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INTRODUCTION

Gold is a chemical element with the symbol Au and an atomic number of 79. It has been a highly sought-after precious metal for coinage, jewellery, and other arts since the beginning of recorded history. The metal occurs as nuggets or grains in rocks, in veins and in alluvial deposits. Gold is dense, soft, shiny and the most malleable and ductile pure metal known. Pure gold has a bright yellow colour and lustre traditionally considered attractive, which it maintains without oxidizing in air or water. Gold is one of the coinage metals and has served as a symbol of wealth and a store of value throughout history. Gold standards have provided a basis for monetary policies. It also has been linked to a variety of symbolisms and ideologies. A total of 161,000 tonnes of gold have been mined in human history, as of 2009. This is roughly equivalent to 5.175 billion troy ounces or, in terms of volume, about 8,333 cubic meters. Chemically, gold is a transition metal and can form trivalent and univalent cations in solutions. Compared with other metals, pure gold is chemically least reactive, but it is attacked by aqua regia (a mixture of acids), forming chloroauric acid, but not by the individual acids, and by alkaline solutions of cyanide. Gold dissolves in mercury, forming amalgam alloys, but does not react with it. Gold is insoluble in nitric acid, which dissolves silver and base metals. This property is exploited in the gold refining technique known as "inquartation and parting". Nitric acid has long been used to confirm the presence of gold in items, and this is the origin of the colloquial term "acid test", referring to a gold standard test for genuine value. Of all the precious metals, gold is the most popular as an investment. Investors generally buy gold as a hedge or safe haven against any economic, political, social or currency-based crises. These crises include investment market declines, burgeoning national debt, currency failure, inflation, war and social unrest. Speculators also buy gold early in a bull market and aim to sell it before a bear market begins, in an attempt to gain financially.
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Gold has been used throughout history as a form of payment and has been a relative standard for currency equivalents specific to economic regions or countries. Many European countries implemented gold standards in the later part of the 19th century until these were dismantled in the financial crises involving World War I. After World War II, the Bretton Woods system pegged the United States dollar to gold at a rate of US$35 per troy ounce. The system existed until the 1971 Nixon Shock, when the US unilaterally suspended the direct convertibility of the United States dollar to gold. Since 1919 the most common benchmark for the price of gold has been the London gold fixing, a twice-daily telephone meeting of representatives from five bulliontrading firms of the London bullion market. Furthermore, gold is traded continuously throughout the world based on the intra-day spot price, derived from over-the-counter gold-trading markets around the world. Today, like all investments and commodities, the price of gold is ultimately driven by supply and demand. Unlike most other commodities, the hoarding and disposal plays a much bigger role in affecting the price, because most of the gold ever mined still exists and is potentially able to come on to the market for the right price. At the end of 2006, it was estimated that all the gold ever mined totalled 158,000 tonnes This can be represented by a cube with an edge length of just 20.2 meters. At the end of 2004 central banks and official organizations held 19 percent of all above-ground gold as official gold reserves. Given the huge quantity of gold stored above-ground compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production. According to the World Gold Council, annual mine production of gold over the last few years has been close to 2,500 tonnes.[15] About 2,000 tonnes goes into jewellery or industrial/dental production, and around 500 tonnes goes to retail investors and exchange traded gold funds. This translates to an annual demand for gold to be 1,000 tonnes in excess over mine production which has come from central bank sales and other disposal. Central banks and the International Monetary Fund play an important role in the gold price. The Washington Agreement on Gold (WAG), which dates from September 1999, limits gold sales by its members (Europe, United States, Japan, Australia, Bank for International Settlements and the International Monetary Fund) to less than 400
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tonnes a year. European central banks, such as the Bank of England and Swiss National Bank, have been key sellers of gold over this period. Although central banks do not generally announce gold purchases in advance, some, such as Russia, have expressed interest in growing their gold reserves again as of late 2005. In early 2006, China, which only holds 1.3% of its reserves in gold, announced that it was looking for ways to improve the returns on its official reserves. Some bulls hope that this signals that China might reposition more of its holdings into gold in line with other Central Banks. India has recently purchased over 200 tons of gold which has led to a surge in prices. Bank failures When dollars were fully convertible into gold, both were regarded as money. However, most people preferred to carry around paper banknotes rather than the somewhat heavier and less divisible gold coins. If people feared their bank would fail, a bank run might have been the result. This is what happened in the USA during the Great Depression of the 1930s, leading President Roosevelt to impose a national emergency and to outlaw the ownership of gold by US citizens.

