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Unit 3: Supply and Market Equilibrium

hard-nosed fellows and the new generation bankers even more so. For their predecessors Notes
gold meant total security. That was not without reasons.
Countries had adopted gold standard and issue of currency had to have commensurate
gold backing. The system had continued till the beginning of this century and in a modifi ed

form, even later. The final link with gold was given up in 1972, after the oil crisis, when the
dollar ceased to be convertible into gold. But the gold hangover continued until the new
generation bankers looked at gold only as an income generating asset. It had ceased to be
one.
Over the years, the central banks had piled up huge reserves of gold. These currently
exceed 37,000 tonnes – equivalent to 12 years’ supply. When part of this gold began to
come to the market, prices crashed. Netherlands possibly took the lead to empty the central
bank coffers of gold. It sold 300 tonnes in four instalments to cut down its gold reserves

by a fifth. The big shock came when Australia slashed its reserves by two-thirds. It was a
shock because Australia is a major producer of gold.
Argentina came out even more boldly and sold out its entire gold reserve of 124 tonnes
for about $1.5 billions. Had it continued with gold, the central bank would have lost $1.5
millions for every one per cent fall in the price of gold. With the shift from gold to US
treasury bonds which are rated even higher than AAA the central bank would, instead, be
earning an income of $80 a year.
The real gold hoarders are the Swiss bankers. They are conservative and gold is the most
prized asset for them. However, last October, a panel of experts suggested that the banks
sell out a half of their reserves in gold. The report of the panel created big waves. The fear
that the central banks will unload their stocks of gold caused panic. Gold prices crashed.
The fall was the highest in any single day.

It is not just the mismatch between demand and supply that forced prices to drop so
sharply. Gold is a favourite with speculators. Even banks have been indulging in this
lucrative activity. Quite a few American banks sold gold short in anticipation of the fall in
price and earned a good packet. Speculation has made prices more volatile than what they
would have been. Considering the oversupply position, it is the bears that hold the sway.

Will gold prices recover? If they do gold would be a good investment. But they won’t.
The demand for gold will now be almost exclusively for jewellery and, to a minor extent,
for industrial use. Even that demand is dwindling because gold does not have a good
resale value and has nearly ceased to be a status symbol for the rich. When most people
understand this the demand for gold, even for jewellery, purposes will shrink.

For the present, it may freeze at around 2,500 tonnes. There is no demand at all from the
bankers for reserves or for investment. The supply will be from the mines from which 2,300
tonnes are dug out every year. On top of that there will be sale by the central banks.
Even if 2 per cent of the world reserves are disposed off, nearly 700 tonnes of additional
supply will enter the market. Again a mismatch between demand and supply is likely
which will prevent prices from fi rming up.
Gold has little future. By and by even its use for ornaments will die out. A bad investment
and no longer kept for reserve, gold will be on par with other metals. The switch will be
from gold to US treasury bonds for the banks and from gold to equity for the general public.
In India, gold will survive a little longer until the public is acquainted with alternative
investment opportunities. Eventually, gold is bound to lose its lustre.

Contd...

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