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In this article I will cover the history of gold, its importance in Indian culture and its market dynamics. Gold, also popularly known as "Yellow Metal", is the most liquid asset in the world. If you wish to sell a pure gold bar or gold coin anywhere in the world, you will get its due worth without the risk attached to other investments like exchange rate risk. No matter which country it is east or west, poor or rich, every country trades gold.
Gold has been the ultimate form of money for six thousand years of human history. Kingdoms across the globe used to have gold coins as a form of currency. We see lot of serials based on ancient epics where kings as well as citizen are shown using gold coins, which are also known as “Swarn Mudra” in Sanskrit. Government-minted gold and silver coins were first used in ancient Lydia in the late 7th century B.C. The growing democratic city-states of Greece soon thereafter introduced similar gold-coin standards, which rapidly spread westward to most of the city-states' republics, including Rome. The Persian Empire collected taxes in gold and minted its own gold coin. Ancient Rome minted two important gold coins: the Aureus, which was approx. 7.0 grams of gold alloyed with silver, and the smaller solidus, which weighed 4.4 grams, of which 4.2 was gold. It was widely prevalent in India till East India Company entered the sub-continent.
When Germany became a unified country following the Franco-Prussian War in 1870, it established the German Gold Mark or simply Mark. Rapidly most other nations followed suit. Gold became a transportable, universal and stable unit of valuation, and the world's dominant economy, the United Kingdom, had a longstanding commitment to the gold standard.
“Gold standards” should not be confused with their historical predecessor, "gold-coin standards", wherein taxes are payable in either gold coins or overvalued, government-minted and less expensive coins. Gold standards replaced gold-coin standards in the 17th-19th centuries in the West as the extent of defensive warfare expanded to where the gold-coin standards were no longer sufficient to the task.
However, after Second World War every thing changed. During the 1939–1942 period the UK depleted much of its gold stock in purchases of munitions and weaponry on a "cash and carry" basis from the U.S. and other nations. Britain was almost bankrupt. This convinced Winston Churchill to get away from the gold standard to something new where they can control the money flowing in their economy. This led to the 1944 Bretton Woods Agreement, which established the International Monetary Fund (IMF) and an international monetary system based on convertibility of the various national currencies into a U.S. dollar that was in turn convertible into gold. Why US dollar? Because US was the most powerful, rich and stable country after the second world war while the rest of countries were left with nothing after years of war.
Indians obsession with gold is world famous. Be it wedding, New Year or festivals, we Indians, especially females, buy gold jewelries every year. No doubt, India is the largest consumer of gold in the world – India constitutes over 22% of global gold demand. Indians view gold as a symbol of purity, prosperity and good luck. Gold is deeply linked with our cultural and religious beliefs, making it a unique commodity in India. Gold has long been a last line of defense for Indian households, a hedge against bad times, lower income and old age. We have seen many an Indian movies where actor’s mother has to sell gold to money lenders in exchange for money or some food items. This also signifies the fact that gold is considered as a currency for major transactions.Whether you walk to someone’s house to any Hindu temple, you will find gold everywhere. No doubt British called our country “Sone ki Chidia” i.e. “Golden Bird”. Though temples were plundered by numerous invaders for centuries, India’s gold reserve never dried up- it infact increased over a period of time. One of the reasons was massive donation of gold bars and jewelries to temples by people on several occasions such as festivals and birth of babies.
Gold possession is unique in India as it is bought with the intention that one day it will be passed to children, especially daughters or daughter-in-laws. Indians associate their pride, prestige and power with gold. Apart from the beauty quotient, Gold has got some healing and medical effects like it strengthens your blood vessels, smoothen your skin and prevents cancer. There is a seasonal consumption of gold in India – highest consumption occurs between September and January. Major Hindu festivals such as Dussehra, Diwali and Dhanteras take place during this time. Also, this is the peak season for wedding across India which again makes the demand strong.
