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Gaurav Choudhury, Hindustan Times
June 25, 2013
Why do people invest in gold? Unlike equities or bank deposits, gold is a physical asset and has been a traditional favourite for parking surplus income. What is the attraction of gold as an investment? Gold is considered a safe haven asset. In times of high inflation and volatile stock markets, gold prices usually tend to go up.

Its price had more than doubled from early 2009 to end of last year as investors in Europe and the US chose the safety of gold rather than park their funds in unstable and risky equity markets.

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What were the factors that drove gold prices to record highs?

The US Federal Reserve had announced a monetary stimulus measure called quantitative easing (QE) to shore up the economy.

By definition, a monetary stimulus infuses money into the system. This increase in money supply, some experts say, pushed up inflation: the classic text-book model says that when too much money chases too few goods, prices rise.

And as inflation goes up, people, it is widely believed, invest more in gold to protect against erosion of their asset values in the wake of high prices.

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What is QE?

“Quantitative easing” or QE broadly refers to the measures that the US Federal Reserve – the central bank of that country — has taken through easy monetary policy.

QE involves purchasing of government bonds by the Fed to pump in loads of cheap money into the financial system.

The American economy has been going through its worst slowdown since the Great Depression of 1929.

The first round of QE began in late 2008, when the Fed bought Treasury bonds and mortgage-backed securities to kickstart the moribund housing market. It did a repeat in 2010.

The third round, or QE3 as it has come to be called, began in September 2012—an open-ended scheme that came without a specific end-date. One condition for revisiting the QE3 was a recovery in the employment scenenario.

How does an unwinding of QE affect gold prices?

On June 19, the Fed announced a time-bound phaseout for the QE3, ending by mid-2014 according to current estimates, as the country has been showing promising signs of a turnaround.

A turnaround in the US economy — which represents about a quarter of the global economy — would make equities more attractive as an asset class than gold.

Investment in gold is entirely driven by capital appreciation, unlike other asset classes such as equities and property.

Therefore, a revival in the US equity markets, coupled with low inflation, will fetch higher tangible returns, prompting people to move out funds that are locked up in physical assets such as gold.

Is any other factor affecting gold prices worldwide?

Apart from the Fed move, a slowdown in the economies of Indian and China, two of the world’s biggest gold consumers, would also affect the prices of the yellow metal. A slowing China, the world’s second largest gold consumer, will push down the yellow metal’s demand. India, the largest consumer of gold, has announced steps to curb gold purchase to rein in a widening current account deficit — the difference between dollar inflows and outflows.

How do monsoon rains — or their absence — affect gold prices in India?

Farm income supports two-thirds of Indians, or about 800 million people. Rural spending on most items – from television sets to gold — goes down if rains are inadequate and farm output dips. Nearly 60% of total gold demand in India comes from rural areas, with most of the purchases happening during weddings.

How big is the Indian jewellery market?

India is the world’s largest market for gold jewellery, accounting for most of the nearly 1,000 tonnes of gold imports in 2012.  According to World Gold Council, 75% of women say they are constantly searching for new designs.

What drives the huge demand for gold in India?

More than 50% of gold jewellery is bought for weddings in India. The festival of Dhanteras, the most auspicious day in the Hindu calendar that comes just before Diwali, has traditionally created a strong seasonal surge in sales. Demand also surges during the Akshaya Tritiya festival in May.

The motivation for jewellery purchase in India is inextricably linked to wealth preservation and growth rather than pure adornment, but there is little distinction between investment and jewellery demand.

Gold is integral to all Indian wedding ceremonies: purchases relating to Indian weddings typically account for about half of India’s annual jewellery demand.  With 50% of the Indian population under 25 and approximately 150 million weddings anticipated over the next decade, the World Gold Council estimates that wedding-related purchases will continue to drive demand, approximately to the tune of 500 tonnes of gold a year.

A further 500 tonnes of existing gold will change hands in the form of gifts.