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Will gold prices go up or down? Here's the economics

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Gold was the most sought after investment in the past decade. During this time, gold added to its reputation as a safe haven during the global economic crisis. But off late gold prices have experienced significant corrections. Here are the factors which made gold prices record new highs in the last decade and the factors which made it take a plunge in the previous months.

US ECONOMY
Being a dominant player in the global economy, the US economy has always maintained an inverse relation with the gold markets.

Past situation
The US faced the deepest and longest recession since the Great Depression of 1930s. The manufacturing industry took a severe hit. The economy was unable to generate new jobs, driving the unemployment rate higher. The housing sector was affected by numerous foreclosures. The US had to support its wrecked banking system by quantitative easing sethods. During that time, the investors were favoring gold over the US equity markets.

Present situation
The US economy started to gain momentum in the month of March 2013. The employment data of US was encouraging with the private sector adding a substantial number of new jobs and posting good gains in the first quarter. Being a personal consumption driven economy, the US found support in the form of increased activity in motor vehicles and housing sectors. This, in turn, started stimulating the much needed labour market activity resulting in increased employment opportunities. Increased household wealth, increased spending at retail outlets and stores also showed signs of recovery. Even the home foreclosures and layoff rates were recorded at pre-recession levels. The economic recovery signs improved investors' confidence in equity markets. They started preferring equity markets over gold.

GLOBAL ECONOMY

Past situation
Not just US but all the major economies across the globe experienced a major financial crisis post 2007. The turmoil in Europe with respect to the economic slowdown and the debt crisis negatively affected the euro. The Japanese economy was spiraling in the effect of the "lost decade".

Present situation
Though the current condition of the euro zone doesn't boast of full recovery, it has started showing good signs. With Cyprus banks opting for selling their gold reserves to pay off the debt, the supply of gold increased. In the anticipation of more euro nations following the suit, investors have cut down their exposure to gold. Gold ETFs experienced huge sell-off pressure.

US DOLLAR

Past situation
The quantitative easing measures by US weakened the US dollar. Demand for the dollar decreased. The major federal banks were opting for gold over the dollar, with China being the front runner. This acted as one of the driving factors for the gold price rally. In anticipation of driving inflation rates higher once the quantitative easing measures end, investors preferred gold as a hedge against inflation.

Present situation
With signs of economic recovery, the US dollar has strengthened. The current inflation data across the globe is not in sync with the anticipations. The inflation numbers were recorded lower than expected. Investors started favoring the dollar over gold.

Conclusion
When compared to the global markets, Indian markets experienced higher growth rates in gold prices.

The Indian rupee, which used trade around 43 per dollar, is now valued at around 54 per dollar. The global economic conditions of the past decade along with the weakness of the rupee acted in favor of higher gold prices during the last decade in India.

The economic indicators in the coming quarter will define the direction of gold in the future. If the US economy continues its good run, you can expect a further decline in gold prices in 2013.

Nitin Vyakaranam is the founder and chief executive officer, ArthaYantra, an integrated online personal finance company.

Disclaimer: The opinions expressed in this article are the personal opinions of the author. NDTV Profit is not responsible for the accuracy, completeness, suitability, or validity of any information on this article.

Story first published on: April 30, 2013 14:37 (IST)

Tags: gold, US dollar, gold prices

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