The fall of gold
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Softer commodity prices may help growth, widen the window for policy response
The crack in gold prices that appeared over the last few weeks could well be the decisive end of the "super-cycle" in the yellow metal. This was perhaps inevitable. Over the last 10 years, the price of gold has risen from $312 per ounce (average price in 2002) to $1,675 per ounce (average price in 2012), that is, an annualised return of 18 per cent over the period. No asset class, at least in recorded financial history, has sustained this kind of return over such a long period. Thus, a sharp correction seemed to be overdue.
The reasons why gold prices are unlikely to stage a dramatic recovery, at least in the foreseeable future, are to be found in the very factors that led to the surge in its prices in the first place. Gold has historically been held as a hedge against economic uncertainty and inflation. The 2008 financial crisis and the turmoil that followed sent investors scurrying for the "safety" that gold offered, bidding prices up sharply in the process. For economies like India, which incidentally was a major contributor to global gold demand (in 2011-12 it imported 800 tonnes), it was the spectre of rising inflation that tilted household portfolios in favour of gold. Both these risks have dissipated.
It is true that pockets of potential financial stress remain, particularly in the eurozone's periphery. The Cyprus imbroglio was perhaps a wake-up call that reminded us that risks still linger in the global financial system. That said, the possibility of a full-blown crisis has certainly waned. This is partly the result of structural improvements in these economies (current account deficits have improved for instance) and risk-mitigation policies like the European Central Bank's Open Market Transactions (OMT) policy. If the risk of financial implosion has waned, a moderation in the demand for "a safe-haven asset" should naturally follow. The correction in gold prices is a reflection of this.