The sharp decline in gold prices, which have hit a four-year low, needs to be seen through the prism of an investment portfolio diversifier. The yellow metal’s attractiveness is primarily driven by its record as a tested hedge against inflation. For households, particularly in India and China, gold has long been considered a safe asset, unlike equities, which are prone to the vagaries of market fluctuation. The slowdown in China, one of the biggest gold markets, has a lot to do with the crash in gold prices. Demand for gold has fallen by 24% during the first six months of the year, compared to 2014, leading to depressed prices in the international market.
More than the Chinese slowdown, it’s the policy moves in the United States that will have a more long-term influence over bullion price movements. Under normal circumstances, the value of the US dollar and price of gold are inversely related. A stronger dollar usually makes gold cheaper. This is because international prices of gold, like many other commodities, are denominated in dollars. If the dollar strengthens, it makes such commodities expensive in the other currencies. The resultant fall in demand sets off a fall in prices.
In the current context, the US Federal Reserve has hinted at the possibility of interest rate hikes, the first in nearly a decade. Analysts expect the first hike to be in by as early as September. An interest rate hike in the US could trigger a flight of dollars from emerging countries such as India. A rate hike in the US will encourage foreign, particularly US-based funds, to move money out of India to safer locations closer home. Global funds park money based on expectations of yields. With short-term rates ruling at near zero for nearly a decade, India and other emerging markets offering higher returns were the preferred hotspots. With interest rates set to rise in the US now, most funds may prefer to move money out of these markets. This expectation is making the dollar gain in value.
Many Indian consumers could sense this as an opportunity. With prices plummeting, it would not be surprising if one sees a rush of buyers to snap up gold and stock jewellery, primarily for wedding purposes. But there is a caveat. Every time the gold prices hit multi-year lows we need to ask ourselves why more of our savings are not financial. The answer to that probably lies in Indians’ penchant for stocking up on physical assets, as also on lack of financial literacy and awareness among a vast majority of the population. This trend needs to be reversed, otherwise the gains from the stock market will go mostly to institutional investors, and not to millions of individuals and households.