable change from the first quarter of 2007 when this demand stood at 25 per cent. Moreover, supply is also finally going up. Considering the run gold prices have seen of late, the 6 per cent rise in supply was almost inevitable. The increase in scrap gold is one of the major reasons behind the supply rise. Furthermore, the proposed sale of gold by the IMF in 2009 will add to the global supply of gold.

In conclusion, all these factors can drive the gold prices down. This seems like a bad dream for investors who have invested in gold to escape the volatilities of the equity markets. And a continuing bad dream it might just be. The fundamentals of demand and supply seem to have caught up with gold and in the future, gold prices are more likely to be heading south than north.