Low or negative real interest rates If the return on bonds, equities and real estate is not adequately compensating for risk and inflation then the demand for gold and other alternative investments such as commodities increases. An example of this is the period of Stagflation that occurred during the 1970s and which led to an economic bubble forming in precious metals. War, invasion, looting, crisis In times of national crisis, people fear that their assets may be seized and that the currency may become worthless. They see gold as a solid asset which will always buy food or transportation. Thus in times of great uncertainty, particularly when war is feared, the demand for gold rises.

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2. ECONOMIC OVERVIEW
The Indian economy has continuously recorded high growth rates and has become an attractive destination for investments, according to Ms Pratibha Patil, the Indian President. "India's growth offers many opportunities for mutually beneficial cooperation," added Ms Patil. "Today India is among the most attractive destinations globally, for investments and business and FDI had increased over the last few years," said Ms Patil. The Indian economy is expected to grow at around 7.5 per cent, according to Dr Manmohan Singh, the Indian Prime Minister. The PM acknowledged Asia's emerging economies were "growing well" and were, "in fact, contributing to the recovery of the world economy". The overall growth of gross domestic product (GDP) at factor cost at constant prices, as per Revised Estimates, was 8.5 per cent in 2010-11 representing an increase from the revised growth of 8 per cent during 2009-10, according to the monthly economic report released for the month of September 2011 by the Ministry of Finance. Overall growth in the Index of Industrial Production (IIP) was 4.1 per cent during August 2011. The eight core Infrastructure industries grew by 3.5 per cent in August 2011 and during April-August 2011-12, these sectors increased by 5.3 per cent. In addition, exports and imports in terms of US dollar increased by 44.3 per cent 41.8 per cent respectively, during August 2011. Over the next two years India could attract foreign direct investment (FDI) worth US$ 80 billion, according to a research report by Morgan Stanley. India has received US$ 48 billion FDI in the last two years. Considering the pace of FDI growth in India, KPMG officials believe that FDI in 2011-12 might cross US$ 35 billion mark.

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Exports in the referred period increased on back of demand for engineering and petroleum products.83 billion during January-June 2011.14 billion in value terms. while the number of deals increased by 33 per cent to 195. up 54 per cent over the same period a year ago. as compared to US$ 4. The increase in Forex is largely attributed due to valuation changes.54 billion in various NRI deposit schemes during April-June 2011. according to data compiled by Chennai-based Venture Intelligence.The Economic scenario  India has been ranked at the second place in global foreign direct investments (FDI) in 2010 and is expected to remain among the top five attractive destinations for international investors during 2010-12. 'World Investment Prospects Survey 2009-2012' by the United Nations Conference on Trade and Development (UNCTAD).74 billion received during the same period last year. 2011. It is the highest monthly inflow during the last 11 years. The rise in the value of the deals so far (June 2011) recorded a growth of 52 per cent.  India's merchandise exports have registered an increase of nearly 82 per cent during July 2011 from a year ago to touch US$ 29.24 billion) by companies through external commercial borrowings (ECB) or foreign currency convertible bonds (FCCB) for infrastructure projects in the financial years 2009-2011. NRIs invested US$ 1.3 billion. nearly 57 per cent higher than the US$ 10.  India's foreign exchange (Forex) reserves have increased by US$ 1. Commerce Secretary. according to Mr Rahul Khullar. The total FDI stood at US$ 16. according to a report on world investment prospects titled.04 billion raised during 2010.65 billion.950 crore (US$ 13. according to a release by the Ministry of Commerce and Industry. during January-June 2011.  Non-resident Indian (NRI) inflows in the first quarter of 2011-12 has witnessed a rise of 38 per cent as compared to the same period in 2010-11.  India's FDI gathered momentum with the inflows growing by 310 % in June 2011 to touch US$ 5. according to data released by the Reserve Bank of India (RBI). Exports during April-July 2011 reached US$ 108. gems and jewellery and readymade garments. 5 .3 billion.  Private equity (PE) investments in India stood at US$ 6.  The Government has approved fund raising worth Rs 60.6 billion to register US$ 318 billion during the week ended August 19.

