Demonetisation, stricter Indian government rules and positive US economic figures have led to a fall in gold demand as well as its prices worldwide. Yet, gold remains the most sought after metal across the globe despite losing its sheen since October 2016, shortly before Prime Minister Modi announced scrapping of the high value Rs 1,000 and Rs 2,000 currency notes. Ironically the demand for gold-backed ETFs and similar products reached a three-year high in 2016, says the World Gold Council (WGC).

Why gold will remain firm

• Heightened political and geopolitical risks;
• Currency depreciation;
• Rising inflation expectations;
• Inflated stock market valuations;
• Long-term Asian growth; and
• Opening of new markets

The demand for gold rose 2 per cent in 2016 to 4,308.7 tonnes, the WGC said pointing that investment demand was up 70 per cent reaching its highest level since 2012. China continued to boost the demand, however, as its growth slowed down. Attention also turned to Europe, where investors added around 114 tonnes to their holdings as concerns grew around the busy electoral calendar in 2017, with the Netherlands, France and Germany all going to the polls.

This is a pointer that gold remains a reserve currency amid economic turmoil. WGC predicts gradually Indian demand is also to grow as it comes out of the shock of note-ban. The falling prices may also attract investors. The US the data, however, present is likely to be the greatest factor in determining the prices which are seen sliding below $1200 an ounce. Better US figures, improving job situation, prospects of Federal Reserve hiking interest rates and a stronger dollar are changing the dynamics. The dollar is more lucrative as investment for its easier liquidity. .

The WGC indicates that India’s fight against black money is having an impact on gold trade. The government had during the past about 18 months imposed several measures. The WGC, however, also states that many of these steps had less than the desired effect. It notes that instead of nuggets, the demand for jewellery is growing. India is the world’s largest market for gold jewellery, representing about 822 tons (746 tonnes) of gold in 2010. Indian women own about 19,841 tons (18,000 tonnes) of gold jewellery.

“Over time, we anticipate that economic growth and greater transparency within India’s gold market will push the demand higher. By 2020 we see Indian consumers buying 850 and 950 tonnes,” WGC says. In August last, the RBI set up a committee to study Indian household financing pattern and why they spend large sums of money on gold. And at the same time, central banks are increasing the gold purchases.

The RBI itself, despite preaching virtues of not holding physical gold, in November 2009, bought 200 tonnes of it at around $6.7 billion from the IMF that boosted gold’s share in overall RBI reserves to 6.13 per cent from 3.3 per cent. The purchase came close on the heels of the global financial crisis, making it look like an effort to safeguard the country’s forex reserves against the impact of the crisis.

The RBI with 557.7 tonnes of gold holds the 11th highest reserves in the world. The RBI statement of March 3, 2017 says that the value is worth Rs 1,329 billion. The IMF rules say that countries can make payments to it in gold. It virtually makes it an international currency. According to the WGC, emerging market central banks have been big buyers of gold since 2009. The purpose of holding gold as a reserve asset by central banks is to diversify risks. This is the exact reason why most Indians buy gold when they can.

The gold investment demand, WGC says, would remain firm for six factors: heightened political and geopolitical risks, currency depreciation, rising inflation expectations, inflated stock market valuations, long-term Asian growth and opening of new markets. This calls for the nations to reformulate their financial policies. European countries are trying to boost economies through various stimuli, which have a high social cost.

It makes their currencies volatile and recently many lost against dollar, including British pound amid Brexit and feared exit of many others from EU. The WGC forecasts that as India comes out of shadow of demonetisation and is bound to grow so would gold demand. It should be viewed as a positive step and not a spanner in the wheel for the economy. Policy makers need to look at the gold paradigm from a new perspective. All major currencies have depreciated over the past century. It has to be integrated with real economy. Gold cannot be hedged out.

By Shivaji Sarkar