Gold (Consolidated)...

All the prices, including gold and stocks, depend upon the level of employment in the economy. The main reason for fall in gold prices is the recovery of the countries form recession, especially the US. The stocks market in the US is showing signs of recovery and people are diverting their resources from gold to stocks, which (gold) was a good investment during recession. Recently the stock market in the US has achieved the heights seen in 2007 just before the sub-prime-crisis which is responsible for the recent gold price crash. Moreover a strong dollar has kept the demand under check. But in INDIA gold prices are going down because the economy has touched its limits of expansion. The unemployment rate in INDIA fell to 3.8% in 2012 and the economy is still handling the hangover. The CPI is still around 10% which has made gold unattractive because real prices are way below the nominal prices which is expected to fall with inflation because of the RBI's commitment of low and stable inflation. Nominal prices (real prices plus inflation) depend upon inflation and when inflation falls nominal prices fall too. The nominal prices diverge from real prices because of the objective of FULL-EMPLOYMENT. Both nominal and real prices increase upto the level of full-employment but after that only nominal prices increase because production can not be increased. And when real prices do not increase people prefer selling instead of buying because inflation is too high.

To elaborate I would like to take, those who disagree, to a situation. “Other things remaining constant, level of employment and income constant. A bubble, say in gold, bursts with a government decision that it will never put its money in gold in any form, directly or indirectly. Or simply the government will never buy or sell gold in any form. And I think this situation will have a devastating effect on gold prices. Nominal prices are very much higher than real prices. And in the long run nominal prices tend or converge to the real prices which is always lower than nominal prices, it’s an expectation not a prophecy, may be just mine. And everybody will try to sell gold at the same time. Prices will start moving down unless everybody who wants that gold gets it, and market will undergo a correction, a downward spiral. And at lot of wealth will go down the drain. But people who have a job and lot of cash will gain from this situation because prices will come down because, again, due to low economic activity. Luckily not that low as in a housing collapse because that is a labor intensive industry and generate a lot of employment. People will go through a loss because of gold and will save more this time. Consumption will lag behind. Prices will come down definitely. And, if in this situation prices come down that will mean that we can, now, buy more than before. And, if we have a lot of cash then we can buy a lot more.”

The level of unemployment can tell us how much gold-prices can rise in future if we are thinking as an investor. Unemployment at 5% and employment near 95% because it is the capacity we have, to expand. Our unemployment rate in 2012 was 3.8% I mean full-employment because after that production can not be increased because labor is fully employed. International trade, apart. Gold prices rise and fall in conjunction with other prices and wages. It moves with demand. If they rise gold prices rise and they fall too. Atleast the recent unfoldings suggest that gold prices fell almost 20% and then WPI fell 4.5 %.

C Rangarajan said the gold demand may go down which is contrary to my view. With decline in inflation real returns on gold will increase because inflation is going down. We can purchase more by selling gold than before. Lower prices will attract more buyers on the expectation that prices will go-up one-day. Lower prices are an attraction to the buyer. This is what an expectation does. It should be a gain. He says that we need to reduce gold demand. But low inflation will make gold more attractive and affordable than before because real returns (inflation adjusted) will be high. It is strange that gold demand increases when inflation is low and decreases when inflation is high. High inflation will make it unattractive because prices will rise more than the price of gold.

Credibility of the central banks is more important than backing your economy by gold. The purpose of the gold is to hedge against inflation and price rise. But that is from an investor’s point of view, the central bank needs only to make credible promises regarding inflation. Their words are more important. In today’s world where recessions are frequent and have been accepted as part of trade cycles and common we constantly need to infuse money and demand. And, in this period of crisis even if the central bank has too much gold pumping more money will erode the value of gold too as in case of money. It makes no difference whether we have gold or not. Pumping more money in the economy will only mean less value for our gold and money. It is inevitable. These days gold has a value only in the eyes of common investors. But that is a myth too. Gold can never restore the value of money once lost. It only compensates in form of the amount of money but that is subject to decrease in value of money also because inflation rises every year. The inflation we see at 2% or 3% is a gauge of increase not a constant value. It also means that gold is losing value with the same rate unless you increase your investment. It is same as depreciating currency, amount increases but value decreases if other prices rise too much. In times of high inflation central banks increase interest rates and economic activity declines and gold prices fall too and therefore it is good to put your money in inflation indexed assets that are paying higher interest rates. Any investment is just a myth as long as inflation and inflationary expectations are not properly anchored. In this world only words have value and gold has a value as long as there is a buyer.