To study the relationship between that exists between gold prices and the various economic indicators.3. Objectives     To study the emergence of the gold standards and its decline. Title of the study ―The impact of gold on the Indian economy and its evolution as an investment option‖ – A Study 3.2. This report also throws a light on the gold standard. 6 .1. 3. it rise in the international economy and its eventual fall. The study the evolution of gold as an investment option. To study the role of gold in the Indian economy. RESEARCH DESIGN 3. Need for Study This study aims at looking into the rise of gold throughout the history and it evolution to its current status in the Indian economy. This study will also help in establishing the relation ship between gold prices and the various economic indicators that are relevant in the current economic scenario.3. It gives an overview on the investment scenario concerning gold in its various forms.

however. 3. Aug 28.1.5. this paper focuses on the impact of the gold standard on sovereign borrowing. Boston. as well as the free flow of capital and goods.5. Mosley. This research will be conducted mostly with the help of secondary data. magazines company websites are the key source of information. This is data collected from literature review. "Golden Straightjacket or Golden Opportunity? Sovereign Borrowing in the 19th and Early 20th Centuries" Paper presented at the annual meeting of the American Political Science Association. I argue that the classical gold standard regime served as both a constraint and an opportunity for governments.4. in a way similar to present-day currency boards. Because it required automatic adjustment in response to balance of payments imbalances. 2002 Abstract What incentives did the classical gold standard provide for its maintenance? How did the benefits of the gold standard help it to be come a central piece of macroeconomic policy in the pre-World War I era? While the gold standard provided a variety of benefits to governments and societies. Massachusetts. Layna. such as monetary restraint and the facilitation of trade flows. or to Economic and Monetary Union. Further the so collected data will be processed with the help statistical tools. Governments? monetary policy autonomy was surrendered in service to the gold standard regime. Sheraton Boston & Hynes Convention Centre. news papers. Research Methodology This is partly a descriptive and partly a causal research study. commitment to the gold standard allowed governments to access international capital 7 . Boston Marriott Copley Place.3. At the same time. Literature Review 3. The research tries to discover and get an insight into the important and defining characteristics of gold and its relationships with the various economic parameters. White papers. the gold standard privileged external commitments (the maintenance of par values) over nations? Internal conditions.

While production has fallen to very low levels in recent years. as well as future debt servicing capacity. Gold production in India was not significant when compared to world standards. gold convertibility appeared to signal sound government finances. Indian mine production has been insignificant and remained static between 1. as evidenced by numerous ancient workings. INDE Abstract Gold. the oldest metal known to man. India offers a good potential for 8 . 3.5 tonnes per annum during the last 10 years.. Extensive and intensive ancient gold mining activity. From the past history of gold mining and striking similarities in geological environment with the leading gold producing countries of the world. Gold exploration and mining scenario in India Raju k. Bharat Gold Mines Ltd. K. demand for the precious metal in domestic market has abnormally increased from 150 tonnes in 1986 to 506 tonnes in 1995 which was mainly met by imports. Ltd.2.272 tonnes.6 and 2. There is ample market potential available in the country for indigenously produced gold as India is highly deficient in gold production. Modern gold mining dates from the year 1870. Considering the big gap in ever increasing demand for gold and the insignificant indigenous supply from the mines. The repeal of the Gold Control Order and economic liberalisation have thrown open new vistas for growth of gold mining in the country. throughout the country testify the flourishing nature of the gold mining industry in India. are the two primary gold producing units in India.5. Hutti. Government of India liberalised the mineral policy. At present. still dominates the world scene. and the vast geological potential. and Hutti Gold Mines Co.markets at lower rates of interest. The Hutti Gold Mines Co.. which was not thoroughly explored and mined. and produced together about 2.5 tonnes of gold during 1995 as against the world's total of 2. Ltd. India was renowned for its gold from time immemorial. This was mainly due to the fact that no new gold deposits of significant size were discovered in the country as the gold exploration and mining programmes were not aggressive due to the meagre budgetary allocations to these sectors as they were controlled by the Government.

USA Abstract Traditional theory implies that the relative price of consumer goods and of such real assets as land and gold should not be permanently affected by the rate of inflation. however. in equilibrium. A change in the general rate of inflation should.gold. Jaffe 1989 CFA Institute.5. Adding a combination of these gold proxies to the hypothetical diversified portfolios raises their mean returns but also increases their standard deviations. more than compensates for the increased risk. And The Prices Of Land And Gold M. A portfolio of gold stocks on the Toronto Stock Exchange and a mutual fund of South African gold-mining stocks mirror the returns on gold. Gold stocks might be expected to be better investment vehicles than gold itself. consumption and convenience values.5. Tax Rules. The experience of the past decade has been very different from the predictions of this theory: the prices of land. 3. The Archaean greenstone belts and the other favourable geological horizons have to be thoroughly explored systematically by the latest state-of-art technology. Cambridge. gold. This suggests that gold can play an important role in a diversified portfolio. Abstract While gold is quite risky as an individual asset. because they do not share gold's high liquidity.3.4. and other 9 . its returns are generally independent of those on other assets. Gold and Gold Stocks as Investments for Institutional Portfolios Jeffrey F. MA 02138. cause an equal change in the rate of inflation for each asset price. 3. Tests of four hypothetical portfolios of varying risk show that the addition of gold in each case increases average return while reducing standard deviation. Feldstein Harvard University and the National Bureau of Economic Research. The increase in returns. Inflation.

