02 do soaring_price_and_mounting_demand_in_indian_gold_market_speak_of_a_paradox


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02 do soaring_price_and_mounting_demand_in_indian_gold_market_speak_of_a_paradox

  1. 1. Do Soaring Price and Mounting Demand in Indian ... Ref. No.: ME0006 Do Soaring Price and Mounting Demand in Indian Gold Market Speak of a Paradox? Demand for gold is a widespread observable fact across the world. However, the major demandfor gold comes from five countries, namely India, Italy, Turkey, US and China. Among these countries,which account for 55% of the total gold demand, India’s share alone comes to around 25%. Culturaland religious traditions involving wearing of jewellery play a major role in influencing Indian golddemand. Around 75% of the world demand for gold is jewellery-based and the rest 25% is investmentbased. Speaking about India’s fondness for gold, Lord John Maynard Keynes is alleged to haveremarked, “India’s gold consumption reflects the ‘ruinous love of a barbaric relic’.”1 In India, there is a huge mismatch between demand for and supply of gold. Hutti Gold MineCompany located in Karnataka is the only company in India, which produces gold by mining andprocessing the gold ore. It produces around 3 tonnes of gold per year. Another source of supply ofgold in India has been coming from recycled jewellery/scrap jewellery. In 2006, it was reported that,“Over the past five years, Indians have recycled an average of 105 tonnes of gold per annum.”2 Tomeet the bulk of the demand, India imports gold. India imports around “700 tonnes of gold a year”.3 In October 2008, demand for gold increased. While this increase in demand for gold was attributedto the falling gold price from $900 per oz. to $7124, some were of the view that it is because of thefestivity of Diwali5, which requires people to purchase gold ornaments without taking price situation1 Kannan R. and Dhal Sarat, “India’s demand for gold: some issues for economic development and macroeconomic policy”, http:// findarticles.com/p/articles/mi_m1TSD/is_1_7/ai_n28026379/, June 20082 Dempster Natalie, “The Role of Gold in India”, http://www.gold.org/assets/file/rs_archive/the_role_of_gold_in_india.pdf, September 2006, page 63 “India 2008–09 platinum consumption seen at 932 kg”, http://in.reuters.com/article/businessNews/idINIndia-34148820080620, June 20th 20084 “Gold Demand Trends Full year”, http://www.gold.org/assets/file/pub_archive/pdf/GDT_Q4_2008.pdf, February 2009, page 115 Diwali is an Indian festival, celebrated in the month of October or November and buying gold is considered auspicious on that dayThis case study was written by Hepsi Swarna, under the direction of Akshaya Kumar Jena, IBSCDC . It is intended to be used as the basis forclass discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was written frompublished sources.© 2009, IBSCDC.No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoeverwithout the permission of the copyright owner. Background Reading: Chapter 3, “Basic Elements of Supply and Demand”, Economics (Paul A. Samuelson and William D. Nordhaus)1
  2. 2. Do Soaring Price and Mounting Demand in Indian ...into account. However, the weakness of the latter argument was shown up by citing the instance of thesame Diwali festival of 2007 when the price registered a rise and surged above $800 per oz. mark andthe demand for gold jewellery decreased. The very high price is alleged to have dampened the demandfor gold, especially in the jewellery sector. Experts, however, pointed to real estate and the BombayStock Exchange as better investment havens for Indians in October 2007 to switch their funds to –away from gold bullion. However, back in 2005, as the gold prices went up demand also went up,making the analysts comment that the demand curve for gold in India is ‘inverted’.6 The higher the goldprice rises in rupee terms, the stronger becomes the conviction of Indians that gold is the best means ofpreserving and enhancing one’s wealth. This conviction started manifesting itself again towards the lastquarter of 2008 when the US-originated worldwide recession drove investors to park their funds in thesafe haven of gold, thus keeping the investment demand for gold high. But the jewellery demand forgold saw huge dip in India due to the price increase. India’s demand for gold is met through imports andrecent gold import figures highlight the demand destruction that has taken place. Imports of gold arereported to have fallen by 83% in December 2008 and by 91% in January 2009.7 India is reported tohave imported zero gold in February 2009; imports so far during March 2009 is also zero. The relationship between gold price and Indian gold demand seems to be negative during someyears and positive in some other years (Exhibit I). Exhibit I Indian Gold Demand (tonnes) and Price (INR) 900 25,000 800 20,000 700 600 15,000 500 400 10,000 300 200 5,000 100 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 0 0 Tonnes LHS Price (INR) RHS Source: “The Role of Gold in India”, http://www.gold.org/assets/file/rs_archive/the_role_of_gold_in_india.pdf, September 2006, page 26 Hamilton Adam, “Global Gold Highs”, http://www.zealllc.com/2005/glogold.htm, October 14th 20057 Mehra Chand, “Is investing in gold risky?”, http://www.rediff.com/cms/print.jsp?docpath=//money/2009/mar/16guest-is-investing-in- gold-risky.htm, March 16th 20092
