Why are Gold prices skyrocketing? Is it a good time to buy?

Why were Gold Prices Sky-Rocketing? And Is it a Good time to Enter?

After the gold prices crossed Rs. 50,000 for 10g after 9 years period since 2011 in India, there seems to be no stop to how high the prices can go. The gold prices touched Rs.58,100 for 10g in Bangalore as of 7th August. This shouldn’t have come as a surprise because commodities like gold have always had exceeding demand in India. Especially after considering that India is one of the world’s largest consumer second only to China.

However, the increase seems unrealistic in times of pandemic where every investment seems to have suffered, only gold seems to have found its biggest boom. In the three year period from September 2016 to October 2019, gold saw an increase of 25% in its value. But along with the increasing troubles of 2020 in the midst of a pandemic the value of gold has already shot up 37.8% or by Rs. 15,240 with 5 more months to go.

Today, we take a look at the scenario finding possible reasons for the boom and also discuss if investing now is a good idea.

The Indian Gold Market

It would be rare to find a market in India that has consistently been in demand such as that of Indian Gold. There have been many jokes that have passed on claiming that the gold available in households is more than sufficient to cover all the deficits and debt that our country faces. But when we look at the following figures these statements may not be exaggerated. Indian households have piled up as much as 25000 tonnes of gold. To put things in perspective that alone would amount to Rs. 145.25 lakh crores in today’s rates. India’s central bank the RBI, on the other hand, has a total holding of 653.01 tonnes of gold. That too after buying additional 40.45 tonnes of gold in the current year. 

The figures in the households are the ones that have been accounted for. It does not include gold smuggled into the country which stands approximately at around 120-200 tonnes every year. After observing these figures it may not come as a surprise that India accounts for 25% of the world’s total physical gold demand worldwide. 

Why is there an increase in Gold Price?

For many Indians, gold has always been the favorite investment instrument traditionally apart from the land. Despite this, a significant portion is still placed in liquid assets like cash, stocks, etc. In the times of a pandemic, individuals are seeking shelter for their savings in an investment that doesn’t necessarily provide great returns but at least maintains its value and provides liquidity. This has led to the demand for gold skyrocketing to new heights.  

Now we take a look at some other factors that have lead to this increase in demand.

1. Scarcity

As you may already know that gold is scarce because all gold is mined. Over time however mining for more gold has become difficult and due to its characteristics, it is safe to say most of the gold is recycled and put back into circulation. But luckily enough this gold cannot be consumed like other commodities. Enabling it to keep its value since time immemorial keeping up with the rising population. Another factor that adds to its scarcity due to its lack of consumption is what happens after the commodity is bought.

Gold, after it is bought, is taken out of the market for long periods of time only to be kept in a drawer or bank locker taking it out of the market for years. But these factors like scarcity, inability to consume, etc, have always existed. Then why have the prices increased now?

These factors have always existed at lower prices only because the increasing demand has always been checked with adequate supply. In order to limit the spread of the virus most countries had to resort to a lockdown. This has had adverse effects on not only mining but also a lack of shipments. As per some estimates, the global demand for gold is 1000 tonnes more than the supply. This rise in demand as mentioned earlier has been due to people’s search for a secure asset.

2. Culture

gold india

The demand for gold also has its roots in humans’ desire for beauty. Demand for gold in India is interwoven with culture, tradition. This is primarily because of the dependence of marriages and other functions on gold. According to a study by the World Gold Council, Indian consumers view gold as both an investment and an adornment. When asked why they bought gold, almost 77 percent of respondents cited the safety of investment as a factor, while just over half cited adornment as a rationale behind their purchase of gold.

3. Geopolitical Factors.

People search for a safe haven like gold extends to periods of geopolitical tension like war. This is the reason why crisis situations like wars have a negative impact on almost all asset classes. But when it comes to gold it has a positive impact. This increase in the price of gold was earlier also noticed during the Korean nuclear crisis. Similar trends are noticed due to tensions between India-China and US-China.

4. Exchange Rates

It has been observed that a weakened US Dollar also leads to a rise in gold rates. The same is noticed in the current situation.