Although the risk of a future government gold auction depresses the price. Announcements making a government auction more probable cause a sudden drop in the price. 1978). 627-648 Abstract This paper is an analysis of the effects of anticipations of government sales policies on the real price of gold. 3. The present paper presents a simple theoretical model that explains the positive relation between the rate of inflation and the relative price of such real assets.such stores of value have increased by substantially more than the general price level. The behavior of real asset prices discussed in this paper is thus a further example of the non-neutral response of capital markets to inflation in an economy with income taxes. 10 . No. Salant and Dale W.5. an increase in the expected rate of inflation causes an immediate increase in the relative price of such ‗store of value‘ real assets.5. pp. it also causes the price to rise in percentage terms faster than the real rate of interest and at an increasing rate.. in an economy with an income tax. Market Anticipations of Government Policies and the Price of Gold Stephen W. Government attempts to peg the price or to defend a price ceiling with sales from its stockpile must result eventually in a sudden attack by speculators. 86. Vol. 4 (Aug. Even risk-neutral investors require this rate of return as inducement to hold gold in the face of the asymmetric risk of a price collapse. Henderson The Journal of Political Economy. More specifically.

Why gold? Because of its rarity and durability. Banking began when gold deposited in a bank could be transferred from one bank account to another by a giro system. and the notes issued are often called certificates. DATA ANALYSIS 4. and avoid the reduction in circulating medium to hoarding and losses. though it is believed by historians that gold's high value for its utility. When several nations are using such a fixed unit of account. the function of paper currency is to reduce the danger of transporting gold. with a weight in gold used as the token to transport value. Early monetary systems based on grain used gold to represent the stored value. 11 . or lent at interest. gold has long been used as a means of payment. to differentiate them from other forms of paper money. When used as part of a hard-money system. density.4. The early development of paper money was spurred originally by the unreliability of transportation and the dangers of long voyages. The gold standard can also be viewed as a monetary system in which changes in the supply and demand of gold determine the value of goods and services in relation to their supply and demand. and easy divisibility made it useful both as a store of value and as a unit of account for stored value of other kinds — in Babylon a bushel of wheat was the unit of account. The exact nature of the evolution of money varies significantly across time and place.1. reduce the possibility of debasement of coins. resistance to corrosion. as well as by the desire of governments to control or regulate the flow of commerce within their dominion. uniformity. the rates of exchange among national currencies effectively become fixed. GOLD STANDARD The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. Money backed by specie is sometimes called representative money.

a means of maintaining general liquidity. as mentioned by Niccolò Machiavelli in The Prince two thousand years later. silver was the primary circulating medium and major monetary metal. The Roman mints were fantastically active — the Romans minted. millions of coins during the course of the Republic and the Empire.4 grams. including the Islamic golden age.2 was gold. which was approximately 7 grams of gold alloyed with silver. long before this time gold had been the basis of trade contracts in Akkadia. They were forced to mix more and more base metal with the gold until. Gold would supplant silver as the basic unit of international trade at various times. and it was not until 1500 years later that the first coinage of pure gold was introduced. this gold became the basis for the gold coinage of his empire. of which 4. particularly for payment of armies. However. and as a store of value. the peak of the Italian trading states during the Renaissance. This represented a tremendous drop in real value from the old 12 . which weighed 4. and circulated. and remains an important hedge against the actions of central banks and governments.Through most of human history. The Persian Empire collected taxes in gold and. Early coinage The first metal used as a currency was silver. Silver remained the most common monetary metal used in ordinary transactions through the 19th century. the Byzantine empire continued to mint successor coins to the solidus called the nomisma or bezant. however. Gold was the metal which was used as an ultimate store of value and as means of payment when portability was at a premium. The paying of mercenaries and armies in gold solidified its importance: gold became synonymous with paying for military operations. when silver ingots were used in trade. and the smaller solidus. After the collapse of the Western Roman Empire and the exhaustion of the gold mines in Europe. and later in Egypt. the coinage in circulation was only 25% gold by weight. by the turn of the millennium. The Roman Empire minted two important gold coins: aureus. when conquered by Alexander the Great. Gold would remain the metal of monetary reserve accounting until the collapse of the Bretton-Woods agreement in 1972. before 2000 BC. and most prominently during the 19th century.

