In the year 2001, Nifty crashed from 1395 points to levels of 850 points against which Gold rallied from Rs. 4300 per 10 grams to Rs. 5800 per 10 grams. In the year 2007, Nifty crashed from 6200 to 2500 levels against which Gold rallied from Rs. 9000 per 10 grams to Rs. 30000 per 10 grams. Again today in the God-forsaken year 2020, Nifty crashed from 12200 to 7500 levels and Gold rallied against it from Rs.34000 per 10 grams to Rs.56000 per 10 grams as on 24th August 2020.
Have you ever wondered why the price of precious metals rallies against the markets? If not, then why not! Was it so simple to digest this cross-movement? Well, it wasn’t enough for me to know the fact without the reason so I kept pondering upon this until I reached an explanation that satisfied me.
Let’s first consider a simple example - a phone. You have a phone which you use regularly. It is working perfectly well but you choose to purchase a new phone, perhaps because of advancements like upgraded features and better user experience.
Now, let’s consider the economic scenario when precious metals like Gold and Silver were used as means of transaction. It was only in the year 1861 that currency was introduced and popularized as a medium of exchange. Owing to the relative benefits of transacting in the currency over precious metals, there was a shift towards the use of currency. Here, precious metals can be compared to the old phone whereas currency can be likened to the new phone. Well, getting a new phone does not make us throw away the old phone - we just stop using the old one!
At times when there is a lot of money flowing in the market and the stock market is giving out ‘top out’ signals, investors either start selling their holdings or they create short positions in the market. Top out signals are usually seen when, in the long run, people are not willing to buy stocks beyond a certain price, that is, they are unwilling to go long in the market at a particular index level.
Here, a sell-off leads to the market falling from the prevailing levels. Subsequently, the currency of the country weakens which implies that the value of one dollar in terms of our country’s currency rises. This is the time when the currency of the country has gotten spoilt and needs a ‘repair’. The next best alternative for a trustworthy medium of transaction is our old phone - precious metals. People begin to gain confidence in favour of precious metals, thus going long on currency while the economy (of which its currency is a representative) recovers. This is basically why the prices of precious metals like a Gold rally against the stock market of a country.
Another question that arises here is - what if the economy is sluggish in a specific country? How does this mechanism work then?
Well, in such a case, the currency of that specific country starts weakening as compared to the currencies of the world. As the dollar persists to become expensive in terms of the country’s currency, the price of Gold in that country begins to rise. Let’s understand this with an example. Between March 2018 and August 2018, when India was experiencing an economic slowdown and a reduction in demand for goods. Manufacturing had taken a hit after the GST was introduced and brought into effect in 2017 and the Prime Minister of India, Shri Narendra Modi announced the demonetization of Rs. 500 and Rs. 1000 currency notes in late 2016. During this period, the price of Gold fell from 1365 USD per ounce to 1161 USD per ounce while in rupee terms, it only fell from INR 30950 per 10 grams to INR 29268 per 10 grams. The price of the dollar shot up by almost 10% from INR 64.86 in March 2018 to INR 71.25 in August 2018. The dollar getting expensive in terms of the INR was because of the weakening of the Indian National Rupee, and hence the Indian economy as compared to the US economy. This is how Gold was relatively expensive in India as compared to the United States because of the weakening of the Indian Economy against the US economy.
Coming back, it is quite interesting to note that when markets begin to rally, the prices of precious metals do not fall as much as the rise in markets. This is because people don’t have a valid reason to sell off these metals; just like you didn’t have a reason to sell off your old phone when you got the new one repaired. Commodity prices fall because of the trades on the futures counter as well as a fraction of the population selling these metals. This fall, however, is very small as opposed to the rise over the years that came after an earlier fall in the market. After rallying to an all-time high of Rs. 34000 per 10 grams in 2011 from Rs. 9000 per 10 grams in 2007, Gold corrected to Rs. 26000 per 10 grams and rallied back to Rs.35000 levels in 2013. It did not breach the significant resistance of Rs.26000 per 10 grams.
In a nutshell, the prices of precious metals start rising against the economy as people begin to lose faith in the currency or the stocks and likewise, gain faith in metals as transacting mediums. However, the price of Gold does not fall to the extent of the market rally. This is precisely why investors prefer to hedge their market investments with precious metals like Gold when the markets begin to give top out signals and they then expect price correction from those levels. Now, we also have a justification for the well-known proverb ‘Old is Gold’ ;-)
- Shubham Baldawa
About the Author
Shubham Baldawa
Stock Market and Finance Enthusiast
Third Year Student of B.A. in Economics and Statistics
St. Xavier's College (Autonomous), Mumbai
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