The Rise and Fall of Gold Prices after Demonetization in India - Motilal Oswal
The Rise and Fall of Gold Prices after Demonetization in India - Motilal Oswal

The Rise and Fall of Gold Prices after Demonetization in India

It has now been more than a month since the government of India announced the demonetization drive to root out the counterfeit money and curb the black money in the country. Our country is undergoing an economic change and our Prime Minister Narendra Modi is serving as the main force behind this move. After Modi curbed the high denomination bank notes, his next move is to uncover the wealth of India; a number of investors and gold traders now fear that gold is his very next target.

Demonetization effects on gold prices were seen immediately after the announcement of demonetization on the 8th of November as there was an immediate rush to buy this precious metal which lifted the gold prices to 3-year highs. With investors now fearing that the Income Tax department will tighten the noose around the jewellers who are into money laundering using gold as the route, the prices of the precious metals started to witness a downward trend.

The actions that were taken by the IT department have put immense pressure on the gold prices domestically. From rising to more than Rs. 31, 700 for 10 grams on the 9th of November, the gold price has dropped to about Rs. 27350 across major markets in India.


High Premiums

The Demonetization impact on gold was seen through the high premiums that were paid for gold in exchange of the currency notes of Rs. 500 and Rs. 1000 that were banned. Premiums up to 50% were paid for 10 grams of gold. Experts say that with the high demand the country has for gold, there might not be an immediate impact, but a long-term impact on the gold prices will certainly be seen. Some of the funds that can be tracked to check the changes in the prices of gold and silver are the iShares Gold Trust ETF (IAU) and iShares Silver Trust ETF (SLV).

Rise in Demand with Reduced Gold Prices

The fall of prices in precious metals has also spurred up the demand and the experts say that this could be temporary and whether it would remain the same in the long term still remains as a question. The retail demand for gold in India was affected due to the cash crunch after the demonetization move. It is also a fact that a number of dealers from the Gold market are charging the premiums that are more than $12 for one ounce over the official prices. The acceptance of the banned bank notes of Rs 500 and Rs 1000 is said to be the reason behind the same.

A number of gold dealers also have complained about their business being stalled after the demonetization move by Mr. Modi. About two-thirds of the demand for gold comes from rural India where gold is seen as a traditional way to save and accumulate wealth. A number of trade experts and financial analysts also suggest that it is hard to read the long-term price outlook of gold due to a number of factors that are impacting it. Experts say that the immediate demand for gold remains weak as the cash in the market has run dry and this is more in rural areas.

The gold demand is also expected to hit its seven-year low and might remain in the range of about 650-750 tons, says the World Gold Council. Experts also feel that the demand for gold will rebound in the longer run and will benefit from the decision making by the government once the new currency starts circulating. As a contrary, some experts also feel that a large portion of gold demand in our country is based on compulsory buying, like for weddings and this would keep the demand for gold intact.

Traders and investors can certainly witness sharp swings in the gold prices. A number of panicked traders and gold jewellers have also circulated messages that state the possibility of a ban by the government on importing the precious metal for domestic use from the first quarter of 2017. Though there is no official disclosure on the same, a number of gold traders are said to have been buying the extra gold that is needed for the wedding season to come. As a conclusion, it can be said that the demonetization move from Mr. Modi has spelled pain for the gold markets in India and investors now may have to turn their savings into different financial products.
 

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