Gold and The Dollar Tangle - The Impact of 'Weak Rupee against US Dollar' on Gold Price in India
Being one of the most time-honored integral means of exchange, Gold - the Neolithic metal, discovered some twelve thousand years ago, continues to amaze human race with its ubiquitous appeal.
A financial writer perhaps rightly conferred it the status of 'a psychological barometer of market sentiments'!
Tracing the Evolution
Before we actually dig into the relationship between the yellow metal and dollar, it is ideal to explore its historical significance in terms of backing centuries old world currency system:
Its resourcefulness in backing currencies dates back to the Byzantine Empire - the first ones to use its intrinsic value in order to support what is today's fiat money. In fact, almost the whole of 20th century flaunted the vitality of gold as a reserve currency, till the Bretton Woods agreement fell apart and United States under President Richard Nixon, renounced use of the gold standard against the value of dollar.
With this, the fiat currency evolved. Labeled as a legal tender by a government, its worth is dictated by the dynamics of demand and supply, without actually being backed by a physical commodity like gold. Since then, gold was left at the mercy of the floating exchange, making its value vulnerable to dollar price. Since then, the relationship between gold and dollar has literally inversed.
The Core Criterion
As per norms, when the value of dollar increases with respect to other currencies, the price of gold drops- in terms of dollar. This hints at the price of gold shooting up in other currencies. Therefore, with the price rise, demand suffers a setback. Similarly, with the fall of the dollar, other currencies experience appreciation, enhancing the probability to invest in gold.
Way back in 2008, the International Monetary Fund gauged that gold price fluctuations between 2002-08 was proportionately equivalent to the change in the external value of dollar.
Interest rates too impact the relationship between dollar and gold. The incapability of gold to yield interest in itself makes it mandatory for the metal to compete against assets pledging high interests.
With ascension of interest rates, dollar invariably appreciates, leading to a fall in gold prices. Vice-versa, drop in interest rates leads to decline in the opportunity cost for hording gold, thus, motivating gold prices to rise.
Stricken by acute crisis, Fed undertook significantly bold rate cuts in 2008, pushing Fed Fund rates almost to the brink. On the contrary, gold prices, then, experienced an all time high of around $1900/oz.
The latest trend suggests, Fed is bent upon increasing rates further in order to strengthen the dollar, thus, foretelling a dismal future for gold prices ahead.
Having mentioned the possibilities, there may be times when both gold and dollar behave in a bizarre fashion- moving in tandem with each other. In case of global crisis, we might find respite in both dollar and gold considering their inherent ability to insulate us against crisis.
The Indian Context
Before we delve into the nitty-gritty of how weak rupee against dollar impacts gold price in India, we need to be aware of the fact that, Gold is usually priced in US dollars or Euro. Thus, for obvious reasons on the eve of a depreciating rupee, gold prices ought to rise.
In the current scenario, Gold prices have declined sharply in the US owing to the strengthening of dollar index under the stringent federal policy. Simultaneously, rise in US bond returns by almost 82 basis points in the previous year is naturally attracting investors towards lucrative bond yields abandoning developing economies like India.
Thus, for obvious reasons, this year rupee has not really fared well in terms of dollar - the globally acknowledged reserve currency today. Hence the chances of investing in gold appear bleak considering the low purchasing power.
This prognosticates a tough future for gold as of now, unless the economy manifests growth by the last quarter, motivating positive demand from India, as market analysts contemplate.