Gold's price spike has its downsides too, and not just for shoppers

Gold price spikes often evoke excitement among various stakeholders in the market - from producers and investors to speculators and analysts.

These fluctuations take averages higher, break resistance levels on the charts, and not only present opportunities for profit-taking but serve to elevate the metal's perceived value. In turn, reinforcing confidence in its performance and driving further market activity.

On the surface, this might seem positive.

Gold has long been synonymous with auspicious occasions, from weddings to childbirth to religious beliefs. Its allure reverberates through global markets, from the bustling gold souks of Dubai to the vibrant bazaars of Mumbai. This buzz finds its way around the world through the entire supply chain, from financial institutions to transportation companies, and to brokers, exchanges, refineries and the mines.

Beneath the surface, gold price spikes are rarely benign. A closer examination reveals underlying factors that are detrimental to both the economy and society at large, as well as to the gold industry itself.

Geopolitics has its say on gold

At present, geopolitical tensions loom large on the world stage, with conflicts in Russia-Ukraine and the Middle East casting a shadow over global stability. With other regions too not being exclusive of these tensions. There are too many contradictions all around and such uncertainties drive investors towards safe-haven assets like gold, causing its price to soar.

Simultaneously, economic indicators paint a grim picture, with inflation and unemployment rates far surpassing official figures. Attempts to curb these issues, such as raising interest rates, often exacerbate them. At the grassroots level, the cost of borrowing becomes more expensive and people find it difficult to manage EMIs for even basic items such as the first-home loan or vehicle loan or for household items such as TV, fridge, etc.

Credit gets expensive for business

At the same time, businesses get starved of essential credit due to higher rates as their cash-flows may not sustain same levels of borrowings, leading to slower growth and resulting in lower employment numbers. In such turbulent times, individuals seeking stability naturally turn to assets like gold.

Central banks, too, respond to these conditions by bolstering their gold reserves, and when they buy, the quantities are huge. This means that their resources are diverted towards an unproductive asset and away from initiatives that could stimulate economic growth. For example, instead of buying gold, the same funds could be used to lend favorably (via the banking sector) to businesses that would enhance economic growth and generate employment.

Adverse side to these spikes

Furthermore, unaccounted income, whether derived from illicit activities or tax evasion, tends to find refuge in highly liquid and globally acceptable assets like gold, further driving demand during periods of uncertainty.

While gold price spikes may initially appear to signal prosperity, they also have adverse effects. The surge leads to a slowdown in consumption demand due to it being a very price sensitive segment, particularly in sectors like gold jewelry, which accounts for a significant portion of global demand.

As consumers postpone purchases, the entire gold supply chain suffers, from manufacturers and wholesalers to retailers. If purchases cannot be postponed, due for instance to a wedding in the family, then the cost of wedding goes that much higher or quantities reduced.

The repercussions extend beyond mere business losses. Accumulated inventories, often acquired through borrowing, impose additional financial burdens on industry players. Margin calls from lenders become more frequent, forcing businesses to liquidate assets and incur losses.

The management of margin calls is a very serious matter for the industry and its impact could be quite severe because during these periods of price spikes, sales and hence cash-flows reduce significantly, while now higher prices require additional cash to be placed with lenders.

If there are not sufficient cash flows, they are forced to melt jewellery which means losing making charges already paid on procuring or manufacturing the jewellery and also incurring incidental charges on melting and then selling the melted gold typically at a discount.

Gold price spikes reflect global turmoil and often signal deeper societal and economic unrest – they tell us that the world and its inhabitants are not at peace; the economies are struggling; the society is suffering; and businesses are reeling.

Gold prices could serve as a barometer for world’s economic and social health, and, sadly, the current reading is negative. Despite their allure, I find myself wary of gold price spikes and their implications for our collective well-being.