The ducat. the Republic of Venice coined their first solid gold coin. and was valued at 16 times the equivalent weight of silver. Other coins. The circulation of Spanish coins would create the unit of account for the United States. The Caliphates in the Islamic world adopted these coins. and the basic coin the 8 escudos piece. using current measures. which was to become the standard of European coinage for the next 600 years. and it continued to be one of the predominant coins for hundreds of years afterwards. because of Venice's preeminent role in trade with the Islamic world and its ability to secure fresh stocks of gold. were also introduced at this time by other European states to facilitate growing trade. The primary Spanish gold unit of account was the escudo. Beginning with the conquest of the Aztec Empire and Inca Empire. zloty. established standard references to Allah on the coins. Spain had access to stocks of new gold for coinage in addition to silver. and guinea. would remain the standard against which other coins were measured.95% pure Roman coins. respectively. and that uncertainty over the future purchasing power of money depresses business confidence and leads to reduced trade and capital investment. The dinar and dirham were gold and silver coins. Theory The essential features of the gold standard in theory rest on the idea that inflation is caused by an increase in the quantity of money. He removed depictions from coins. the ducat. or "doubloon". an idea advocated by David Hume. noble. but it is with Caliph Abd al-Malik (685–705) who reformed the currency that the history of the dinar is usually thought to begin. trade was increasingly conducted via the coinage in use in the Arabic world. and Philadelphia's currency market would trade in Spanish colonial coins. the florin. Thus. and fixed ratios of silver to gold. The central thesis of the 13 . the "dollar" based on the Spanish silver real. The wide availability of milled and cob gold coins made it possible for the West Indies to make gold the only legal tender in 1704. which was originally set at 27. The growth of Islamic power and trade made the dinar the dominant coin from the Western coast of Africa to northern India until the late 1200s. In 1284.4680 grams of 22 carat gold. grosh. produced from African gold: the dinar. originally minted by the Persians.

or a full gold standard. advocates of the gold standard often believe that governments are almost entirely destructive of economic activity. In much of gold standard theory. International gold standards often limit which entities have the right to redeem currency for gold. friction between kinds of currency. gold coins circulate as legal tender or paper money is freely convertible into gold at a fixed price. Differing definitions of "gold standard" If the monetary authority holds sufficient gold to convert all circulating money. In an international gold-standard system. since on any "partial" gold standard the value of circulating representative paper in a free economy will always reflect the faith that the market has in that note being redeemable for gold. gold or a currency that is convertible into gold at a fixed price is used as a means of making international payments. and possible limitations in future trading partners will dramatically benefit an economy. by reducing their ability to intervene in markets.gold standard is that removing uncertainty. and that a gold standard. 14 . Others. when exchange rates rise above or fall below the fixed mint rate by more than the cost of shipping gold from one country to another. these were called "SDRs" for Special Drawing Rights. and the markets from which its consumers may purchase goods. by expanding both the market for its own goods. the solidity of its credit. then this is known as a 100% reserve gold standard. Some believe there is no other form of gold standard. Under the Bretton Woods system. the benefits of enforcing monetary and fiscal discipline on the government are central to the benefits obtained. Under such a system. will increase personal liberty and economic vitality. such as some modern advocates of supply-side economics contest that so long as gold is the accepted unit of account then it is a true gold standard. which may exist in the absence of any internal gold standard. In an internal gold-standard system. large inflows or outflows occur until the rates return to the official level.

15 . commanded such universal confidence that it actually needed very little gold. political and financial power. But the central banks have affirmed that gold will remain an important reserve asset for the foreseeable future and it retains an important role in reserve management. Even Australia had more than the UK. Russia 1. but everybody had sufficient confidence in convertibility that there was no danger of this option actually being exercised.293 tonnes. have been major holders of gold for more than 100 years and are expected to retain large stocks in future. at 310 tonnes. As other countries decided to join the gold standard. Under that system. the amount of money in circulation was linked to the country's gold stock. Austria 378 tonnes and Italy 356 tonnes.233 tonnes. They currently account for about 20% of above-ground stocks.100 tonnes in 1913. its reserves were 161 tonnes and by 1913 this had risen to a still moderate figure of 248 tonnes. and official international institutions. GOLD AS A RESERVE ASSET Central banks. the then dominant economic. That at least was the case during the height of the gold standard for the UK.4.030 tonnes. Central banks started building up their stocks of gold from the 1880s. The world's total of official gold reserves is estimated to have been about 8. The development of banking and credit meant that the amount of money in circulation was greater than the gold stock itself. for countries on the gold standard. Some other countries had by then accumulated much larger stocks: the United States had 2. The Bank of England.2. In 1870. France 1. Germany 439 tonnes. compared with only 700 tonnes in 1870. they also started to accumulate gold so as to be able to maintain convertibility at a fixed price. Argentina 440 tonnes. The process of rebalancing reserve portfolios to adjust to changing conditions has led to a reduction in the amount of gold held by some central banks recently and this process may continue for some years to come. as the central bank at the centre of the system. and paper money was convertible into gold at a fixed price. during the period of the classical gold standard.