  3. 3. Do Soaring Price and Mounting Demand in Indian ... The price of gold and the quantity demanded of gold in India for the above time series whenplotted against each other in a tabular form, give rise to a straightforward demand schedule (ExhibitII). The graphical translation of it gives rise to demand curve. While the periods 1992–1993, 1996–1999 and 2000–2003 show up the negative relationship between price of gold and the quantitysupplied of it, the periods 1991–1992, 1993–1996 and 2003–2005 reveal a positive relationship. Exhibit II Demand Schedule of Gold (1999–2005) Year Price of Gold (INR) Quantity of Gold Demanded (Tonnes) 1991 8,518 271 1992 9,629 371 1993 11,481 314 1994 12,222 428 1995 12,962 514 1996 13,333 556 1997 12,222 771 1998 12,000 871 1999 12,222 813 2000 12,592 813 2001 13,703 800 2002 15,925 628 2003 17,777 600 2004 19,259 685 2005 20,370 813 Compiled by the authors from “The Role of Gold in India”, http://www.gold.org/assets/file/rs_archive/ the_role_of_gold_in_india.pdf, September 2006, page 2 The apparent positive relationship between price of gold and its demand is often due to thepresence of the non-price factors (Exhibit III). In 2004, it was reported that, “Indians are enjoying arapid acceleration in income growth, which is supporting discretionary spending on consumer goods,including gold.”8 The demand for gold increased during that time even in the face of rising gold pricebecause as more and more workers moved from low income to middle and high-income groups, theirdemand for gold also increased. A World Gold Council study in 2006 conducted across six key goldmarkets, including India, revealed that, “gold has become a more relevant and desirable product to agreater number of women”9, thanks to increasing economic independence of women in developingcountries.8 “The Role of Gold in India”, op.cit., page 59 “The Role of Gold in India”, op.cit., page 53
  4. 4. Do Soaring Price and Mounting Demand in Indian ... Exhibit III Non-price Determinants of Demand 1. Income of the customer 2. Price of related goods 3. Consumers’ taste and preference 4. Population 5. Expected future prices of the good. Prepared by the authors In order to disintegrate the various factors influencing the quantity demanded, the economistshave employed the technique of showing the price factor alone and its influence on quantity demandedby means of a demand curve. The influence of non-price factors such as income on the quantitydemanded is shown by a shift of the whole demand curve itself. Besides income, other non-pricefactors include prices of related goods, size of the population, consumer tastes and preferences,expectations about future conditions, etc. In February 2009, it was reported that platinum was nearly half the price it was in 2008. When thegold prices were steeply climbing and the price of platinum was falling during the first 2 months of2009, Indians started substituting platinum for gold due to near parity of prices between gold andplatinum. Vijay Jain, chief executive of leading jewellery chain Orra, opines, “there is a new-foundlove for platinum among Indian buyers because the precious metal has lost around 30% of its value incomparison to gold”.10 He further says, “A 10-gm platinum ring is now priced around INR 22,000 asagainst INR 35,000 a year-ago.”11 The high gold price accompanied with declining platinum pricemade Indians dump gold and embrace platinum as reflected by the increase in the market share ofplatinum from previous 15%–40% as on January 2009.12 The size of the population in India being solarge, demand for gold in India also sums up to a huge quantity. Rising rate of population growth callsfor increasing demand for gold. Tastes and preferences represent a variety of cultural, religious andhistorical influences. India’s demand for gold has its roots in cultural and religious traditions. In India,gold is seen as a symbol of status and it also plays a major role in a girl’s wedding. Festivals likeDiwali and Akshaya Tritiya13 are regarded as auspicious occasions to buy gold. Thus, demand forgold is associated with cultural and religious beliefs in India. Another factor that affects the demandfor a good is the expectations about future. The continued expectation about rising trend in gold priceshas swayed the investors into purchasing more of gold even if its price is on the rise. In February10 “Indian buyers dump gold, embrace platinum”, http://www.commodityonline.com/news/Indian-buyers-dump-gold-embrace-platinum- 15342-3-1.html, February 19th 200911 Ibid.12 “Platinum-Gold price differential almost zero”, http://www.commodityonline.com/news/Platinum-Gold-price-differential-almost-zero- 15558-3-1.html, February 27th 200913 Akshaya Tritiya is an Indian festival, celebrated in the month of April or May. Buying and wearing gold is considered auspicious on that day.4
  5. 5. Do Soaring Price and Mounting Demand in Indian ...2009, as gold crossed INR 15,000 mark, investors increased their demand for gold, as they expectedthe gold prices to go up to INR 20,000. The uncertain economic conditions resulting from the globalrecession in 2008 has also made investors switch their funds from distressed financial assets to ever-alluring gold. This increased investment demand for gold has sent the gold prices soaring. And thehigher the gold price, the higher will be the investment demand for gold since it creates strongerexpectations of continuing optimistic trend, especially when business scenario all around is pessimistic.But some analysts counter argue that the world’s demand for gold being no more money based butmajorly jewellery based, high gold price will eventually lead to destruction of jewellery demand andoverall gold demand.14 Seventy Five percent of the world’s demand for gold is for making jewellerywhile nowhere in the world the monetary system is based on gold. The simultaneous exertion of various forces on the quantity demanded of gold often masks thelone influence of the price of gold. But a disaggregated careful analysis would reveal the actualrelationship between price and quantity demanded of a good. Whether this relationship is positive orinverse depends upon the combined strength of the substitution effect and income effect of the pricechange of gold.14 “Is investing in gold risky?”, op.cit.5