The Chinese word for crisis is composed of two characters signifying both “danger” as well as “opportunity”, meaning that every crisis provides us with an opportunity to create something. While the COVID-19 was officially declared a pandemic on 11th march 2020, the governments around the world are still trying to control the situation. With lockdowns in most countries and economies in recession, a lot of economists are worried about the after plans of reviving them. This certainly has created hysteria among the investors. It has been observed that whenever there is a crisis, the prices of gold rises. The gold rates are highest since November 2012, and even continues to be during Covid-19 but, why is it so? What are the reasons that gold is seen as a safe asset? Let’s try to understand and explore these questions.
Gold had served as money for thousands of years until 1971 when the gold standard was abandoned for the fiat currency system. Since that time, gold has been used as an investment.
Why do we value gold? It is because collectively our system has decided that it is to be considered valuable, mainly because it is a natural resource which makes it scarce, it’s a metal which does not react with other chemicals and lastly because gold is considered to be weakly related with other assets (more stable), making it appropriate to be used as security reserve.
With an annual demand equivalent to about 25 percent of the total physical demand worldwide, India is one of the largest consumers of gold and ranks third in its imports. The reason for such a large demand for gold is that it is seen as a safe haven asset (assets which are not correlated with many other assets and remain more or less stable during recessions) by not only the central banks but also by the common people. The common people can either buy gold in the form of jewelry, coins, or in the form of bonds that are provided by the central banks. During the lockdown or a crisis like COVID-19, the gold is not available to the people to buy in the physical form so the only way to invest is through the sovereign gold bonds, and because it is a safe option, the demand for gold rises during a crisis or pandemic. So, in order to discourage the selling of huge bonds, the government raises the price of gold as it needs a huge amount of gold reserve to maintain stability in the economy. This is one of the main reasons why the price of gold is increasing in India amid this pandemic.
The other reason could be that gold is seen as inflation positive, that is when the prices of commodities in an economy increase, it decreases the value of the currency (as you would have to pay more for the same good) and then people only find gold as a safe option to invest, again increasing its demand and price. Therefore, in times when inflation remains high over a longer period, gold becomes a tool to hedge against inflationary conditions. But this positive relation may not always hold true since during SARS (February-May 2003) there was a fall in the price of gold though the pandemic was at its peak during the period.
Other factors of the rising prices of gold can be interest rates. Interest rates are essentially the cost of borrowing, so when the interest rates are reduced and there is more money in hand for consumption, it leads to an increase in demand and hence, a subsequent increase in prices. In March, when the COVID-19 crisis deepened, the risk-averse investors initially flocked to cash. This happened due to last month’s fall in the gold price, which was also thought to be due to investors being forced to sell the metal and take profit from its gains, in order to cover losses elsewhere, otherwise known as a “margin call.” However, when the U.S. Federal Reserve cut interest rates to zero later that month, there was less incentive to hold dollars. Cutting interest rates meant the already low returns that investors received from investing in debt, or bonds, were nudged even lower.
Gold has since, therefore, regained its popularity, with the price climbing back up to its highest point in nearly seven years last week, at $1,769 per ounce. Total global gold demand rose about 1% to 1,083.8 tons in the first quarter as investment offset declines in demand from the jewelry and technology sectors.
A shorter supply of gold in COVID-19 has also bolstered the prices of the metal pointed out by Sheridan Admans, investment manager at U.K.Stockbroker, The Share Centre. As the virus has forced mines to close, the gold supply fell by 4% and mine output hit a five-year low.
But in the COVID-19 crisis, there have been two diverging markets in gold this year, with demand rising in the West and falling in the East. The hunt for a haven helped boost the U.S. and European investment in the first quarter to levels last seen after the Brexit vote and Donald Trump’s election, according to the World Gold Council. At the same time, jewelry, bar and coin consumption in China and India dropped to multi-year lows as higher prices and coronavirus-led lockdowns deterred buyers. While in India, retail investors are selling billions in the hope that they get it cheaper again in the West, investors proved to be more cautious in selling and momentum buying is stronger. Holdings in SPDR Gold Trust, the world’s largest gold-backed exchange-traded fund, rose 0.6% to 994.19 tonnes recently.
The investors don’t expect the situation of COVID-19 to get better any time soon but it is likely that gold prices will continue to rise. Among the other assets, gold and other precious metals might be the best investment as of now. Like said in the beginning, this crisis is indeed an opportunity for some.