it was still the foundation of the international monetary system. circulating as currency among citizens and across borders in commercial trade transactions. So gold provided the "anchor" to which all currencies of member countries were linked. was faced with the choice of deflating.000 tonnes in 1925 to 18. with President Nixon "closing the gold window". and dollar convertibility. which had been the foundation of the first genuinely international monetary system during the period before World War 1. Although there was no direct link between gold holdings and national money supplies (as there had been under the classic gold standard).67 an ounce to $35 an ounce.000 tonnes at the end of World War II. Gold can indeed play a crucial and strategic role in central bank reserve mobilisation in case of need. raising the price from $20. and the United States. Gold. Mobilising gold As the ultimate form of payment. through the fixed official dollar price of gold. came to be used as a weapon in economic competition and national rivalries. In August 1971. as central banks created more money than was consistent with stable prices. the United States under President Roosevelt devalued the dollar in terms of gold.of all above ground stocks. most gold had always been held privately. But gradually. This new higher price caused holders of gold around the world to sell their holdings to the United States. when it had about 60%of all the official stocks of gold.The rise in official gold stocks The period of economic nationalism between the two world wars saw a rapid concentration of gold in official hands . Central banks could convert dollar balances into gold at the official price. as the pivot of the system. when used either as cash or as collateral. In 1933-34. US official holdings rose from 6. official gold stocks reached about 38. the fixed official gold price again became unrealistic.or perhaps slightly more . it abandoned the system. acceptable to counterparties. 16 . gold was still the primary "reserve asset".000 tonnes and probably accounted for about 50% . At their peak in the 1960s. directly or indirectly. and after several years of moderate but persistent inflation. gold has sometimes proved the only asset.up to that point. devaluing or abandoning the system. Central banks kept gold because.

Iran refused to accept U. regards the US gold stock as part of our national patrimony and of value as a precautionary asset."  Finally. India had to rely on its bullion holdings to survive.Some examples of where gold has been used in political or economic emergencies are as follows:  For example. South Korea and Thailand among them."The Treasury. dollars in return for releasing the American hostages it held. First the government swapped 20 tonnes on the Swiss market and.and in the light of this recent experience . gold in the private sector can provide a vital support for public sector purposes.S. So the U.  In 1974 Italy secured a $2 billion loan from the Bundesbank with gold as part of a package (including the then largest ever IMF loan) to shore up its balance of payments after the 1973 oil price rise. The gold collected was either placed directly in reserves. so there was no net cost to US reserves. As then Treasury Assistant Secretary Manuel Johnson went on to say in Congressional testimony in 1983 . 17 . An IMF official at the time noted: "There were discussions over the weekend about a pool of central banks coming to the rescue and the first question that was asked by those sponsor banks was whether they were prepared to give their gold as collateral. later. or sold for dollars which could be used to repay external debt or in intervention to support their ailing currencies. Only South Korea raised significant amounts (approximately 270 tonnes) but the avowed intent of all three was to rely on local citizens' patriotism to surrender gold in return for government bonds or local currency. thereby adding to credibility. shipped a further 46 tonnes to London as collateral for a loan from the Bank of Japan. of course." The US government simultaneously took ownership of an equivalent quantity of Iranian gold that had been frozen at the New York Fed. in the 1981 Iranian hostage crisis.S. In the aftermath of the 1997 Asian currency crisis several countries in the region announced plans to mobilise residents' gold holdings .  Hit by a short-run foreign exchange crisis in 1991.Malaysia. transferred 50 tonnes of gold instead.