5. Limited Influence by Big Market Movers.

increasing gold prices Limited Influence by Big Market Movers

In stock markets, it is the FII and DII’s that are termed as market movers. This is because of their ability to influence market trends due to top huge capital in possession. In the Gold market, it is the central banks that have a significant influence. This is because almost every central bank keeps reserves in the form of investment in gold. When an economy is performing well and the RBI has sufficient foreign reserves it will want to get rid of gold.

Because gold does not generate any return and a booming market will provide a better return if the money is invested elsewhere. But in this scenario, the other investors as well will not want to invest in gold as they too would prefer to earn returns. Hence central banks are caught on the wrong side of the trade leading to a fall in the value of gold.

 But however, the influence the central banks like RBI have is limited. This is because of the Washington Agreement. This agreement, however, is not binding and is more like a gentleman’s agreement. According to it, central banks will not sell more than 400 metric tons a year. Limiting the influence of central banks even if they want to benefit from high prices.

In Closing: Should you Invest in Gold now?

Predicting Investments is always tricky due to the uncertainties present. Most of us may have already noted the effects of economic turmoil on gold and decided to invest in the future if we are faced with a similar scenario. But that doesn’t help today, does it? In order to help you take better decisions, let us take a look at previous gold rate highs.

In Closing: Should you Invest in Gold now?

If you notice in the above chart you’ll be able to see that the Gold rates boomed in the 1980s as well. But a person investing in such a high would only reap the benefits almost 3 decades later post 2008. Similarly, a person who invested in 2011 is reaping some minimal positive benefits in 2020. Hence considering this if investments were made in gold say in early 2020 is a completely different story than investing now.

However, it is also best to take a look at the forecasts predicted by analysts. Analysts, however, have been bullish and have predicted that gold prices could go up to Rs. 65,000 for 10g in the next 18-24 months. But it is necessary to note that these estimates depend on a period that COVID-19 will take a while more to be controlled. Also, public vaccine availability is not anticipated for at least months to come. 

From the above arguments, it shows that when the investment is made on a long term perspective there may be other alternatives that provide better results in the same time frame. However, investing for short periods completely depends on one’s estimates for COVID control or vaccine availability oy unavailability.

Also read: [Update] COVID-19 Vaccine: When can we expect it to be ready?

investing in gold in india cover

Is Investing in Gold a good idea in India?

A large proportion of the Indian population considers Gold as one of the best options to invest in India. Here, gold is not only treated as a satisfactory long term wealth creator but also auspicious and a symbol of social status. As per the World Gold Council, India ranks second in the globe in Gold consumption, after China. Up to 20-25% of the world’s Gold is consumed in India in the form of jewellery, bars, coins etc.

Ironically, a few years back, the fixed deposit was considered more promising investment options for the middle-class Indians. However, nowadays, the interest earned on FDs has gone substantially down, because of which FDs don’t seem to be as genuine potential wealth generating option like earlier. These days, people are again revealing a lot more inclination towards Gold investment.

Anyways, Gold is a long term investment option and not suitable for earning short term gains. Moreover, the prices of Gold fluctuate in a cyclical manner. Therefore, one cannot expect Gold to perform well all the time.

Why should you invest in Gold?

Indians have been investing in gold for thousands of years and it has so far proved to be a solid investment option. Here are a few best reasons why you should invest in gold:

— Gold acts as a hedge against inflation: History states that Gold has performed relatively better compared to equities or other investment options in the scenarios of high inflation. Stock prices do not have any functional relationship with inflation. However, as Gold belongs to the commodity market when the economy witnesses rising inflation, the Gold price goes up.

bloomberg report gold inflation

(Image credits: Goldsilver.com)

— Investing in gold won’t cost you a fortune: Unlike investing in real estate (which requires a bigger investment amount) or equities (which require paperwork to open your trading account), investing in gold is easier for most of the average Indians and does not require a big amount to get started.

— Investment in gold offers high liquidity: If you own a Gold coin or jewellery, you can easily liquidate it as you can sell your physical gold at a local jewellery shop anytime. Although stocks and mutual funds can also be converted into cash fast. However, such instruments do take a few days time to process the redemption and the selling amount to get credited in your bank. As compared to these securities, Gold offer higher liquidity.

