IB Economics Extended Essay 2007

Why is the demand

for gold increasing
despite increasing
price of gold in
India?

Word Count: 3842

Name: Athul Ravunniarath

Candidate Number: 000638
Supervisor: Esther Chau

1
Contents

Chapter 1
1.1 Introduction
1.2 Hypothesis 1 (Consumer Demand)
1.3 Hypothesis 2 (Lack of substitute due to cultural reasons)
1.4 Hypothesis 3 (Investment Purposes)
1.5 Hypothesis 4 (Industrial use)

Chapter 2
2.1 Background of Gold production and consumption in the
world
2.2 The price of Gold over the past few years
2.3 The Cultural background of gold consumption in India

Chapter 3
3.1 Proof for hypothesis 1
3.2 Proof for hypothesis 2

Chapter 4
4.1 Proof for hypotheses 3 & 4

Chapter 5
5.1 Limitations of this Extended Essay
5.2 Conclusion and evaluation

Appendix A

2
Abstract

The objective of this research is to explore the reasons for the

increase in the increase in the demand for gold against increasing
prices in India for the last five years. India, the second most populous
country in the world with a population of over 1.1 billion people and
GDP per capita of hardly 3000 USD per annum is also the world’s
biggest consumer of the gold.

Gold perhaps the most valued and the most appreciated among all the
known metals to man has historically been valued and has been used
a currency standard at various points in human history. This rare and
expensive commodity is what once drove the Spanish Conquistadores
to plunder South America. One of the main reasons why gold is
interesting today is that the value of gold has not decreased in the
past couple of years and therefore is seen as a very strong
investment.

In the past five years, there has been positive co-relation between the
price of gold and the demand for it in India. From my observations and
the surveys conducted I have discovered that the reason for this
increase in demand against this increase in prices which goes against
the demand-supply relationship is due to a variety of reasons ranging
from very strong cultural affiliations to gold as well as simple
investment purposes.

Word Count: 222

3
Chapter 1

1.1 Introduction

India is the biggest consumer of gold in the world. Around 18% of the
total production of gold in the world is consumed in India which is
around 800 Tonnes. In the last 5 years, despite the price of gold
increasing in co-relation to the price of oil, the demand for gold has
only gone up. The growth in the demand for gold is at almost alarming
stage. This relation between the price-rise and the demand is what
aroused my interest in the topic. I have come up with some plausible
hypotheses for this.

1.2 Hypothesis 1

Increasing GDP per Capita

The increase in the demand for gold is directly linked to the increasing
GDP per capita of the country or perhaps an increase in the disposable
income of the average middle-class Indian and thereby increasing
consumption of gold jewellery.

1.3 Hypothesis 2

Cultural Reasons
Indian society has traditionally been very attracted towards gold. And
therefore despite the increase in price of gold, the society feels the
need to purchase gold and gold jewellery. It does not have a
substitute and is a necessity to the Indian cultural life.

1.4 Hypothesis 3

Investment purposes
Since a long time the prices of gold have only increased over time.
This may have caused investors to invest in a reliable and steady
source of returns such as the basic gold metal.

4
 Chapter 2

2.1 Background of Gold production and consumption in the

world

Roughly 2600 Tonnes of gold was produced in 2005. Roughly the same
amount was being produced for the last couple of years peaking in
1999 with a little over 2600 Tonnes being produced. The major
producers of gold are South Africa, Australia, USA, Indonesia, Peru and
China. One of the very distinct features of gold is that Gold is never
‘consumed’ like oil. It is possible to recycle and reuse the gold. In fact
it is even possible to amalgamate all the gold ever mined in the world
since man started mining gold. Very little of the gold mined has been
lost completely. And some of the ‘consumption’ of gold these days is
simply investment where the gold is left as it is.1

Only around 120000 Tonnes of gold have been mined throughout the
history of man. 120000 Tonnes, which is the total global hoard of gold,
is such a small volume that it can be transported in a single oil tanker.
The entire worth of the total hoard is about 1.4 Trillion US Dollars.2