These are recognised by central banks themselves although different central banks would emphasise different factors. Why central banks hold gold Monetary authorities have long held gold in their reserves. it rarely makes sense to have all your eggs in one basket.000 tonnes . there are good reasons for countries continuing to hold gold as part of their reserves. including reports made under the Standard Data Dissemination Standards. 18 .similar to their holdings 60 years ago. Official holdings are therefore generally more transparent and easier to track than those of other large holders such as most major private investors. The price of gold therefore behaves in a completely different way from the prices of currencies or the exchange rates between currencies. However.but so too do the exchange and interest rates of currencies held in reserves. some central banks also hold stocks of gold that are not considered or reported as formal reserves while some official or quasi-official institutions have gold holdings that are not reported. in the public domain and report them regularly to the IMF. Obviously the price of gold can fluctuate . whereas currencies and government securities depend on government promises and the variations in central banks‘ monetary policies. However. Diversification In any asset portfolio. In addition holdings may not always be reported in a way that facilitates analysis. It is sometimes suggested that maintaining such holdings is inefficient in comparison to foreign exchange. Today their stocks amount to some 30. including gold. Gold has good diversification properties in a currency portfolio.Tracking central bank gold holdings Most central banks place data on their reserve assets. These stem from the fact that its value is determined by supply and demand in the world gold markets. A strategy of reserve diversification will normally provide a less volatile return than one based on a single asset. The World Gold Council compiles a number of statistical tables based on official data in the public domain and drawn from a variety of sources.

Gold provides this. an unexpected surge in inflation. Its status cannot therefore be undermined by inflation in a reserve currency country. highly damaging event. a regression to a world of currency or trading blocs or the international isolation of a country. Gold is liquid and is universally acceptable as a means of payment. a generalised crisis leading to repudiation of foreign debts by major sovereign borrowers. it is that today‘s status quo will not last for ever. paper currencies always lose value in the long run and often in the short term as well. while global shocks can affect the whole international monetary system. It provides a form of insurance against some improbable but. Reserves held in the form of foreign securities are vulnerable to such measures. Total and incontrovertible liquidity is therefore essential. Reserves are for using when you need to. gold is much less vulnerable. at the worst. Unexpected needs If there is one thing of which we can be certain. Physical Security Countries have in the past imposed exchange controls or. Where appropriately located. Economic developments both at home and in the rest of the world can upset countries‘ plans. In contrast. In emergencies countries may need liquid resources. Nor is there any risk of the liability being repudiated. Gold has maintained its value in terms of real purchasing power in the long run and is thus particularly suited to form part of central banks' reserves.Economic Security Gold is a unique asset in that it is no one else's liability. Such events might include war. 19 . if it occurs. It can also serve as collateral for borrowing. total asset freezes. Owning gold is thus an option against an unknown future.

representing the world's governments. There is a gold lending market and gold can also be traded to generate profits. There may be an "opportunity cost" of holding gold but. has recognised that the Fund's own holdings of gold give a "fundamental strength" to its balance sheet.Confidence The public takes confidence from knowing that its Government holds gold . And rating agencies will take comfort from the presence of gold in a country's reserves. Some countries give explicit recognition to its support for the domestic currency. 20 . The IMF's Executive Board. an unexpected surge of inflation. or the international isolation of a country. It is the price deliberately paid to provide protection against a highly improbable but highly damaging event. this is less than is often thought. Income Gold is sometimes described as a non income-earning asset. in a world of low interest rates. This is untrue. a regression to a world of currency and trading blocs. The other advantages of gold may well offset any such costs. a generalised debt crisis involving the repudiation of foreign debts by major sovereign borrowers.an indestructible asset and one not prone to the inflationary worries overhanging paper money. The same applies to gold held on the balance sheet of a central bank. Such an event might be war. Insurance The opportunity cost of holding gold may be viewed as comparable to an insurance premium.

gold bullion and foreign securities.28 billion to Rs.4. The RBI bought back all 67 tonnes of gold later that year. It also revalued its gold reserves from Rs. which though small in comparison to total reserves (4. under the Reserve Bank of India Amendment Act 1956. The system was later amended. India shipped a total of 47 tonnes of the country‘s gold reserves (the RBI is allowed to hold up to15% of its total old reserves outside the country) to the Bank of England as collateral against a $400 million loan and leased a further 20 tonnes of confiscated gold (not included in the reserve figures)to Union Bank of Switzerland with a six month buyback option to raise a $200million loan. RBI and Its Gold Policy Measures The Reserve Bank of India (RBI) holds 357. The RBI currently olds 357. is still he fifteenth highest of central banks in tonnage terms in the world.72 billion. to the minimum reserve system.1150 million of its assets in gold (this did not imply the need to acquire additional gold. viz. The funds were used to help India meet its short-term debt obligations and import bill.7 million at today‘s exchange rate and is tiny in comparison to India‘s total foreign exchange reserves of 151. Between May and July. weaning away people from gold. THE RESERVE BANK OF INDIA The Reserve Bank is required to hold a fixed amount of gold under the Reserve Bank of India Act. India mobilised its gold reserves during the 1991 balance of payments crisis.75 tons of gold forming about 6 per cent of the current value of its total foreign exchange reserves. 21 . The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin.1150 million equates o just $24. with not less than Rs. reducing the domestic demand and prices and curbing smuggling. Rs. as it moved from using an outdated gold price4 to valuing its reserves at close to he international market price. as the value of existing gold reserves were revised up at the time)..4% as at September2006).6 billion.3. The move vastly improved India‘s reported import coverage ratio.7 tonnes of gold. 400 million in value held in gold. regulating the supply of gold. that required the bank to hold at least Rs. The evolution of the gold related policy since independence was centred around some major objectives.

