The price of gold dipped 2% in international markets on Friday ahead of Diwali, giving Indian buyers some respite from a relentless rise over the past four years.
Gold gained 70% between 2008 and 2011 as the US Federal Reserve bought $2.3 trillion of bonds in two rounds of quantitative easing. Fed chairman Ben Bernanke in September announced an open-ended third round to buy $40 billion of bonds a month till the US economy showed signs of reviving. Around the same time the European Central Bank armed itself with the power to buy bonds to ease the debt crisis stricken European Union (EU) states. Japan and China are also trying to stimulate their economies, respectively, by monetary easing and spending on infrastructure. All of these are keeping gold prices aloft and last week’s dip was based on data from the US that showed the unemployment situation had improved.
Gold has a unique capability to transform from commodity to currency when confidence in paper money declines, as it has in the US and EU after the sub-prime crisis.
Western investors are using gold as a hedge against future inflation from all the money that is being printed to prop up their economies. Indians, however, have a secular attraction to gold. This has declined with western demand making gold unaffordable in the country. Imports have fallen from last year as the price of 10 grams of gold crossed R30,000. Yet, gold remains the most potent hedge against persistent inflation faced by Indians. The amount of gold we imported in 2011 has widened the trade deficit and the government is considering issuing inflation-indexed bonds that could ease some of the demand for the yellow metal.
For many in an under-banked country like ours, bullion will remain the first choice for capital protection. This constrains India’s economic growth by locking a big chunk of household savings in an unproductive asset. The pre-Diwali dip is an opportunity to stock up on our favourite metal, but gold prices will not oblige by staying low.