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 demand for gold comes from five countries, namely India, Italy, Turkey, US and China. Among these countries, which account for 55% of the total gold demand, Indias share alone comes to around 25%. Cultural and religious traditions involving wearing of jewellery play a major role in influencing Indian gold demand. Around 75% of the world demand for gold is jewellery-based and the rest 25% is investment based. Speaking about Indias fondness for gold, Lord John Maynard Keynes is alleged to have remarked, Indias 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 Mine Company located in Karnataka is the only company in India, which produces gold by mining and processing the gold ore. It produces around 3 tonnes of gold per year. Another source of supply of gold 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 To meet 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 attributed to the falling gold price from $900 to $712 per oz.4, some were of the view that it is because of the festivity of Diwali5, which requires people to purchase gold ornaments without taking price situation
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Kannan R. and Dhal Sarat, Indias demand for gold: some issues for economic development and macroeconomic policy, http:// findarticles.com/p/articles/mi_m1TSD/is_1_7/ai_n28026379/, June 2008 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 6 India 200809 platinum consumption seen at 932 kg, http://in.reuters.com/article/businessNews/idINIndia-34148820080620, June 20th 2008 Gold Demand Trends Full year, http://www.gold.org/assets/file/pub_archive/pdf/GDT_Q4_2008.pdf, February 2009, page 11 Diwali is an Indian festival, celebrated in the month of October or November and buying gold is considered auspicious on that day

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This case study was written by Hepsi Swarna under the direction of Akshaya Kumar Jena, IBSCDC . It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. The case was written from published sources. 2009, IBSCDC. No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without the permission of the copyright owner. Background Reading: Chapter 3, Basic Elements of Supply and Demand, Economics (Paul A. Samuelson and William D. Nordhaus)
License to use for the Class of 2015, Semester I, IBS Hyderabad. Course: Managerial Economics

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 the same Diwali festival of 2007 when the price registered a rise and surged above $800 per oz. mark and the demand for gold jewellery decreased. The very high price is alleged to have dampened the demand for gold, especially in the jewellery sector. Experts, however, pointed to real estate and the Bombay Stock 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 gold price rises in rupee terms, the stronger becomes the conviction of Indians that gold is the best means of preserving and enhancing ones wealth. This conviction started manifesting itself again towards the last quarter of 2008 when the US-originated worldwide recession drove investors to park their funds in the safe haven of gold, thus keeping the investment demand for gold high. But the jewellery demand for gold saw huge dip in India due to the price increase. Indias demand for gold is met through imports and recent gold import figures highlight the demand destruction that has taken place. Imports of gold are reported to have fallen by 83% in December 2008 and by 91% in January 2009.7 India is reported to have imported zero gold in February 2009; imports during March 2009 has also been zero. The relationship between gold price and Indian gold demand seems to be negative during some years and positive in some other years (Exhibit I).

Exhibit I Indian Gold Demand (tonnes) and Price (INR)

900 800 700 600 500 400 300 200 100 0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

25,000 20,000 15,000 10,000 5,000 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 2

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Hamilton Adam, Global Gold Highs, http://www.zealllc.com/2005/glogold.htm, October 14th 2005 Mehra Chand, Is investing in gold risky?, http://www.rediff.com/cms/print.jsp?docpath=//money/2009/mar/16guest-is-investing-ingold-risky.htm, March 16th 2009

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 when plotted against each other in a tabular form, give rise to a straightforward demand schedule (Exhibit II). The graphical translation of it gives rise to demand curve. While the periods 19921993, 1996 1999 and 20002003 show up the negative relationship between price of gold and the quantity supplied of it, the periods 19911992, 19931996 and 20032005 reveal a positive relationship.

