What Next for Gold?

Article By

V.P. Nandakumar,

MD & CEO, Manappuram Finance Ltd

Despite elevated prices, faster-than-expected economic expansion is driving domestic demand for gold

For me, gold is always a subject that I keep close to my heart. And I always find it amusing to see how the gold market navigates through the various phases of an economic cycle. A nuanced reading will show that many a time gold market behaviour puts conventional economic wisdom to test by taking a different course.

For the sake of context, economic theory has it that the demand for any goods or for that matter services is a function of supply and demand. The market arrives at an equilibrium when the demand and supply curves intersect at a particular price point which is considered as optimum for both producers and suppliers. However, a closer scrutiny of gold market behaviour may prove this hypothesis null and void.

For one, in the case of gold, the first condition – that supply clears demand at an equilibrium price point – could be relaxed since the availability of the yellow metal is a given at any point of time. It goes without saying that it is the singular factor of inelastic supply that gives gold the status of precious metal. Therefore, it is a no brainer to infer that the demand for gold – indeed while other things remain equal –may be influenced by many other factors.

The recent tidings in the Indian gold market support this hypothesis that the demand for yellow metal is a function of a host of factors and prices have a diminishing role to play in explaining its demand. To sticklers to economic dogma, this line of argument may sound bizarre or outlandish and they might have their reasons to think so. But, as is often proved, real life economic realities are far from textbook economics, and the gold market behaviour in recent times provides further evidence to this fact.

Let me elucidate my line of argument with evidence from the Indian gold and jewellery market. We hit the festival and wedding season this year with the hope of higher retail gold sales but high prices were seen weighing on demand with many in the industry throwing up their hands in desperation. Many in the retail trade even foresaw lower sales as prices tend to trend high as the geopolitical situation took a turn for the worst. However, the negativity soon gave way to optimism, if not euphoria, as the festival sales reportedly beat previous records.  Though, we still don’t have the required numbers to prove this point, umpteen conversations I had with my friends in the industry unequivocally pointed to the fact that this festive season was exceptionally good for gold retail trade.

There are supplementary evidences to support this optimism.  Government data shows that India’s October gold imports surged to a 31-month high to 123 tonnes against 77 tonnes a year ago as traders increased buying on the back of good demand. To me, two factors indeed played out for gold; a good monsoon and increase in household discretionary spending. It may be in order here to note that in India, economic growth and demand for gold are highly correlated despite the evolution of market for financial assets. In other words, higher the level of economic activity, higher is the demand for gold. A plausible reason for such a strong correlation may be the insurance the yellow metal provides in times of need for the Indian households.
Going by this line of reasoning, the outlook for gold looks promising to me since Indian economy is poised to grow at a faster clip driven by both urban and rural demand unless, to borrow a fashionable term from Prof Nassim Nicholas Taleb, who famously predicted the 2007 global financial crisis, any black swan events surface. To conclude, despite growing risks to global growth and elevated prices, faster than expected domestic economic expansion is driving domestic demand for gold and that may remain so going forward.

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