Factors that affect gold price

Factors that affect gold price

Demand for gold in India is interwoven with culture, tradition, the desire for beauty and the desire for financial protection.

(ET-Online) With an annual demand equivalent to about 25 percent of the total physical demand
worldwide, India is one of the largest consumers of gold. Traditionally, there is a surge in
jewellery demand during the festive and wedding seasons, leading to a rally in gold prices.
While the demand for gold has a role to play in its price, there are several other factors that have a bearing on it as well.
According to a report by the World Gold Council, annual data from 1990 to 2015, revealed two significant factors affecting gold
consumer demand (jewellery, and bar and coin combined) over the long-term. "All else being equal, gold demand is driven firstly by,
income i.e. gold demand is seen to rise with income levels. For a 1 percent increase in income per capita gold demand rises by 1
percent and secondly, gold price level i.e. higher prices deter gold purchases. For a 1 percent increase in prices, gold demand falls by
0.5 percent."
Here are few important factors that impact the price of gold.

Consumption demand

Demand for gold in India is interwoven with culture, tradition, the desire for beauty and the desire for financial protection. According to a
study by World Gold Council commissioned by the World Gold Council and Federation of Indian Chambers of Commerce and Industry
(FICCI), Indian consumers view gold as both an investment and an adornment. When asked why they bought gold, almost 77 per cent
of respondents cited safety of investment as a factor, while just over half cited adornment as a rationale behind their purchase of gold.

Protection against volatility

People want to invest or buy gold to protect themselves from volatility and uncertainty. The preference for physical assets makes Indian
households view gold as a safe haven, an asset to buy when other assets are losing value. Underlining gold's attraction as an asset for
good times and bad, most investors would buy gold whether the domestic economy was growing or in recession.

Gold and inflation

When inflation rises, the value of currency goes down and therefore people tend to hold money in the form of gold. Therefore, in times
when inflation remains high over a longer period, gold becomes a tool to hedge against inflationary conditions. This pushes gold prices
higher in the inflationary period.

Gold and interest rates

According to some industry experts, under normal circumstances, there is a negative relationship between gold and interest rates.
Rising yield indicates an expectation of strong economy. Strong economy gives rise to inflation and gold is used as a hedge against
inflation. Also, when rates rise, investors flock to fixed-income investments that yield a fixed return unlike gold which does not carry any
such return. So, demand takes a back seat with prices remaining flat.

Good monsoon

Rural demand plays an important role in the demand for gold in the country which depends primarily on monsoons. India annually
consumes 800-850 tonnes of gold and rural India accounts for 60 percent of the country's gold consumption. Therefore, monsoon plays
a big part in gold consumption because if the crop is good, then farmers buy gold from their earnings to create assets. On the contrary, if
there is deficient monsoon, farmers tend to sell gold to generate funds.
Impact of rupee-dollar equation
The rupee-dollar equation has a role to play in Indian gold rates although it does not impact global gold prices. Gold is largely imported
and hence if the rupee weakens against the dollar, gold prices will likely appreciate in rupee terms. So, a depreciating rupee may dent the demand of gold in the country. However, remember the change in rupee-dollar rates has no impact on gold rates denominated in
dollars.

Correlation with other asset classes

It is believed by some economists that gold is a highly effective portfolio diversifier due to its low to negative correlation with all major
asset classes. Still, as a rule, gold shows no statistically significant correlation with mainstream asset classes. However, some suggests
that there is evidence that when equities are under stress, in other words when shares are falling rapidly in value, an inverse correlation
can develop between gold and equities. Gold protects one's portfolio from volatility because the factors, both at the macro-economic and
micro-economic fronts that affect the returns from most asset classes do not significantly influence the price of gold.

Geo political factors

Gold usually does well during geopolitical turmoil and the current crisis over Korea's nuclear capability has boosted the prospects of the
yellow metal. Crises such as wars, which have a negative impact on prices of most asset classes, have a positive impact on gold prices
since the demand for gold goes up as a safe haven for parking funds.

Weakening dollar

Under normal circumstances, gold and dollar share an inverse relationship. Since international gold is dollar denominated, any
weakness in the dollar pushes up gold prices and vice versa. The inverse relationship is because firstly, a falling dollar increases the
value of currencies of other countries. This increases the demand for commodities including gold. It also increases the prices. And
secondly, when the US dollar starts to lose its value, investors look for alternative investment sources to store value and gold is an
alternative for those investors.

Future gold demand

According to some estimates, global demand for gold is 1,000 tonnes more than the supply. With no new mining capacity coming
through, most of the gold is being recycled. Therefore, less of supply is another factor for changes in gold rates. Inflationary pressures in
the world economy are positive drivers of gold prices.

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Forex, stocks, commodities Trader & Markets Analyst. Makkaba Co., Ltd. ST&C

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