Coping with price inelasticity of gold

Last Monday I woke up to a commotion at home. I heard a scream from the bathroom, jumped out of bed and dashed round.

My wife was sitting on the floor trying to pull out the drainage pipe connected to the washbasin. She was in tears, and didn't utter a word. On repeated enquiry she pointed to the drainage pipe and mumbled something about our marriage.

I could not make much sense of that, except perhaps it meant our marriage was down the drain. I couldn't recall any recent misadventure from my side that might cause such an unfortunate consequence.

Calming her down, I turned to what the big fuss was about. Eventually she told me her wedding band had slipped off from her finger and fallen. I made light of it, and pulled out the drainage pipe — but couldn't find the ring there. In an effort to check the drain further down, I removed a ceramic cover and eventually broke it.

About this time I realised I could do nothing more and suggested we should call the security guy. When he arrived on the scene he was pretty confident of rescuing the situation. He removed floor tiles and followed the drainage pipe up to the junction that connected it to another pipe that passed under the bathtub.

But his initial confidence wore thin. After a while he suggested we should call a plumber.

The plumber came and worked his way under the bathtub. He then informed us that it would be a good idea to inform the building's maintenance department.

Battle of Waterloo

By this time the bathroom looked as though the Battle of Waterloo had just been fought there.

After a while the maintenance supervisor came up to our apartment. From his look I could discern he was not so pleased with what he saw. He heard the full story and with great regret announced there was no way of recovering the ring.

My wife was almost hysterical. In an effort to ease the distress, I told her to buy a new ring. By the time I was ready to leave for the office I saw her dressing up to go shopping for gold.

At the office, I saw on the Bloomberg terminal that gold was trading above $1,444 (Dh5,311) an ounce, an all-time record. I picked up the phone to ask her to postpone her purchase for a couple of days. But before I dialled a message flashed on my mobile phone that a purchase worth a significant amount has been made on my credit card.

I became instantly philosophical, which can be the best way to deal with apparent misfortune. In fact, I turned my mind to muse on economics, to convert the real setback into something more like an abstract exercise.

I convinced myself that the price inelasticity of demand for gold is for real. For most commodities, price rises have an effect on supply and demand; a higher price increases the supply and reduces demand (leading in turn to an equilibrium or lower price).

That's what conventional economics tells us, and economists say it's a good thing, too — otherwise a shock in the market could result in prices zooming off to infinity. Investors often buy gold as a shield against inflation. Currently, with rising inflation, many economies are heading deeper into negative real interest rates. The lower the rate of interest, the greater the demand for gold, which, bearing no running yield, generally then gets sidelined again in favour of stocks, high-yielding currencies and bonds when rates rise and returns improve.

While inflation and historically low real rates provide a sound economic rationale for rising demand and price of gold, the bulk of world demand still comes from seemingly price-inelastic consumers like my wife.

Still, culturally, such unfettered consumption of the yellow metal has its merits — such as keeping the peace.