What has happened
Over the past few weeks (July 2015), gold prices have dipped alarmingly all over the world to lows not seen for five years.
Why this has happened
The Dollar is very strong right now, and gaining against most currencies. Hence, the US Treasury Department feels the US economy can handle a tighter monetary policy. Therefore, for the first time in ten years, it is going to increase interest rates on US Treasury bonds. So now, investors everywhere are demanding these US bonds as sources of investments (they are anticipated to give a better return in the future), and demand for gold has gone down. Hence, gold prices have been badly hit.
At the same time, there has been over-production of oil resulting in excess supply. Also, the Greek crisis and the Chinese stock market crash have reduced the demand for oil in those regions. So, oil prices are also very low right now. Because the major expenditure in most economies is oil, this means inflation is also low everywhere, including the US. So, there is a chance that low inflation could cause the US to slow down or delay its proposed tightening of the economy. This means there is a chance that the huge demand for US Treasury bonds will fall and investors will start getting interested as an investment again, causing the value of gold to rise. So, oil could play a role in determining gold prices.
Another thing to understand is that gold is almost always traded in dollars. So, a weaker dollar makes gold cheaper for other nations to purchase. It increases demand for gold.
Today, the dollar is strong and this is also contributing to low gold prices.
Remember, since gold and US bonds are both two types of investment available in the market, investors will always go for the one that is more attractive. When interest rates on bonds go up, they will prefer investing in bonds because bonds will give a greater reward than gold. Gold doesn’t give that great a return. But since it is a stable entity, it is almost used as a backup investment in unstable economies. So, gold prices and US Treasury rates are inversely connected.
(A concept that should reinforce your understanding: When inflation is high, the value of paper currency falls in terms of the goods and services that it can buy. Investors look for something that doesn’t lose its value. Gold is an alternative for investors when inflation is high. As a result, gold usually has a direct relationship with inflation i.e. the demand for gold increases during inflation and decreases during deflation).
What this situation implies for India
India is traditionally a heavy user of gold. with almost all of our demand being met by imports. Since gold is available cheaply right now, Indians will want to buy a lot of it before prices rise. So, even though the price of gold imports has fallen, demand for imports is going to rise, and our overall expenditure for gold will not fall by much:
This is where the proposed “Gold-monetisation scheme” comes in. There is a lot of gold in Indian homes right now. And, the govt is trying to convince people who do not plan to use their gold to deposit that gold in banks and earn interest. If this can be successfully done, then Indian banks will end up with a lot of gold in their hands. And, the excess gold that other consumers are demanding can be obtained from inside the country itself. When both the cost of imports and the demand for imports have fallen, only then we can expect some serious savings in our import bills.
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