The major consumption of gold is to make jewellery. Around 82 % of

the gold produced is used to make jewellery, 6 % for medals ad official
coins, 6 % for the manufacture of electronic equipment, 3 % for
dentistry, and another 3 % in a wide variety of industrial applications.
As stated before, India is the biggest consumer of gold in the world
accounting for 18% of the global consumption followed by the United
States with 14% and followed by China. 3

1
http://www.lbma.org.uk/statistics_current.htm
2
http://about.reuters.com/productinfo/s/gold_price_history/
3
http://www.gold.org/value/stats/statistics/prices/index.html

5
2.2 Price of Gold over the last few years

4
http://www.gold.org/value/stats/statistics/images/avpriceofgold1900-2005.gif

6
 5

5
http://www.kitco.com
6
http://www.gold.org/value/stats/statistics/images/dailyshort_1.gif

7
 7

As we can see from the graphs above, the price of gold has always
kept on increasing. The only exception in the long term was the gold
price crash in the mid 1980s which is directly linked to the oil price
crash in that time period. Otherwise we can see that the price of gold
7
http://www.gold.org/value/stats/statistics/images/dailyshort_8.gif
8
http://finance.indiamart.com

8
has steadily increased in the long term from 1900 to 2006. Over 106
years.

2.4 The Cultural background of gold consumption in India

Gold is one of the few metals in the world to be used as a currency. It

has been used as some form or currency or other since around 560 BC
till the end of the Bretton Woods system in 1971. This linking of gold
to currency is one of the reasons why people still feel and believe that
even if the monetary system was to fail, gold would still be valuable.

One of the major drivers of gold demand in India is the cultural values
tied to the purchase and the use of gold. Weddings and the wedding
season account for nearly 60% of the 600 Tonnes of gold jewellery
consumed in India.9 Traditionally, parents give the bride the gifts of
gold jewellery in order for the bride to financially independent in her
husband’s household. This is because gold is one of the most highly
liquid metals ever known and is considered by most Indians to be a
very monetary asset. And for the last couple of decades the
performance for this metal has been exceptionally strong. If this is
true, the demand for gold will be price inelastic for up to the 60% of
the gold demanded by the wedding season because of the belief
people have in the performance of the metal. The chances of prices
going down are negligible and therefore gold will be gifted to brides in
order for her to remain financially independent in her husband’s
household. This means that even the price of gold increases, the rough
60% gold demanded by the weddings cannot decrease, because it is
close to being a necessity.

Not only weddings, but other strong reasons include the festival
Diwali, when maximum gold is purchased, and other religious
occasions such as Onam and Pongal. The Indian Hindu calendar also
encourages purchase of gold during certain auspicious days to bring
luck and fortune to the family. Gold is also purchased during the birth
of a child. In fact a female child has her ears pierced with gold studs
as early as 6 months from birth.

I have again tried to prove this hypothesis, which is the demand for
gold is price –inelastic to a certain extent because of the cultural
affiliations to gold by the Indian community by a sample survey
conducted in both urban and rural areas about price elasticity involved
with cultural reasons.
9
http://www.goldinspirations.com/headlines/2005/01/19/story/7600534/

9
 Chapter 3.1

India is the largest consumer of gold jewellery in the world followed by

the United States of America. This is despite the fact that India is a
third world country with the per capita income hovering around 550
US$ per annum while the per capita income in the USA is around
40,100 US$. According to the World Gold Council, Jewellery accounts
for the largest share of final demand for gold. This is approximately
70% of the total demand for gold and worth approximately 40 Billion
US$. 10

As per the figure given above, we can see that India is the major
consumer of Gold jewellery. By volume India consumes approximately
590 Tonnes of gold jewellery in a year. As I have noted in Chapter 1,
the annual total consumption of gold in India is approximately 800
tonnes; which means that jewellery accounts for almost 74% of the
total gold consumption in India.

