When real interest rates are low, the yellow metal glitters
“When paper money systems begin to crack at the seams, the run to gold could be explosive” ~ Harry Browne
What is real interest rate (RIR)? “Real interest rate is the lending interest rate adjusted for inflation as measured by the GDP deflator” – World Bank. From this definition, it is very clear that RIR is a factor of interest rates prevailing in the economy and the rate of inflation.
It is a known fact that India is struggling with the problem of persistently high inflation despite the tight monetary policy stance adopted by the Reserve Bank of India (RBI). This has resulted in a lower-to-negative RIR in India in past few years.
On the other hand, western economies are facing the problem of a liberal monetary policy with all-time low interest rates and constant infusion of money by way of quantitative easing to boost their economies. This has resulted in the lower or negative RIR in western economies.
RIR has a direct influence on household savings. The lower or negative RIR makes investments in asset classes like fixed income instruments unattractive. This results in a steady increase in demand for gold, leading to a sharp surge in gold prices as seen in last five years. Historically gold is acknowledged as a hedge against inflation. India is the world’s largest gold consumer market. It is a well known fact that in India, gold is seen as a symbol of security and a sign of prosperity.
Currently, India has one of the highest saving rates in the world, estimated at around 30 per cent of total income, of which around 10 per cent is invested in gold. More than 50 per cent of household savings are invested in fixed deposits. With a low RIR prevailing in the economy, and with limited low-risk investment options available with the potential to earn inflation adjusted high returns, the incremental household savings are being invested in gold.
The ease of buying gold for the investors in the electronic form (e-gold and gold ETFs) and various attractive schemes offered by domestic gold jewellers are adding fuel to demand.
In recent times, the price of the yellow metal has been north bound. It has reached an all time high of `32,500. The recent rally in gold is fuelled by the announcement of the unlimited bond buying programme by the European government and the expectations of further quantitative easing by the central bank of the US.
With persistently high retail inflation rates in India showing no signs of easing and with further quantitative easing by the central banks of the US and Europe, it seems RIR is expected to remain lower resulting in a further surge in the price of the metal in times to come.
This article was originally published in Business India Magazine.
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Disclaimer: The views expressed in this article are personal and the author is not responsible in any manner for the use which might be made of the above information. None of the contents make any recommendation to buy, sell or hold any security and should not be construed as offering investment advice.
