Why is gold falling, and where is it headed?

Domestic gold prices have plunged below Rs 25,000 per 10 g for the first time since August 2011, mirroring an international trend. Harish Damodaran explains the factors behind the fall, after the bull run earlier in this decade.

Why have gold prices crashed — to more than five-year lows globally, and to near four-year lows in India?
To answer that, we need to answer why they went up so much in the first place. If one takes a real long-term view, world gold prices barely rose for almost three decades, even more so when adjusted for inflation. The $ 850 per ounce price at London reached on January 21, 1980, was surpassed only on January 3, 2008, and crossed $ 1,000 levels by mid-March, before plunging again to $ 700-750 levels in late October following the financial crisis. The actual rise took place only thereafter, with prices reaching an all-time high of $ 1,895 per ounce on September 5, 2011. But since then, they have come down to just above $ 1,100. In India, too, prices of standard 24-carat gold in Mumbai touched a record Rs 33,265 per 10 g on August 28, 2013. On Wednesday, they fell to Rs 24,820, the lowest since August 6, 2011.

The point to be noted is that bull runs in gold have been episodic and rare, and largely a response to currency crises. The last rally, for instance, came in the aftermath of the global financial crisis that led to unconventional monetary policies in industrialised countries — from near-zero interest rates and forward guidance to quantitative easing. The perceived debasement of fiat currencies by the printing presses of the world’s leading central banks — including the US Federal Reserve — prompted investors to put money in gold and other ‘solid’ assets. The pessimism over fiat currencies extended to even interest in Bitcoin and other such krypto-currency experiments. Gold’s high coincided with the US debt ceiling crisis of 2011, that saw the federal government almost running out of cash before a last-minute deal stitched with Republican congressmen allowed the Treasury to raise its borrowing limit before the deadline ran out.

Simply put, gold prices have gone up whenever public confidence in the dollar — the world’s reserve currency — has suffered erosion. This is hardly the case today, with the US economy recovering from a recession even with low inflation — defying dire predictions of an imminent dollar collapse. The best proof of it is the US dollar index, which measures the value of the greenback relative to a basket of six other global currencies. The dollar index (base: March 1973 = 100) is currently close to 98, compared to the low of 72.93 on April 29, 2011 when the American economy was still sputtering. A strong dollar has made the world somewhat less pessimistic about fiat currencies, while reducing the allure of gold as a safe haven asset. The dollar index and gold prices generally move in opposite directions.
What about India? Why are prices falling here?
India imports the bulk of its gold requirement. So, a decline in world prices automatically translates into lower prices here. The rupee’s value also plays an important part. The day gold prices in Mumbai hit a record high of Rs 33,265/10 g — on August 28, 2013 — was also when the rupee crashed to an intra-day low of 68.85 to the dollar. Again, the demand for gold in India as an investment option peaked when the rupee was viewed as a weak currency, both externally as well as in terms of domestic purchasing power. It is the opposite today, with a strong rupee in combination with relatively low inflation making the yellow metal not a very good investment. (The huge outflows from gold exchange-traded funds would testify to this.) Gold ultimately has very little utility other than being raw material for jewellery and a store of value (though perhaps not over the long run). Nor does it generate any income — unlike rentals from land, dividends from shares or interest from bonds.

But can the shiny metal rally again?
Unlikely, at least in the immediate future. A strong dollar, reinforced by a hike in interest rates by the US Fed which seems increasingly inevitable, could well force gold to test the $ 1,000/ounce floor levels. Add to this Greece’s avoiding a messy default on its payment obligations or an exit from the Euro zone for now, and a landmark nuclear deal between the world’s major powers and Iran, there is no ‘safe haven’ support for gold either. And as far as India goes, a big negative for gold is diminished rural purchasing power. Given that an estimated two-thirds of India’s gold demand comes from rural areas, lower crop prices and a not-so-good monsoon so far is not good news for bullion traders and jewellers. But it isn’t bad for the country’s balance of payments. Gold imports peaked at $ 55-56 billion in 2011-12 and 2012-13 and, along with oil, were the primary source of current account deficits, before falling to $ 29-34 billion in the last two years. And they could fall further this year.

-Indian Express