Gold: The View from Mumbai

Why do Gold Prices shoot up when financial markets are plunging to historic lows...?

AS WORLD STOCK MARKETS are caught in a tangling web of unprecedented turmoil, there is a glitter in the yellow metals market, writes Shiv Krishna for Commodity Online in Mumbai.

Gold prices are setting new records every day against non-US currencies, including the Euro and British Pound. As Asian markets opened on Friday after a dull holiday, the Bombay Stock Exchange benchmark index – the Sensex – fell to the nadir of desperation by plunging 1000 points and touching the 10,000-mark, its lowest level since June 2006.

But as brokers and traders cried over these markets in misery, Gold Bullion soared to new highs on fears of the global recession that's set to follow. At the NCDEX futures exchange, November contracts gained 3.64% to 14,085 Rupees per 10 grams. Gold December Futures at the MCX gained 3.86% at Rs 14,130 per 10 grams.

Why is it that Gold Prices shoot up when financial markets are plunging to historic lows?

Traders said Friday that concerns over global financial markets and also the depreciation of India's Rupee have created an appeal for gold as an alternative investment. Many people in the country are looking to hedge themselves against both further equity market losses as well as the ongoing inflation in Indian shop prices.

The metal has gained value in Rupee terms almost every year over the last four decades. India accounts for the largest single physical gold market in the world. And in the physical Gold Bullion market here in Mumbai last week, gold touched a new historic high on Wednesday of Rs 13,820 per ten grams.

Investors are looking at gold to moderate some of the risks in their portfolio. They are concerned mainly about counter-party risk, market risk and liquidity risk. Although gold does not necessarily remove the counter-party risk unless you own it outright – free from anyone else's business performance and balance-sheet – the current negative real yields paid on cash are also another reason to hold gold. In India, as in much of the developed world, the difference between interest rates and inflation is now below zero. So money itself, even if “safe” in a bank, is losing value as the cost of living rises.

Gold Investment has so far been immune to the financial crisis, except for those periods when the US Dollar strengthened. One of the reasons behind the longer-term Gold Price surge in recent times has been the fall in value of Dollar. That made commodities priced in the US currency cheaper for people earning and holding other currencies.

From 1998 to early-2002, gold prices stayed mostly below $300 per ounce with heavy central bank selling and little interest from investors. In April of 2002, prices broke above $300 and eventually traded their way up to $1,000 per ounce by March of 2008. This has been an incredible climb and it is hard to say if it is over yet or not as world production is not increasing. The current range, analysts here say, appears to be between $700 and $1,000.