“Speaking to DNA Money, Varij Sethi, managing director, SB&T said,

"Jewellery is one of the fastest growing and most profitable segments
in the Indian retail space today."”11

10
http://www.gold.org/discover/knowledge/amazingfacts/index.html
11
http://www.dnaindia.com/

10
India is generally one of the most price-sensitive markets in the world.
Generally, value for money is a big deciding factor when it comes to
purchasing any sort of luxury goods such as electronic appliances and
automobiles. But the price of gold has not gone down and has been on
an upward trend for the last couple of years; hence it is not the price
factor that is driving up the demand for gold. Therefore a simple
theory to explain the increase in the price of gold could be related to
the fact that the booming middle-class in India is spending more on
gold as they have higher disposable incomes. I have used a sample
survey to prove that the demand for gold is income-elastic to certain
extent. That is if people have more money to spend, then the spending
on gold will increase. I have surveyed over 100 consumers in jewellery
stores in both urban and rural parts of the country.

The per capita GDP has been increasing ever since the 1970s and
continues to increase even today.

Per Capita GDP 1970 - 2005

800
700
600
500
US

400 Per Capita GDP

300
200
100
0
Period

1972

1978

1984

1987

1993

1999
1975

1981

1990

1996

2002

Year

11
 Per Capita GDP 1995 - 2005

800
700
600
500
US

400 Per Capita GDP

300
200
100
0
1996

1999

2001

2002

2004
1995

1997

1998

2000

2003

2005
Years

We can see that the per capita GDP has almost doubled since 1995
from 392 USD to a little over 720 USD. Because of this fact the
booming middle class contributes to growth of the gold sector and
purchases gold as they have more disposable income.

Also the population of India has boomed and has almost doubled from
about 500 Million in the 1970 to 1.1 billion in 2005.

Population

1,200,000,000

1,000,000,000

800,000,000

600,000,000 Population

400,000,000

200,000,000

0
1970

1973

1988

1994

2000
1976

1979

1982

1985

1991

1997

2003

Year

12
 Both these factors cause an external shift in the demand for gold
especially gold jewellery. The demand curve shifts outwards as shown
below.

Price
S

D’
D

Quantity

As we can see from the figure above, the price of gold is driven up by
increasing demand from the consumers who these days have more to
spend because of higher disposable income.

As per the government of India figures, around 25% of the population

of the country falls into the middle income category.12 This 25%
translates into almost 300 million people. This figure was hovering
around 6% of the population in the mid 1980s; which was around 50
million people. There has been a growth of almost 250 million in this
category. This means that the population almost the size of the United
States has been empowered with a higher purchasing power. This will
automatically translate into higher purchase of gold. Out of this 25 %
population in the middle class, 10 percent has just broken into the
middle class layer in the last 10 years. The top 5% is almost on the
verge of becoming upper class. In the last one year there has been
accelerating trend of about at least 1 percent of the total population
breaking into the middle class. It is an accelerating trend. Along with
this massive middle income population, around 10% of the population
is reported to be in the high income group. With the New Economic
12
Census India 2001
www.censusindia.net

13
policy being implemented in India in 1991, the figure has been
growing exponentially.

One of the features of the middle class group around the world is the
consumerism. As they earn more money, they will consume more. This
is true in the case of the gold consumption. In the GDP of India,
private consumption as part of the GDP was only 50% in 1990; this
has increased up to 65% in 200413. All these have contributed
effectively to the consumerism.

In the survey that I conducted, one of the questions was “If your
salary or profits increased considerably, do you think your purchase of
gold will also increase accordingly?”
Most of the survey takers responded that they would purchase more
gold. Their main argument for doing that was that, when they earn
more, they would need to spend and invest more. And therefore they
would be willing to spend more money on gold. Percentage of people
who think their consumption of gold would increase with respect to the
increase in their incomes

22, 23%

Yes
No

73, 77%

Consumption-Salary
As we can see from the graph above almost 77% think that their
consumption would increase. In the survey that I conducted, only the
high income group in the urban areas said that they would not
purchase more gold with respect to their incomes; While the middle
class and the lower income groups were almost 100% sure that their
consumption would increase.