Exhibit II Demand Schedule of Gold (19992005)

Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Price of Gold (INR) 8,518 9,629 11,481 12,222 12,962 13,333 12,222 12,000 12,222 12,592 13,703 15,925 17,777 19,259 20,370 Quantity of Gold Demanded (Tonnes) 271 371 314 428 514 556 771 871 813 813 800 628 600 685 813

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 the presence of the non-price factors (Exhibit III). In 2004, it was reported that, Indians are enjoying a rapid 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 price because as more and more workers moved from low income to middle and high-income groups, their demand for gold also increased. A World Gold Council study in 2006 conducted across six key gold markets, including India, revealed that, gold has become a more relevant and desirable product to a greater number of women9, thanks to increasing economic independence of women in developing countries.
8 9

The Role of Gold in India, op.cit., page 5 The Role of Gold in India, op.cit., page 5

Do Soaring Price and Mounting Demand in Indian ...

Exhibit III Non-price Determinants of Demand

1. 2. 3. 4. 5. Income of the customer Price of related goods Consumers taste and preference Population Expected future prices of the good.

Prepared by the authors

In order to disintegrate the various factors influencing the quantity demanded, the economists have employed the technique of showing the price factor alone and its influence on quantity demanded by means of a demand curve. The influence of non-price factors such as income on the quantity demanded is shown by a shift of the whole demand curve itself. Besides income, other non-price factors 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 the gold prices were steeply climbing and the price of platinum was falling during the first 2 months of 2009, Indians started substituting platinum for gold due to near parity of prices between gold and platinum. Vijay Jain, chief executive of leading jewellery chain Orra, opines, there is a new-found love for platinum among Indian buyers because the precious metal has lost around 30% of its value in comparison to gold.10 He further says, A 10-gm platinum ring is now priced around INR 22,000 as against INR 35,000 a year-ago.11 The high gold price accompanied with declining platinum price made Indians dump gold and embrace platinum as reflected by the increase in the market share of platinum from previous 15%40% as on January 2009.12 The size of the population in India being so large, demand for gold in India also sums up to a huge quantity. Rising rate of population growth calls for increasing demand for gold. Tastes and preferences represent a variety of cultural, religious and historical influences. Indias 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 girls wedding. Festivals like Diwali and Akshaya Tritiya13 are regarded as auspicious occasions to buy gold. Thus, demand for gold is associated with cultural and religious beliefs in India. Another factor that affects the demand for a good is the expectations about future. The continued expectation about rising trend in gold prices has swayed the investors into purchasing more of gold even if its price is on the rise. In February 2009,
Indian buyers dump gold, embrace platinum, http://www.commodityonline.com/news/Indian-buyers-dump-gold-embraceplatinum-15342-3-1.html, February 19th 2009 Ibid. Platinum-Gold price differential almost zero, http://www.commodityonline.com/news/Platinum-Gold-price-differentialalmost-zero-15558-3-1.html, February 27 th 2009 Akshaya Tritiya is an Indian festival, celebrated in the month of April or May. Buying and wearing gold is considered auspicious on that day.

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Do Soaring Price and Mounting Demand in Indian ...

as gold crossed INR 15,000 mark, investors increased their demand for gold, as they expected the gold prices to go up to INR 20,000. The uncertain economic conditions resulting from the global recession in 2008 has also made investors switch their funds from distressed financial assets to everalluring gold. This increased investment demand for gold has sent the gold prices soaring. And the higher the gold price, the higher will be the investment demand for gold since it creates stronger expectations of continuing optimistic trend, especially when business scenario all around is pessimistic. But some analysts counter argue that the worlds demand for gold being no more money based but majorly jewellery based, high gold price will eventually lead to destruction of jewellery demand and overall gold demand.14 Seventy Five percent of the worlds demand for gold is for making jewellery while 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 the lone influence of the price of gold. But a disaggregated careful analysis would reveal the actual relationship between price and quantity demanded of a good. Whether this relationship is positive or inverse depends upon the combined strength of the substitution effect and income effect of the price change of gold.

14

Is investing in gold risky?, op.cit.