— Gold investment can help you to balance the risk in your portfolio: In order to reduce the portfolio risk, it is important to diversify your investments. Gold, having a negative correlation with Equities, can help you in diversifying your portfolio in a convenient way. Whenever your equity portfolio is going through a bear phase, a notional loss on the same can be absorbed by your gold investments.

Also read: How Does The Stock Market Affect The Economy?

How to invest in gold?

First of all, Gold investments do not only mean investing in physical Gold like gold coin or jewellery. There are various other ways available for investing in Gold in India.

Although investing in Gold via jewellery is decent in terms of generating long term wealth. However, keep in mind that when you purchase Gold jewellery, you have to pay the making charges too. Despite, when you sell that jewellery, you will only get the price for the Gold (and not the making charges that you paid earlier). Instead of investing in Gold jewellery, opting for Gold coins or bars seems a better choice. The latter is more profitable because here you do not need to pay the making charges.

Anyways, you can also invest in gold via Gold Mutual Funds. These funds invest in those companies which carry out extraction and mining of Gold or marketing of the same. The Gold Fund schemes are managed by skilled and experienced Fund Managers and are highly liquid. Therefore, investing in these Funds is a convenient option if you are looking to invest in gold. Nonetheless, the cons associated with the gold fund is that you might have to pay an exit load on your investments. Apart from that, you also have to pay an expense ratio which is deducted from your NAV every year for management and operational expenses.

Further, Gold ETF is another option while investing in gold. It works in a similar manner like Gold Mutual Funds but the same is traded on a stock exchange. However, you need to have your own Trading and Demat Account with a broker to invest in a Gold ETF. In addition, Gold ETF does not allow you to invest via SIP mode, unlike Gold Mutual Funds.

Lastly, if you want to invest in gold via the direct stock market, you can opt for investing in Gold mining companies. Investing in Gold mining stocks means investing in companies engaged in the mining and marketing of Gold. The performance of these stocks is not only related to the fundamental factors of the companies but is also dependent on the Gold rates.

Cons of investing in Gold

No investment option is perfect and gold investing also have some limitations. Here are a few key pointers which you should keep in mind while you invest in Gold:

— Gold does not generate sufficient returns like stocks or bonds: Gold is not a passive investment option. Investing in gold does not offer dividends or interests. Therefore, the only way to make a profit from Gold investment is by selling off.

–  Your Gold investment may demand safety against theft or robbery: Gold is a valuable asset. If you are planning to keep physical Gold, storing the same might be a matter of concern. Alternatively, you may store your physical gold in a bank ‘locker’ but this may cost you periodical maintenance charges.

gold safety thief

— Investing in Gold is not tax-free: When you purchase physical Gold, you will be charged GST on the same. Moreover, Gold is treated as a capital asset. Therefore, whenever you sell Gold for profit, a tax on short term capital gain or long term capital gain is applicable. You can read this blog to know more about taxation of Gold in India.

— Gold investing is cyclical: As we discussed earlier, the prices of Equities and Gold usually move in the opposite direction. When the stock market witnesses a bearish (downward) trend, the Gold price goes up and investors find Gold an attractive investment option during these times. However, when the cycle changes and the stock market goes in a bull run, the gold price starts going downwards and gold investing may be ignored by the investors.

Conclusion

In this post, we covered the basics of investing in Gold. If you are seeking a regular source of income through your investments, Gold may never serve this purpose. However, if you want to hedge your existing investments in Equities and Bonds, you should consider investing in Gold. Further, if you are planning to invest in Gold for the very first time, it is recommended to start investing via Gold Mutual Funds or Gold ETF.

Apart from acting as a hedge against inflation, Gold comes in handy during the situation of financial crisis. Nevertheless, you should not treat Gold as your only choice, but consider it as one of the investment options in your portfolio. Ideally, you should allocate up to a maximum of 10% of your portfolio in Gold.

Whether you invest in Gold or not is solely your choice. However, what matters more is the clarity in your mind regarding why you are investing in the same.