Why falling gold is not as good as we think it is?

This inflation is a weird thing and the common man is its sufferer. With food and petrol prices soaring high up, gold, in turn, decided to take a route downwards. Even though this movement of gold prices can be mainly explained by two phenomena which we’ll be discussing in a while, let’s take a moment to put forward how this fall may not be as good news as you may think. To put this decline in prices in some actual numbers to assess their significance here are some statistics to note that gold prices in the global market have declined nearly five per cent since January 1, 2021, with the metal falling 2.77 per cent during the week ended February 6. On February 8, gold gained a tad to quote at $1,810.69 per ounce as the US dollar slipped against the Japanese yen for the first time in eight days. Prices have dropped more than $50 since February 1. Gold analysts say the metal could see a fall of another $100, though technical charts show good support in the $1,775-1,780 range. If gold manages to rise, it could face resistance around 1,825.

As for India, we can’t say the trend has been a different one, with gold being sold at Rs 4,739 a gram on February 8 against Rs 4,875 per gram on February 1, while 22-carat gold, used in jewellery, being sold at Rs 4,578 against Rs 4,709 a week ago. Gold prices topped Rs 5,600 a gram on August 6 2020 in line with the rise in the global trend. Along with the global trend for a decrease in the prices of the precious metal, another major factor that contributed to gold’s fall in prices can be attributed to the Finance Minister- Ms Nirmala Sitharaman’s proposal to cut the custom duty on gold to 7.5 per cent from the then 12 per cent during the budget announcement of the financial year 2021-22. The global trend of decline of the value of gold comes from the US dollars gain against most currencies. If you’re wondering what the US dollar has to do with prices of gold, think of the fact that gold is traded in US dollars, meaning any fluctuation in the currency brings about fluctuations in the metal, with the relationship following an inverse proportion. As a result, as the US dollar rises, gold prices fall, which can be currently witnessed with the US dollar gaining against most currencies except for the British Pound, Indian rupee and the Chinese Yuan. Along with that, excess liquidity as proposed by the government over the course of the pandemic as an attempt to recover the recessing economy has made investors more interested in going for riskier investments such as stocks. So, while gold may continue to be a safe bet, the securities market’s risk appetite has intrigued investor interest.

Why falling gold is not as good as we think it is?

Now, to talk about why this fall in prices of gold may not entirely be a piece of good news, think of two things- investors and gold loan lenders. The thing about gold loans is that the lender while hoping to gain profit from the interest payment made by the borrower, expects to counter the default risk under the assumption that the value of the pledged asset i.e. gold will rise over the loan tenure. Gold loans extended by the country’s commercial banks had increased 132% last year, according to the latest credit growth data from the Reserve Bank of India. This helped banks grow their loan books at a time when loans to many other sectors were contracting on risk aversion and asset quality concerns. Now, as prices of the asset fall, like the one we can see currently, it implicates that the margin of the current value of the precious metal and the amount of loan issued should be made up for by the borrower to the lender, either by pledging more collateral or by paying the margin in cash. Again, if the borrower fails to match the margin, the probability of default risk increases significantly. As a result, the lender gets increasingly critical of the loan supply and risk liquidity crunch, marking a question in their financial books.

Not only that, the loan provided on gold is assessed through the current market value, with a proportion of it being lent out. As a result of high volatility in the asset prices and low current value, the loan to value falls extensively, making borrowers less interested in going for a gold loan as compared to other alternatives available in the market. As a result, the demand for the gold loan also significantly falls, which can be proven through data collection of the current times, clearly indicating a pattern of fall in demand for gold loan.

Thus, as predicted by analysts and experts, it is being vividly anticipated that the commercial banks and non-bank lenders may have to rejig their policies in this segment because of the fall in gold prices. Even if we think from the consumer point of view the effect of fall in prices, we can’t expect much change in demand of the asset especially in light of the current economy when most people have had their savings exhausted in the pandemic and the investment inclination of the middle class is at its all-time low.  What lies next in the course of gold loan lenders and investors is yet to be seen, but it can be said with certainty that while the consumer may think of this fall in price as a good sign, there are a lot of other sections that may be more disappointed than we think at the point.

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