Gold by Raunaq Sen Gupta

From the very beginning, something about gold attracted civilizations all over the world without those civilizations ever having made contact with each other. Not only does gold`s natural beauty make it so mysteriously precious, but it may also be the most useful metal in the world. Gold is also one of the few commodities that can also be thought of as a currency or monetary asset. Many currencies around the world used to be backed by gold until recently and, although the gold standard is long since abandoned, gold is still very effectively used as a safe haven asset in times of economic turmoil to preserve wealth.

The first person or civilization to discover gold is the Ancient Egyptians. They mined gold in Nubia around 2450 BC. An Egyptian alchemist named Zosimos was the first to find pure gold (24 centuries before Columbus reached the Americas). The discovery of gold is attributed to the ancient Egyptians, who made jewelry out of gold. It was at a time when other metals were scarce and valuable. 

Historians agree that the civilization of Ancient Egypt was at its prime and had almost everything under control except when it came to maintaining permanent sources of weight. There was an era when even gold was relatively heavier for them than stone.

The history of gold is long connected with money, but gold relinquished this role in developed economies after the outbreak of the Second World War. At the end of the war, the Bretton Woods monetary system, a regime of fixed exchange rates, was created. This system broke down in 1971 when the US unilaterally ended its gold standard, which set the convertibility of gold and the dollar to US$35 per ounce. References to the Gold Standard often refer to two key periods in history: that of the Classical Gold Standard and that of the post Bretton Woods gold-pegged exchange rate system.

Domestic currencies were freely convertible into gold at the fixed price and there was no restriction on the import or export of gold. The system drawn up fixed the dollar to gold at the existing parity of US$35 per ounce, while all other currencies had fixed, but adjustable, exchange rates to the dollar. .

 

Economics Of Gold  - Indian Perspective

According to some estimates, India has a stock of about 23,000-24,000 tonnes of gold which is mostly held by households. In value terms, based on the 2015 average price, it was worth $800 billion.

To put this into context, tech giant Apple's market capitalisation at the same time was around $600 billion, and two of India's largest listed companies, Reliance Industries and Tata Consultancy Services, were quoted at around $100 billion each. The role and the impact of gold are reflected by the gems and jewellery industry which contributes around 7 percent of the country's gross domestic product (GDP) and 15.71 percent to India's total merchandise exports. The gems and jewellery sector in India is one of the largest in the world and contributes to about 29 percent of the global consumption. In FY 2014-15, the sector constituted 13.30 percent of the country's total merchandise exports. 

This insatiable hunger for gold has resulted in India’s gold imports constituting a massive 12.50% of its total imports in 2012-13, which is a whopping $61,409 million dollars. In 2012, the total gold production in the world stood at 4,130 tonnes, and India imported 26.12% of that (1,079 tonnes) – one fourth of the world’s total gold production.

A country’s exports must be more than its imports to maintain a favourable balance and grow the per-capita income of the country. As of December 2012, we have a current account deficit of 6.7% (experts, analysts and the RBI says that we can sustain only with a maximum consistent deficit of up to 2.5%). To counter this, the RBI has implemented an 80:20 system, wherein 80% of the imports would be used to satisfy domestic demand and 20% would have to be re-exported after value additions, by turning gold bricks into jewellery.

In 2011-12, around 56% of all the gold that was being imported came through banks who sold it to the public in the form of coins. In 2013, the Finance Ministry banned banks from selling gold coins in an effort to control the expanding current account deficit (CAD).

Gold is used in India as a form of tackling inflation, and holding an item with an intrinsic value because of its rarity is a good way to counter the fluctuations in fiat currency. As a traditional form of savings in India, gold instils a feeling of comfort and security in a person’s wealth. This has been termed the “exposure effect” by psychologists.

While holding financial gold and gold in the form of ETFs and E-gold is a prudent investment, holding physical gold in the form of a real asset is preferred for the simple reason that it can be held, felt and kept safe in a box. This experience of physically owning gold is important to Indians, and is another reason why we like gold so much – it’s safer in terms of real value than the Rupee, and appreciates over time. 

Gold - WTI Crude Ratio

 The Gold - Oil Ratio is a key indicator that indicates the health of global economy.  

Since both gold and oil are denominated in Dollars, they are strongly linked .i.e as US dollar rises, commodities priced in USD falls and vice versa. Simply speaking USD and commodity prices are inversely related. Also, gold and oil is linked by inflation. Energy prices constitute a substantial portion of CPI and thus when crude rises, it affects inflation. Since gold is seen as a inflation hedging asset, it follows higher oil prices i.e as inflation rises, due to higher crude prices, the gold price also moves in the same direction as oil, so as to beat inflation. This happens as investors invest in gold, in order to hedge their portfolio against gold. 

 

The above diagram represents the  Gold – WTI Crude Ratio. For most of history, this ratio has been between 10 and 30. Anything beyond 10-30 indicates that gold is more expensive relative to oil.

The ratio spiked in 2020, due to the COVID Pandemic. This was due to combination of WTI falling to very low levels due to low demand for oil ( supply greater than demand) and rising gold prices. Economically speaking, if oil prices are coming down and gold prices are rising, it means that the economy is in very poor shape and that a recession might be around the corner.

Gold & Silver Prices

Over the past half century, gold and silver prices have shown a strong positive correlation. Historically, the Gold-Silver correlation has been in the range of .040 to 0.80.

Also, silver has outperformed gold during periods of economic expansion and tended to outperform gold during periods of economic stress.

Gold is primary used for jeweler y and investment purpose. As on 2021, 12% of total gold was used for industrial application, 28% for investments and the rest 60% for jewellery. On the other h2

Silver prices tend to follow Chinese growth with a considerable lag -  Silver prices rose sharply from 2005 to 2007 following a period of strong growth in China. They then fell sharply in 2008 as China’s economy slowed a great deal during the early stages of the U.S. sub-prime crisis.  Starting in 2009 Chinese growth surged as China launched a massive stimulus program that took the growth rate of its industrial sector up to 27% year on year.  Silver prices soared in the wake of this extraordinary Chinese boom, eventually rising towards $50 per ounce in 2011.  By this time, however, China’s economy had begun to slow sharply and silver prices fell with it.  Silver’s extraordinary rebound versus gold in 2020 and 2021 may relate to the rebound in growth that China experienced in late 2020 and early 2021 as they were the first nation to emerge from pandemic lockdowns.  However, China’s growth has slowed considerably this year and that might explain why silver has underperformed gold in recent months .