Understanding Option Chain

Demonetization Scheme – How It Will Impact The Gold Price

Post Demonetization Scheme the maximum rumor mongering is related to the fate of Property and Gold Price. The reason being that these 2 were the most popular avenues to park the black money :). There was strong rumor that Govt is planning to limit the Gold holding per person. Later govt clarified that there is no such plan to limit the gold holding. Based on my understanding I can assure the readers that if you are holding legitimate gold then you need not worry. The only concern of gold investors is on Gold Price. Even if you are not a hardcore gold investor, financial planners always suggest holding 10% to 15% of portfolio either physical Gold or Gold ETF to hedge risk.

I covered the impact of demonetization on gold price briefly in my post, Demonetisation Scheme – How it will impact your Money Matters. A lot of readers requested me to share a detailed post on this topic. There is a lot of uncertainty on how the demonetization will impact the Gold Price. Experts are of the opinion; the Gold Price will drop sharply. Their prediction is just based on the assumption that maximum inflow in gold is through black money. Once the black money dries up, the demand for gold will reduce. Secondly, now it is mandatory to quote PAN for a gold purchase of more than Rs 2 lac. In a nutshell, people will not buy gold. I agree that gold demand in India will drop but does that mean Gold Price will drop. Let’s check out

Demand in India is not the Sole Factor to decide Gold Price

The demand for physical gold in India and China are two important factors to decide the Gold Price but not the sole factors. The gold price is decided internationally. The international factors and strength of US dollar are 2 key drivers of gold price. Many experts are linking recent 5% drop in gold price to demonetization. It is not RIGHT conclusion. The actual reason is different.

The recent drop was because of 25 bps increase in Fed Rate and as a result of US dollar index strengthen from around 98 to 103 thus there was an equivalent negative impact on the gold price. The drop cannot be linked to demonetization.

Cost of Gold Production

Mining of gold is a costly affair. According to experts, the all-in sustaining cost of gold per ounce is around $1100. It translates into roughly around Rs 27000 per 10 gm in India. In other words, the cost of gold is Rs 27,000 per 10 gm. If the gold price fall below the cost of production then the gold mining companies will stop or cut production of gold as they did in past. Therefore, limiting the supply of gold in the market. It will ensure the stability in the price of the gold. The probability of gold price going drastically below Rs 27,000 is negligible.

This is another reason why the demand for the Gold in India will not have any impact. It will be foolish for gold mining companies to produce gold below the cost of production. The reduced demand in India will be offset by a cut in supply/production by the mining companies. India’s contribution to gold mining is negligible thus India cannot control gold price.

Also Read: Demonetization Impact on the Stock Market and Stock Investors

Gold Trading in International Market

The change in gold price in International market is attributed to 2 factors i.e. (a) Change due to weakening or strengthening of the US dollar and (b) Change due to normal trading.

Any change due to the strengthening of the US dollar is limited as none of the central banks want their currency to appreciate or depreciate sharply. It impacts the import and export of the country thus trade balance. The gold investors should get worried in case of lack of interest of investors. It is reflected in the change due to normal trading. There are no such signs till date in the international market. The demand for gold is intact and drop is only because of fed rate hike or in other words strengthening of the US dollar.

Demonetization Scheme – How It Will Impact The Gold Price

With the background shared by me in this post, it can be concluded that demonetization will not have any impact on Gold price in India. Currently, there is a perception that lack of Indian demand is driving the gold price down. To share an example that demand of gold is consistently declining in India from last few years still the gold price appreciated more than 20% during first 3 quarters of CY 2016. It proved the point that the demand for gold in India does not have any impact on the gold price.

In my opinion, post demonetization the supply of “legitimate” gold will reduce in India because purchase through black money will dry up. The Govt of India may take stringent action to flush out the “Black” Gold from the market. “Black” Gold will be sold at heavy discounts in the gray market. For example, people who bought gold from black money will not be able to sell it in white. Therefore, it will be sold at almost 30% to 50% discount similar to demonetized “black” currency. These transactions will be negligible thus not impacting overall supply in the market.

On the other hand, choking off supply will increase the “white” gold price in India provided the demand remains the same. The reason for this optimism can be summarized from famous saying in India “Gold is Gold”. Maybe this optimism is because of traditional thinking but fortunately, the factors highlighted by me also support this optimism. Still, in my opinion, Gold Price will double in next 2 years as i shared in my earlier posts.

There is also widespread speculation that under GST, govt will keep GST rate high for gold to discourage import. Any increase in import duty or increase in tax rate under GST will appreciate the gold by equivalent %. Thus it will be good news for the existing gold investors.

Also Read: Why demonetization is good news for Income Taxpayer?

Word of Caution: International factors are not in our control. For example, the price of gold may remain depressed depending on the policies of American Federal Reserve Bank and USA govt. This is the risk a gold investor will be carrying. The policy change impacts the US dollar index that in turn impacts the gold price. On the contrary, as I keep highlighting that gold loves uncertainty. Any uncertainty in future will support the gold price.

Another risk is of Indian Rupee movement. This I already clarified in my earlier posts that Indian Rupee is all set to depreciate and this is good news for the gold. Depreciation of US dollar in International market and Indian Rupee in Indian market can be a double bonanza for the Gold Investors.

Lastly, once the liquidity is back in the market the Gold will shine again as demonetization has squeezed the investment options for the investors. It is better to keep faith in so-called international currency i.e. gold. I am sure that it will live up to its tag of “Safe Haven”.

Copyright © Nitin Bhatia. All Rights Reserved.

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