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Unit 3: Market Supply and Equilibrium




                                                                                                Notes


             Case Study  Demand - Supply and Price of Gold


                  ast month saw more housewives in the jewellery shops than in any month in the
                  past. There were no big festivals, neither too many marriages. What attracted them
             Lwas the fall in the price of gold. That was so the world over.
             Gold prices have been falling for nearly a decade now. Last week they had drifted to their
             lowest in the past 18 years. The highest price in the world market was reached in 1980
             when it touched $850 an ounce, almost three times the present price. Indian buyers did not
             experience the full impact because of the restrictions on import of gold. These have been
             significantly eliminated and the price behaviour in the domestic market now conforms to
             the international price.
             The fall in the price of gold has more to do with the change in demand. Gold has many
             uses, Jewellery is only of them. It is an industrial metal, a form of saving for the rainy day
             and an international reserve asset for most central banks. The lure of gold for ornaments
             remains almost in tact. But as a form of saving or as reserve for the central banks, gold is
             no longer attractive. It is precisely this loss in trust that has caused the fall in the price of
             gold.
             Gold has become a bad investment. Anyone would weigh an asset in terms of the return
             it earns, the security it gives and the ready market it enjoys. The last is the best with gold.
             But with the price going down; investment in gold makes no sense. An investment of
              1,000 in gold in India in 1990 would have fetched today   1,120. That gives a yield of less
             than 3 per cent. Not worth the game.
             The same investment  in equity would have matured into   1,900 and in bank deposit
              2,200. Gold is no longer a viable investment though the housewife may still buy gold
             partly for display and partly from ignorance about the alternative opportunities.
             The  penchant for  jewellery is much more in India  and West  Asia than  in most  other
             countries. The world demand for jewellery was 2,807 tonnes  last year.  Gold that was
             actually mined was only 1,350 tonnes. The balance came from sales by the central banks.
             The bankers are hard-nosed fellows and the new generation bankers even more so. For
             their predecessors 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 modified
             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 billion. Had it  continued with gold, the  central bank  would have  lost
             $1.5 million 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.
                                                                                Contd...



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