13
Reserve Bank of India: The Economy in 2005

14
 High Income Group

16
14 14
14
12
10 9
Yes
8 7 7
No
6 5
4
2
0
Urban Rural Total

Middle Income Group

30 28

25

20
16
Yes
15 12 No
10 7
6
5
1
0
Urban Rural Total

15
 Lower Income Group

35
31
30

25

20 18
Yes
15 13 No

10

5
1 0 1
0
Urban Rural Total

As we can see from the graphs above, other than the urban High
income group, almost 100% of the respondents said their purchase
would increase along with the increase in their incomes. Another
question on my survey was what amount the person spends on
purchasing any form of gold in a year. Most of them came up with a
reply that it would be hard for them to estimate the amount they spent
on gold in a year. Most of them said that it varies year to year with the
occurrence of different reasons like weddings, anniversaries etc. The
next question on the survey was did the respondent feel that the
amount they spend on gold increased over the years. Most of them
said they spend more on gold because the price of the gold keeps
increasing and even though the quantity of gold purchased doesn’t
increase, the amount spent on gold keeps increasing. But the general
consensus was that more people felt that they were in a position to
buy more gold than they were 15 years ago. They attribute this to the
general rise in their incomes is far more than the general increase in
the price of gold. The price increase in Gold is around 98% from 1990
to 2005. The growth in per capita income from 1990 to 2005 is around
110%. This could probably be the reason why people in the country
think they are able to afford more gold and that their general
consumption of gold has increased.

We can also explain this effect using indifference curves.

16
The increase in the income will cause a parallel shift in the demand for
the gold; which is shown in the diagram above as the increase in
demand from X1Y1 to X3Y3.

In conclusion to this chapter, I would like to state that one of the

major reasons for the increase in demand and the price of gold are
directly linked to increasing purchasing power of the middle income
group of the Indians who make up almost 250 million of the
population.

3.2

The second hypothesis for the increasing demand for gold despite the
increasing prices is that the Indian society is traditionally affectionate
towards gold. I think there are a lot of cultural reasons that affects the
average Indian consumer’s mentality when it comes to buying gold. I
have given many cultural and traditional reasons associated with gold
in chapter 2.3. With my survey, I was further able to establish this
hypothesis of cultural reasons. This is because; through the survey I
was able to find out the reasons why some consumers buy gold.

I was able to draw up a preference chart for both rural and urban
consumers indicating their preference towards Gold, silver or platinum.
As I expected, most consumer prefer gold.

17
 Precious Metal Preference Chart

25
22 22

20
16
15 HIG

10 10 MIG
10 LIG
7
6
5
2
0
0
Gold Silver Platinum

Urban Precious Metal Preference Chart

12
ta

10
10 9
No. of People

8
8 7
High Income Group
6 5 5 Middle Income Group
Low Income Group
4 3

2 1
0
0
Gold Silver Platinum

As we can see from the urban preference chart, gold is preferred by

most people from varying income groups. But we can see that there is
almost the same preference for platinum and gold amongst the higher
income group. This probably because the Higher income groups do not
buy gold as an investment and probably only as ornaments or fashion
accessories and hence have the same preference for platinum as well.
There was also a rising preference for platinum among the middle
class as well while there was no interest at all for platinum among the
lower income groups. There is also a significant preference for silver
among the lower income group; probably because of its affordability
and liquidity.

18
 ta
Rural Precious Metal Preference Chart

14 13
12
12
No. Of People

10
8
High Income Group
8
Middle Income Group
6 5 Low Income Group
4
4 3

2 1 1
0
0
Gold Silver Platinum

As expected, most people prefer gold to any other precious metal.

Unlike the urban areas there was very limited interest in platinum and
ta

there was similar interest in silver. But the preference for gold is very
high.

