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Explained: Why are gold prices going up, and will this rise continue for long?

Gold Price: Why is the yellow metal continuing its dream run at a time when Covid-19 pandemic has pushed the global economy into a contraction mode? Will the gold prices continue the upward momentum?

Written by George Mathew , Edited by Explained Desk
New Delhi | July 23, 2020 11:44:26 am
Many gold analysts have now revised their price targets saying that prices could go up to Rs 65,000 per 10 grams in the next 18-24 months. (Source: Bloomberg)

After over nine years, gold prices hit Rs 50,000 per 10 grams on Wednesday in India – the world’s second-largest gold consumer after China – as a host of factors like global uncertainties triggered by Covid pandemic, weak dollar, low-interest rates and stimulus programmes have increased the appetite for gold.

Why is the yellow metal continuing its dream run at a time when Covid-19 pandemic has pushed the global economy into a contraction mode? Will it continue the upward momentum?

Why is gold going up and up?

Gold had a remarkable performance in the first half of 2020, increasing by around 25 per cent from its low in March and significantly outperforming all other major asset classes. Gold futures prices soared to a nine-year high of $ 1,856.60 per troy ounce in London on Wednesday, inching closer to their record high of $1,920 an ounce hit in September of 2011. One troy ounce is equivalent to 31.1034768 grams.

Though equity markets around the world rebounded sharply from their March lows, the high level of uncertainty surrounding the Covid-19 pandemic and the ultra-low interest rate environment supported strong flight-to-quality flows. Like money market and high-quality bond funds, gold benefited from investors’ need to reduce risk, with the recognition of gold as a hedge further underscored by the record inflows seen in gold-backed ETFs. Gold prices in India are dictated by international prices.

“International gold prices have been on the rise in the last a few months and picked up pace amid sharp losses in the dollar, additional stimulus measures and robust investor inflows. Rising virus cases and US-China tensions have also underpinned the gold price,” said Ravindra Rao, Head of Commodity Research, Kotak Securities.

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Why is it a safe haven?

Gold – an integral part of wedding ceremonies in India — is traditionally used as a hedge against inflation and considered as a safe haven for investors during periods of uncertainties. Whenever stock markets, real estate and bonds fall across the world, investors turn to gold to park their funds. The fall in the value of other asset classes and global uncertainties in the wake of Covid-19 helped gold climb to a record high. A key factor behind this robust performance is that the supply growth of gold has changed little over time – increasing by approximately 1.6 per cent per year over the past 20 years. In contrast, fiat money can be printed in unlimited quantities to support monetary policy, as exemplified by the Quantitative Easing (QE) measures in the aftermath of the global financial crisis. Gold, established as an investment, a reserve asset and an adornment, is highly liquid, no one’s liability, carries no credit risk and is scarce, historically preserving its value over time.

Will gold prices continue to rise?

Many gold analysts have now revised their price targets saying that prices could go up to Rs 65,000 per 10 grams in the next 18-24 months. Analysts are bullish as the fundamental factors like lower interest rates, negative rates in some economies, enormous amount of liquidity and expanded fiscal balance sheets of governments which are trying to push growth amidst Covid-19 are expected to dictate the price trend. “We expect precious metals to trade firm until the number of global cases of Covid-19 is under control or a vaccine is introduced in the market which is still a few months away,” said Nish Bhatt, Founder & CEO, Millwood Kane International.

With prices on the rise, investors have embraced gold in 2020 as a key portfolio hedging strategy. Regardless of the recovery type, the pandemic will likely have a lasting effect on asset allocation. “It will also continue to reinforce the role of gold as a strategic asset. And we believe that the combination of high risk, low opportunity cost and positive price momentum looks set to support gold investment and offset weakness in consumption from an economic contraction,” says a World Gold Council report.

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Has it given good returns?

Historically, gold has generated long-term positive returns in both good times and bad. Looking back almost half a century, the price of gold has increased by an average 14.1 per cent per annum since 1973 after Bretton Woods collapsed and the gold standard system of pegging the currency to gold ended, WGC says. Gold has surged nearly 40 per cent in the last one year while the Sensex showed a loss of 0.41 per cent at 37,871.52 (Wednesday closing) in the same period.

How big is India’s gold market?

WGC has estimated that households in India may have piled up around 24,000-25,000 tonnes of gold. Various temples across the country also hold sizeable gold holdings. The Reserve Bank of India bought 40.45 tonnes of gold in the financial year 2019-20, taking its total holdings of the yellow metal to 653.01 tonnes. While prices had shot up, economic slowdown and the lockdown triggered by the Covid-19 pandemic hit the demand for the yellow metal. As a result, demand for gold fell 36 per cent to 101.9 tonnes during the January-March quarter of 2020 as compared to 159 tonnes in the same period of last year. India’s gold demand for the full-year 2019 was 690.4 tonnes compared to 760.4 tonnes in 2018, down 9 per cent, according to WGC data.

However, around 120-200 tonnes of gold are estimated to be smuggled into India every year. The government last year hiked the import duty on gold to 12.5 per cent.

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