How is Price of Gold Determined?

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What’s in today’s article?

  • Background
  • How is Gold Price Determined Globally?
  • How is Gold Price Determined in India?

Background

  • Global price of gold (24 carat) on April 10 was $2,349.88 per ounce. In India it was ₹7,174 per gram.
  • In recent weeks gold has witnessed phenomenal price increase, with expectations to rise further.
  • There is a direct relationship between global price of crude oil and the international price of gold (positive correlation).
  • On the other hand, there is an inverse relationship between the external value of the U.S. dollar and the international price of gold (negative correlation).
  • Simply put, whenever global oil prices shot up, the price of gold also rose.
  • Similarly, whenever the U.S. dollar declined in value against the currencies of its major trading partners, gold appreciated in price.
  • Reason Behind these Positive & Negative Correlations:
    • Rise in international crude oil prices signaled the specter of global inflation.
    • This leads to an increase in the demand for gold as a hedge against inflation.
    • Gold being a real asset unlike financial assets and hence not subject to loss of value.
    • Similarly, since the global price of gold is expressed in U.S. dollars, its depreciation meant global price of gold had to rise.

How is Gold Price Determined Globally?

Gold’s price is determined by supply and demand factors.

  • Supply Side:
    • The production of gold by producing countries and the cost of mining gold are factors to be considered on the supply side.
    • Since most of the available gold in the world has already been mined, new production will involve digging deeper into the bowels of the earth, which is expensive, as goldmining is both an energy and labour intensive.
    • So when the prices of crude oil and natural gas rise, it contributes to the rise in the price of gold.
  • Demand Side:
    • However more than gold’s supply, its demand contributes to periodic spikes in its price.
    • The demand for gold can be broken up into institutional, investor, consumer and industrial demand.
    • It is institutional demand in the form of central banks’ demand for gold that drives its price up to record levels each day.
    • Central banks buy gold to boost their reserve assets, as it is a store of value and forms the basis for the issue of new currency.
    • Faced with the threat of inflation against the backdrop of the current increase in crude oil prices (Brent crude touching $90 a barrel) and geopolitical uncertainty in the wake of the wars in West Asia and Eastern Europe, central banks worldwide, especially the Central Bank of China, are stocking up on gold.
    • Foreign currency reserves in central banks under the current situation are subject to risk and loss of value.
    • Investor demand comes from individuals as well as institutional investors, who would like to invest in physical gold or their financial derivatives and Exchange Traded Funds (ETFs) as a component of their investment portfolio.
    • Return on investment is an investor’s primary concern, but diversification of risk and safety of investment, under uncertain geopolitical and economic conditions is driving demand from this group.
    • Consumer demand arises from individuals as well as jewelers.
    • In both China and India, the largest consumers and importers of gold, it is bought as a traditional store of wealth and as ornaments for special occasions. So, consumer demand is mostly seasonal.
    • Industrial demand is influenced by technology. Gold as a metal is preferred by industry for its intrinsic properties like malleability and conductivity.

How is Gold Price Determined in India?

  • Demand and Supply:
    • The demand and supply largely influence the gold rate in the domestic market.
    • The price will be higher when the demand for gold exceeds supply.
    • But the price will fall if the demand in the market is lower than the supply of gold.
  • Interest Rate:
    • The gold loan interest rate in India are monitored and changed by the RBI.
    • It is done to manage the capital flow in the Indian market.
    • In case of higher interest rates, gold sell-off will be heavy.
    • It leads to increased supply which means higher gold rates. But the low-interest rates increase demand and lower gold prices.
  • Economic Situation:
    • People often invest in gold to hedge against inflation and recession.
    • Any adverse economic factors lead to a fall in the financial market.
    • In such a situation, investors have limited liquidity and more losses.
    • That's why they invest in gold because its demand increases in the domestic market.
  • Rupee-Dollar Conversion Rate:
    • If the value of the dollar increases against the rupee, it becomes expensive for India to import gold from international markets.
    • Therefore, the price of gold also rises considerably in the Indian market.
  • Mathematical Formula to Calculate Gold Prices:
    • The gold rate in India can be calculated using two mathematical formulas depending on the purity of gold.
    • The two formulas to calculate gold prices are as follows:
  • Purity Method (Percentage)
  • Gold value = (Gold rate x purity x weight) / 24
  • Karats Method

Gold value = (Gold rate x purity x weight) / 100


Q1. What is the difference between 24 carat and 18 carat of gold?

24 carat is pure gold with no other metals. Lower caratages contain less gold; 18 carat gold contains 75 per cent gold and 25 per cent other metals, often copper or silver. The minimum caratage for an item to be called gold varies by country.

Q2. What is PetroDollar?

Petrodollars are U.S. dollars paid to an oil-exporting country. Petrodollars are the primary source of revenue for many OPEC members and other oil exporters. Oil exporters settle sales in U.S. dollars because the dollar is the most widely used currency, making it easier for them to invest export proceeds.

Source: What’s the positive correlation between prices of gold and the U.S. dollar?