Precious Metal preference Chart

35 33

30 27
No. Of People

25

20 Urban
15 12 Rural
9 10
10
4
5

0
Gold Silver Platinum

This is the combined chart showing preference in rural and urban

areas without factoring in the income differences.

The second question on the survey was also tied to the reason for the
preference of gold. The second question was regarding the reason for
preferring gold. The reasons for the attraction were quite diverse. In
fact most of the respondents to the survey gave different answers. All

19
the reason I received (from the people who said they preferred gold) is
listed below:

• Value never decreases

• Necessity for weddings
• Investment
• Easily Liquidable
• Looks good
• Lasting
• Re-moldable

Most of the answers overlapped quite a lot. But from the above
reasons we can see most of the reasons for the attraction of people
towards gold.

In fact one of the ladies I had surveyed coming from the rural part of
the country and a member of the lower income group responded that
she prefers to buy gold just for the reason that it is safer to keep gold
than liquid cash. Because if you buy an ear ring with the 2000 rupees
that I save, then I can always keep that amount on me by wearing the
ear ring. But if I keep the money in the house, then my husband just
uses it up for buying alcohol. At that point, I asked her why not open a
bank account and she responded that she did not trust the banks and
banking services in general.

The third question was also a part of this series of questions. What is
your current reason for purchasing gold?

Current reason for purchase of gold

4, 6%

14, 20%
Wedding
Investment
Jewellery/Fashion
6, 8% Gift
47, 66%

20
There were only four solid reasons I got from 71 people who were in
the jewellery to buy gold. The four reasons were investment, wedding,
fashion/accessory and gifting. I have graphed the number of people
buying gold for different reasons. As said in chapter 2.3 weddings
account for the most of the gold sales in India. On some average days
during which the surveys were conducted, over 66% of the crowd that
came with the intention of purchase gold were there because of
wedding related reasons.

As I said in chapter 2.3, weddings account for almost 60% of the 600
Tonnes of gold sold in India; which is approximately 360 Tonnes of
gold. I did not conduct the survey during the peak of the wedding
season. Yet, 66% of the gold sold was due to wedding reasons.

Now half the population of India is under the age of 25. Almost 600
Million people are under the age of 25.14 This means that more number
of young people getting married could directly result in an increase in
the amount of gold being purchased for wedding reasons.

Price

D’
D

Quantity
Therefore for the next two decades, as long as the average age of the
population is less than 25, then the consumption of gold due to
marriages is not going to decrease. The average age for marriage is
between 26-29 years. Because of the cultural affiliations towards gold
and the need for gold during marriage, the demand will not decrease.

14
Census 2000

21
The fifth question in the survey also invoked quite a surprising
response quite contrary to the economic theories I have learnt. The
question was, if the price of gold increased further, would you still
purchase the gold? The response of the majority of the respondents
was that buying gold was unavoidable and there will be consumption
of gold whatever the price of gold.

16 15

14 13
12
12

10 9
HIG
8 8 8
8 MIG
6 LIG
6 5
4 4
4 3

0
UrbanYes UrbanNo RuralYes RuralNo

As we can see from the chart above, very few people said that they
would not buy gold if the price increased. A big proportion of them
were the urban Lower income group which said that they will not be
able to afford gold if prices go up even more. Some of the rural and
urban lower and middle income groups said that they will borrow
money from banks and loan sharks if the price goes up so that they
can buy gold because they cannot avoid buying gold.

The questions 8 and 9 evoked similar responses to the question above.

Most said that there are situations in which buying gold becomes
unavoidable especially during marriages. Some of the respondents said
they will buy gold however high the price is, if there is a wedding in
the family.

I would like to conclude this chapter saying that, a major reason for
increasing demand for gold despite the high prices is the cultural
reasons linked to the purchase including the need of gold jewellery in
marriages.

