DH Deciphers | Gold demand down but prices are up - how's that possible?

Gold prices have been on the rise since the beginning of the last financial year. A slowdown in the global economy, the US-China trade war and investors' never-ending appetite for the yellow metal have all contributed to the exponential rise in gold prices. The coronavirus pandemic was the final straw, and gold prices have now reached levels that seemed improbable just a few months ago.

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This unrelenting price rise has, however, spooked the buyers of physical gold. Jewellers were complaining of low sales much before March. But the lockdown has brought their business to a complete halt.

In short, the yellow metal continues to attract investors but its physical variety finds few takers. What explains this paradox?

Also Read: Coronavirus India update: State-wise total number of confirmed cases

How is gold traded?

Gold traders have three choices: the physical asset, the mutual or exchange-traded funds (ETFs) and the commodities market (futures and options). The physical asset can be purchased in the form of bars or coins or as jewellery. But buying physical gold has its own hassles. You have to pay the making and wastage charges, taxes, insurance, etc, all of which make physical gold an expensive commodity.

Gold ETFs, on the other hand, can be traded just like stocks on an exchange with its price replicating the price of gold. Gold ETFs rise and fall faster than the price of gold itself, making them rewarding and risky at the same time. A less-risky option is buying options on gold futures or gold ETFs.

ETFs are the best option if you want to diversify your investment portfolio. But you would want to own the physical gold if you want protection during financial crises.

How's the gold price fixed?

Global gold prices have been determined by the London Bullion Market Association (LBMA) ever since the first gold rush brought the yellow metal from Brazil to London in 1697. The prices are set twice each trading day: at 10.30 am and at 3 pm UK time. Internationally, gold prices are determined in US dollars per ounce (=28.35 grams). This is also the price benchmark for gold in India.

In our country, however, the India Bullion and Jewellers' Association (IBJA), whose members include some of the biggest dealers in the country, determine the daily gold price. There are two types of gold prices — spot and futures — like many other commodities.

The current gold price, according to the LBMA, is $1,702.75 per ounce. In India, the base price is Rs 40,769.7 per 10 grams — with different premiums charged in different cities.

Are gold prices guided by LBMA's whims and fancies?

Not exactly. Other than the LBMA pricing, the primary determinant of global gold prices is the basic economic principle of demand and supply. Gold prices rise when the demand is high and the supply low, or vice versa. Since gold is finite, supplies are limited.

But why doesn't the high gold price reflect the low demand?

This is the tricky part. It's true that gold jewellery demand in India fell 41% to an eleven-year low of 73.9 tonnes between January and March 2020. Even Akshaya Tritiya, the auspicious buying day that fell on April 26, couldn't uplift it. But remember, that's physical gold which is a prized asset in some countries like India where people attach a sentimental value to it.

Globally, the demand for gold as an investment class remains robust. The yellow metal has seen an unprecedented investor demand through gold ETFs that saw inflows of over 298 tonnes in the first three months of this year, which pushed global holdings in these products to a record high of 3,185 tonnes.

With the lockdown extending into the crucial summer wedding season, the demand for physical gold will drop further. But globally, investors continue to fall for gold because the expected or actual returns on other asset classes fall. As the stock markets crash and the crude oil gives negative returns due to the COVID-induced recession, gold is used as a safe haven. In times of uncertainty, trust gold.