The recent depreciation in gold prices is a result of a number of factors - such as a dip in demand as a safe haven relative to currency and better performance of equities. The immediate reason for the price crash was the fear that Cyprus may sell some of its gold reserves to reduce its debt burden and that Euro Zone countries with larger gold reserves may emulate Cyprus. Gold continues to provide an important store of wealth to individuals and institutions. This precious metal is often seen as a hedge against inflation, especially during hyper inflation.

Gold’s problem is that it yields no return or interest on investment. In Act 5, Scene 1 of William Shakespeare’s Romeo and Juliet, Romeo tells the apothecary: -

“There is thy gold, worse poison to men’s souls,

Doing more murder in this loathsome world,

Than these poor compounds that thou mayst not sell.”

Gold standard

From 1821 to 1937 a gold standard existed in one form or another. Gold standard worked very efficiently till World War 1. It succeeded in ensuring exchange stability and gold served the purpose of an international medium of exchange. But with the starting of the War in 1914, many countries failed to observe the rules of the ‘gold standard game’ and gold standard was abandoned by most countries mainly to avoid adverse balance of payments and to prevent gold exports to enemy nations. Central banks of most countries still hold gold reserves as a store of value and as a support backing the currency issued. The US Federal Reserve System, the largest gold depository in the world, holds about 3 per cent of global gold stock. The Reserve Bank of India’s gold reserves are 557.75 tonnes. Gold as a percentage of RBI’s total reserves was only 8 per cent in 2009.

India consumption

Apart from gold, the RBI’s reserve assets include foreign currency assets, Special Drawing Rights (SDRs) and reserves held with IMF. SDRs are artificial currencies used by the IMF and defined as a “basket of national currencies”. The IMF allocates SDRs to its member countries and uses them for internal accounting purposes.

Central Banks are the biggest losers in the latest price crash as they own 31,694.8 tonnes or 19 per cent of all gold mined. It is reported that the recent fall in gold prices has already eroded $560 billion from the value of central bank reserves. Some central banks, such as that of Canada, eliminated their gold stock.

India is the world’s largest single consumer of gold. It is also the largest importer of gold. India buys about 25 per cent or 800 tonnes of the world’s gold every year. Indian households hold 1,800 tonnes of gold worth $950 billion, which represents 11 per cent of global stock. The demand is mostly for jewellery.

Global annual gold production over the last ten years averaged 2,300 to 2,500 tonnes. The prominent gold producers are South Africa, Australia and Canada.

The average annual global demand during the same period was around 3,800 to 4,000 tonnes of which jewellery demand was the single largest component; 10 per cent of the demand was for industrial use and 9 per cent for retail investment in bullion. With consumption of gold always exceeding production, one is led to conclude that the price of gold will continue to rise. Gold standard no longer exists and industrial demand represents only 10 per cent of its overall demand. Hence, gold should be viewed just like any other commodity. The Indian economy struggling with high current account deficit and inflation is expected to get some short-term relief from lower gold prices.

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