1 . Investors gain from rising prices of gold. It may not give high returns like equity in short term but always maintain the value of investment. Also, these prices are not as volatile as stocks and hence offer more stability. Thus, investors should maintain 2-5% of their portfolio investment in gold.
2 . Gold is a perfect hedge against inflation – higher the inflation faster the value of currency devaluation. Thus, the real interest rates in the economy reduce or even become negative. In that case, gold become an obvious choice of investment because it value does not devalued affected with increase or decrease in inflation. Moreover, it is a safe haven against any economic, political, social or currency based crisis.
Like any other asset, the price of gold is influenced by demand and supply dynamics. Demand is both fuelled by consumers and investors. Both have different intentions of buying gold; even quality of gold differs for them. Consumers buy it on occasions such as wedding, festivals and New Year while investors buy gold when they feel it is more lucrative and stable than other forms of investments.
India is the biggest consumer of gold in the world. With a growing economy and rising affluent population, the demand for gold is getting stronger. Also, with the introduction of gold traded ETFs, people, who never invested in gold but wanted to do so, have started putting a portion of their income in these funds.
Gold has always been considered a good hedge against inflation. Rising inflation rates typically appreciates gold prices. It has an inverse relationship with interest rates. As gold is pegged to the US dollar, US interest rates affect gold prices. Whenever interest rates fall, gold prices increase. Lowering interest rates increases gold prices as gold becomes a better investment option vis-a-vis debt products that earn lower interest. Gold loses its shine in a rising interest rate scenario.
Before the US dollar, gold was the de-facto currency of exchange. However, after Second World War it was replaced by US $ because of growing US financial and economic clout as well as bankruptcies of major western powers. As gold is pegged to the US dollar, it has an inverse relationship with the dollar. Right now with US being in great financial turmoil, the dollar has weakened against many other currencies. Dollar is expected to weaken further and prices of gold are expected to rise further. Dollar is a de-facto currency of exchange around the world. But now with US on the brink of depression, gold is substituted as a safe haven for investments. Though dollar seems to be getting stronger, it may be a temporary effect and very soon it can head southwards once again, in turn making gold an attractive and safe investment.
Any political uncertainty or war like situation increases the demand for gold. This is because investors around the world invest in gold to prevent erosion of their investments. For example after 9/11 terror strike in the United States the demand for gold had increased. With the recent events like tension between India-Pakistan, Israeli strikes over Gaza, the ongoing war in Iraq, looming attack on Iran coupled with global recession have forced investors scrambling for gold. The moment investors become skeptical of economy or capital markets, they start moving their funds to gold – an universal hedge against uncertainties.
Central banks and the International Monetary Fund play an important role in the gold price. At the end of 2004 central banks and official organizations held 19 percent of all above-ground gold as official gold reserves. Also, with the depreciating dollar, central banks of most of the developed countries have started increasing their share of gold. This also explains the increasing market demand for gold.
General rule of thumb in the market is that gold is always attractive when all other investments are unattractive. Why is this? As gold is negatively co-related to stocks, bonds, and real estate, gold is considered to be a safe haven and hence during any crises, investors would like to sell off what they would term as risky investments and be invest the funds in gold.
Given the huge quantity of stored gold, compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production. However, the supply of gold does affect it price to some extent. Gold mining is decreasing across the world and the demand for gold is increasing. South African gold mining production fell by 6.5% in 2007 in volume terms against the previous year. Gold supply has decreased by almost 40 per cent as the cost of mining, legal formalities and geographical problems have increased which has led to a fall in gold mining. Theory of demand-supply says that lower the supply and higher the demand, higher is the price of an asset.
My idea of this article was to help our readers realize the importance of gold, to explore gold as an investment and understand the dynamics of gold pricing in the market. In other words, you should always look at gold beyond jewelry as it is a very stable and safe form of investment.
In the next article, I will cover different investment strategies for gold, its comparison with leading stocks in India and methods of investment in Gold. Whether it is better than investing in stocks or index fund, I would explore it in great details. Till then please keep an eye on this amazing Yellow Metal!!