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Capital Notes Honey, will the stock markets make money? Why did the yellow metal crash?
Why did the yellow metal crash?
Gold, the precious metal that captivates the common man because of its sheen and intrigues the economist by being a hedge against inflation, has finally succumbed to the law of gravity.
YES, THAT WHAT goes up has to come down, sooner or later.

Gold is generally considered as a safe haven that acts as a hedge against inflation. There is a sort of positive correlation. So, when inflation is either low or is perceived to become low, the demand for gold decreases. JP Morgan Chase Global Consumer Price Index (reflecting the position in 30 economies accounting for 90 per cent of world’s economic output) has predicted future inflation at 2 per cent. Such benign inflation has softened the demand for gold. According to World Gold Council, demand for gold in the shape of physical bars and for coinage depends on investors’ need for a safe-haven from economic and inflationary pressures. This demand is now depressed. Also owing to herd instinct, there is now a lot of redemption pressure on Gold Exchange Traded Funds. Such funds are now releasing a lot of gold into the market to generate liquidity causing further dent in gold prices.

Self-fulfilling prophesy of Goldman Sachs, the opinion leader of financial community, has also played its part. In the recent past, they have been reducing their forecasts of gold prices. Even gold is not immune to the influence of Goldman Sachs! Reuters reports that a further fall is expected in gold price from US$ 1382 per ounce to US$ 1245.

Dollar strengthens...

Quantitative easing of the US is expected to get diluted with lesser release of dollars into the market. So the value of dollar in relation to gold is going up. Ever since the threat of ‘fiscal cliff’ was averted, albeit temporarily, the greenback has been appreciating. Crisis after crisis bedeviling the euro economies has further bolstered the American dollar.

Central Banks of several countries are offloading their gold stocks in apprehension of further fall in gold price. Increased supply of gold in the international market causes further pressure on gold. Banks in Cyprus, which have incurred huge losses on account of their exposure to sovereign debt of Greece, are offloading a large part of their gold holdings in order to shore up liquidity and to reduce losses. Cyprus may have to sell gold worth euro 400 million. to effectively deal with its fiscal deficit.  Various central banks own nearly 19 per cent of all the gold mined. Drop in gold prices has reduced the value of such reserves by $ 560 bn.

The volume of gold required for industrial purposes is on the wane particularly that from China. China is the most important producer of gold accounting for about 11 per cent of world’s production every year. And then of-course is the fact that twelve years of non-stop appreciation in price is now followed by an inevitable gravitational correction.

So what are the consequences?

Companies whose business is gold-centric are likely to report losses or reduced profits. Manappuram Finance and Muthoot Finance are two such companies. Even companies like Titan Industries, which are into gold jewelry will face pressure on profitability.

US dollar will become a unipolar safe haven refuge. It will become stronger exacerbating the pressure on the euro.

Central Banks in many countries will face depreciation in their stock of forex assets depending on their gold holdings. RBI has nearly 9 per cent of its assets in the form of gold. The RBI had purchased 200 tonnes of gold from IMF in November, 2009 when the price of gold was $ 1200 per ounce. At that time it was hailed as a sagacious move. Recent bearishness in gold prices drives home the importance of timing in effecting purchases of even precious metals. RBI’s present gold reserves are valued at $ 28.45 bn., down from its September 2011 peak by 27 per cent
India’s import burden will be lessened because of softening of prices of both gold and crude. Current account deficit will become less ominous.

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