Understanding Inflation, gold prices, and interest rates

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Looking closely at the topic of interest, there appear to be three components to it, namely inflation, gold prices, and interest rates. These are vastly different aspects that are heavily interdependent when looked at from a financial perspective. Any amateur or experienced investor or close observer of market trends will be able to validate the fact that such forces work in tandem and provide a track of future movements if looked at from a clear understanding of individual determinants and group effects of the same. To deep dive, let’s consider each aspect individually first to then gradually draw out a map of correlation between the three.

What is inflation?

Economics will simply define inflation as the gradual increase in prices of goods and services within a specific geographical area or a country that is the ultimate decline in purchasing power of a currency over time. The rise in the average price level of a selected basket of goods and services in an economy over a specific period is the quantitative estimate of the rate at which the purchasing power of the currency declines. The change in purchasing power of the currency is generally expressed in terms of percentage which means the degree by which a unit of currency effectively buys less of a good or a service than it did in any prior period. Inflation is a positive or a negative measure depending upon the individual viewpoint and the change in rate.

Gold Prices and some related determinants

Gold prices are generally considered to be a hedging tool in times of inflation.  A hedging tool is essentially a counter-attack measure in response to any change in the financial environment of the economy. Usually, gold prices are positively affected by inflation. Sometimes, when inflation persists for a long time, the gold prices might not be affected that much.

Gold has also done well in the recent past owing to very low-interest rates and presently gold prices have traded in the specific range for almost a year now. Per 10g, it has been trading in the range of Rs. 46,000 to Rs. 50,000. Given the current market trends, we are expecting interest rates to only increase which is bad news for the positive stability of gold prices. It can also be stated that the prices of gold increase when the cost of living goes up. As clearly experienced during the covid-19 crisis, interest rates can hamper gold prices to a large extent.

Interest rates in the context of things

Rising interest rates are a reason for government bonds, stocks, and other investments to look more attractive. This encourages investors to put their money in substitutes of gold and thus decrease volume investing in it. This is because gold is a damage control investment in times of crisis and no reason to invest in it in financially healthy times. This is applicable for both situations of financial well-being and financial decline.

Interest rates are a different parameter for every economy depending on their stage of development but inflation has more or less the same impact on gold prices globally. In a country like India, where gold is still considered more than just a yellow metal and a holy investment for some, a haven money lock-in for others. 

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