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May 22, 2024
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Why is the gold price increasing? Reasons and effect of the price rise


Usually, gold and equity market returns have an inverse relationship – if equity delivers good positive returns, gold prices are muted. However, at present, the stock market and the gold price are at an all-time high. The price of yellow metal is not only increasing in India but across the gold. The gold prices in the US hit an all-time high above $2,250. 

The gold price is up 38% from its last low point in 2022. Even in India, with the start of the new financial year, the gold price has crossed a new milestone of Rs 70,000 per 10 grams in some parts of the country. In this article, our focus will be to understand why the gold prices are increasing and what will be its overall impact.

History of gold prices in India

Before we get to the details of the gold price increase, let us look at the gold prices in India over the decades. It will help you understand how the prices have increased and what to expect from the shining metal in the future.

Here is how the gold price has increased in the recent decades:

Year

Average Gold Price (per 10 grams)

1980

Rs 1,800

1990

Rs 3,200

2000

Rs 4,500

2010

Rs 18,500

2011

Rs 26,000

2012

Rs 31,500

2013

Rs 29,000

2014

Rs 27,500

2015

Rs 26,000

2016

Rs 28,500

2017

Rs 29,500

2018

Rs 31,000

2019

Rs 35,000

2020

Rs 49,500

2021

Rs 52,000

2022

Rs 48,500

2023

Rs 64,500

Over the last two decades, gold has given an average return of 11.2%, which is much better than the other asset classes. However, as you can see in the table above, there are a lot of lean phases. For example, between 2012 and 2018, there was no increase in the gold price. Post that the prices have been continuously increasing, and it takes us to the important question.

Why are gold prices increasing in India?

Here are some reasons for the increase in gold prices:

Reason 1: Fall in Dollar Index

The relationship between the price of gold in India and the US Dollar Index (DXY) is often inverse, meaning that when one goes up, the other tends to go down, and vice versa. The Dollar Index has fallen in recent months. In March, it even touched 102.5 levels. But why does it have an inverse relationship? Let us understand.

Gold is denominated in US dollars on global markets. Therefore, when the US dollar strengthens against other currencies, the price of gold tends to decrease in dollar terms. Conversely, when the US dollar weakens, the price of gold tends to increase. This relationship is because a stronger dollar makes gold more expensive for holders of other currencies, leading to decreased demand and lower prices while a weaker dollar makes gold relatively cheaper and increases demand, pushing prices higher.

Reason 2: Interest Rate Cut Expectation by the Fed

It is expected that the Federal Reserve will announce the first interest rate cut in June this year. Gold typically has an inverse relationship with interest rates. When interest rates are low, the opportunity cost of holding gold (which doesn’t yield interest or dividends) decreases, leading to increased demand and higher prices. Conversely, higher interest rates can reduce the attractiveness of gold as an investment, leading to lower prices. Now, with interest rates expected to go down in the US and also in India, gold prices may continue to rise.

Reason 3: The Chinese Demand

Gold demand in China has been on the rise in recent quarters. The Chinese central bank has been adding substantial quantity of gold to its reserves which is leading to the increase in the gold price in the US and also in India. Not only this, as per reports, a new trend has emerged in China where gold buying is becoming popular among young Chinese.

Effect of increase in gold prices

An increase in gold prices has a different impact on different industries. Let us look at the effect on different areas:

Consumers

  • Purchasing Power: Higher gold prices may reduce the purchasing power of consumers, particularly in countries where gold is widely used in jewelry and cultural ceremonies.
  • Substitution Effect: Consumers may substitute other materials or assets for gold in jewelry or other purchases if gold prices become prohibitively high.

Global Economy

  • Inflation Expectations: Higher gold prices may reflect increased inflation expectations, which can have broader implications for monetary policy, interest rates, and economic growth.
  • Risk Sentiment: Changes in gold prices can impact overall market sentiment and risk appetite, particularly during periods of economic uncertainty or financial market turbulence.

Central Banks

  • Reserve Management: Central banks that hold gold reserves may see an increase in the value of their reserves as gold prices rise.
  • Monetary Policy: Higher gold prices may influence central banks’ monetary policy decisions, particularly in countries where gold plays a significant role in the economy or monetary system.

Governments

  • Export Earnings: Governments of gold-producing countries may benefit from higher gold prices through increased export earnings.
  • Fiscal Policy: Higher gold prices may influence government fiscal policy decisions, such as taxation and regulation of the gold mining industry.

Effect on Indian Economy

Below are the effects of an increase in gold price on the Indian economy:

Current Account Deficit (CAD): India is one of the largest importers of gold in the world. When gold prices rise, the value of gold imports increases, leading to a widening of the current account deficit. A higher CAD puts pressure on the country’s balance of payments and can lead to the depreciation of the domestic currency.

Import Bill: Higher gold prices lead to an increase in the import bill for gold, which affects India’s trade balance. The increased import bill puts pressure on foreign exchange reserves and can impact the overall stability of the economy.

Government Revenue: The Indian government imposes import duties on gold to regulate its imports and generate revenue. An increase in gold prices leads to higher import values, which in turn results in increased revenue for the government through import duties.

Gold Loan Market: India has a significant gold loan market, where individuals borrow money against their gold assets. An increase in gold prices can lead to higher loan values for borrowers, potentially increasing liquidity in the economy. However, it also increases the risk of default if borrowers are unable to repay their loans.

Jewelry Industry: The Indian jewelry industry is one of the largest consumers of gold in the country. Higher gold prices can lead to increased production costs for jewelers, affecting their profit margins. It may also lead to a shift in consumer preferences towards alternative jewelry materials.

Before you go

The gold price has been on the rise. It is expected to increase further. However, it is essential to note that gold prices are influenced by a complex interplay of various factors, and prices can be volatile in response to changes in these factors. As a result, predicting gold price movements in the short term can be challenging.



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