22
Chapter 4

One of the reasons for the high demand for gold is the investment
related purchase of gold. As I have said before, gold is one of the few
metals that have always had a constant growth rate. Therefore many
people invest in gold; especially in the form of bullion as an
investment purposes. In an interview with the Senior Investment
manager of Franklin Templeton India, he mentioned that serious
investment in the form of gold bullion is limited to the urban high
income group and middle high income groups. The urban income
groups due to their increased income over the past few years have
diversified their investment portfolio from stocks and bonds into
something more stable and tangible like gold and silver. The major
consumers of gold bullion are people who are averse to risky
investment like stocks and bonds. The gold bullion demand has
increased in the last 2 years with the extreme fluctuations caused in
the stock exchanges. Since gold is a more stable investment, people
prefer to invest in gold. The urban high income groups also invest
heavily into real estate along with gold.

Again the demand for investment is there because the price of gold is
increasing. One of the questions in my survey was if the respondent
would buy gold if the price of gold declined. All the respondents who
considered gold as an investment said they would reduce their
consumption of gold especially for investment reasons if that
happened. Although most of the respondents claimed that that
situation would never happen given the history of gold.

My last hypothesis for the increase in demand for gold was probably
the unavoidable rise in the industrial consumption as part of the new
economic policies since 1990. But apparently the industrial use for gold
in India is very minor and is not significant enough to cause a
remarkable difference to the price of gold. One of the industries that
rely heavily on gold though is the dental and dentistry. With increasing
incomes and disposable incomes, the demand for gold filling and gold
teeth have increased ten fold. Even then, this demand is negligible and
the industry is really insignificant.

Chapter 5

Limitations

23
The most serious limitation is that a lot of assumptions and claims
made in this extended essay were based on a survey which had a
mere 95 participants. The survey which generalizes the entire situation
in India is based on simply two locations in the same southern state of
Kerala in India. I don’t think that such a small sample size is enough to
prove a serious claim and hypothesis.

Conclusion

With this research I have tried to show the reasons for why the
demand for gold is increasing in India despite the increasing prices of
gold throughout the world. It was observed that the cultural ties
toward gold in the Indian society along with increasing per capita
income and the disposable incomes of the middle class Indian is the
most significant driver of the demand for gold.

I think the major drawback of this excessive consumption of gold is

that the capital used for the purchase of gold could actually be used to
develop industries and for proper investment purposes and or social
development.

I will end this essay with a quote from the ex-American Federal
Reserve chairman Alan Greenspan "Gold is an irrational exuberance
which may lead to a financial asset Bubble!” That is Alan Greenspan
giving a warning about the situation in India.

Word Count: 3842

Bibliography

1. Andrew Gillespie. Advanced Economics through

diagrams. New York: Oxford University Press. 2001.
2. Paul A. Sammuelson, William D. Nordhaus.
Economics (17th Edition). USA: McGraw-Hill Higher
Education. 2001.
3. www.gold-eagle.com

24
 4. http://serc.carleton.edu/research_education/nativelands/pi
neridge/golddeposits.html
5. Census India 2001, Government of India 2001
6. Reserve Bank Of India, Economy: An Outlook
7. New York Mercantile Exchange. www.nymex.com

Appendix A

Survey Questionnaire

1. If you were given the option of purchasing the option of Gold, silver
and platinum, which would you prefer and why?
2. What is the reason for the attraction to gold?
3. What is your current reason for purchasing gold? Wedding,
investment etc
4. Even though the price of gold is at its highest levels in a long time,
why do you still purchase it?
5. If by any reason, the price of gold increased even further, will you
still buy gold?
6. If your salary or profits increased considerably, do you think your
purchase of gold will also increase accordingly?
7. If the price of gold decreases, will your consumption increase?
8. Are there factors by which buying gold becomes unavoidable?
9. If there is a wedding in the family, will you purchase gold
regardless of the price?
10. Do you think gold has a very high resale value?
11. Do you purchase gold for investment purposes?
12. In a year, what amount do you spend on buying gold jewellery?

25
13. Has this amount increased over the years?

26