4. including how the jewellery sector is being affected by the current social and economic changes. Bullion imports and exports were also banned but restrictions on import of gold into the country resulted in the flourishing of smuggling and unofficial transactions in foreign exchange. It looks at all the major aspects of demand and supply. Gold is seen as a symbol of wealth and prosperity in the Hindu religion. it was felt in some circles that it would be feasible to make a frontal attack on demand for gold in India. Accordingly. which is practiced by around 80% of the population. banning the making and selling of jewellery above 14 carats. The country has one of the most deeply religious societies in the world. However.. it did not have any major impact on smuggling. The origins of gold demand Indian gold demand is firmly embedded in cultural and religious traditions. productiveness and prosperity. the role of the Reserve Bank of India and on the supply-side. mine production and the scrap market. the most widespread faith being Hinduism. Official imports to discourage smuggling was first mooted in 1977 but viewed against the forex reserves available then. is said 22 . The Government decided to sell confiscated gold in small quantities through the RBI. the Gold Control Order 1962 was issued. one that has expanded considerably during its period of liberalisation. new ways to invest in gold. who symbolises fertility. This coupled with complexities resulted in the failure of the Gold Control order. 4. The goddess Lakshmi. it was thought as an impossible proposition. making it compulsory for gold smiths to be licensed and submit accounts of all gold received and utilized by them etc. This part of the report provides a broad overview of the gold market within the context of India‘s new super charged economy.In the wake of the Chinese war. The measures met with lot of resistance and criticism. ROLE OF GOLD IN INDIAN ECONOMY India is the world‘s largest gold market in volume terms.

Akshaya Thrithiya. dressed in gold-embroidered red clothes. though a good many purchases will be made well in advance of the wedding. Gold is also viewed as a secure and easily accessible savings vehicle by the rural community. Akshaya Thrithiya has become a major gold-buying occasion in the South of India. where sales have reached record levels. especially in the State of Tamil Nadu. it is customary for the parents of a baby girl to start accumulating gold for this purpose soon after the child is born. whereas she may not be privy to the family‘s other financial affairs. where around 70% of the population lives. as Hindu tradition dictates that the family‘s assets are only passed down to sons. wedding-related demand is big business. falling in April or May. which they like to buy or gift during religious festivals. the idea has been promoted across the North and West of the country. The association between gold and ―auspiciousness‖ has been used in recent years to promote the idea of buying gold. Gold also plays an important role in the marriage ceremony. Over the past five years.to have been bathed by elephants who carried pure water in golden vessels. with gold coins flowing from her hands. The most important of these is Diwali.. Much of this demand takes place in the wedding season. With an estimated 10 million marriages a year taking place in India. and April and May. Since it is suggested that those who worship her gain wealth. which marks the beginning of the Hindu New Year and usually takes place in October or November. Not all gold demand is allied with cultural and religious beliefs. Purchases on this day are considered auspicious (it is the third most auspicious day in the Hindu calendar). has also become an important day to buy gold. She is depicted as a beautiful woman of golden complexion. Most of this will be a gift from her parents as a way of giving her some inheritance. Indeed. where brides are often adorned from head to toe in gold jewellery. This is because the Rupee is not yet fully convertible – Indians are only allowed to hold financial assets in Rupees – whereas they have been allowed to hold gold since 1990 when the Gold Control Act was repealed. Gold has the added virtue of being an inflation hedge. The gold (and other gifts) the bride receives or her ―Streedhan‖ (―Stree‖ meaning woman and ―dhan‖ meaning wealth) mean her parents can make sure she is financially secure and enjoys at least the same standard of living to which she was accustomed in her childhood. Hindus consider gold an auspicious metal. which has also resulted in a significant rise in gold sales in these regions. which falls between October and January. Since 2005. Gold is especially important in this respect as it remains directly under her control. 23 .

The economy shows no signs of slowing either. Spending was especially strong in 1998 thanks to the release of pent up demand following the removal of import controls in November 1997. 24 . Gold Demand Trends and Outlook The past decade can be split into two distinct periods as far as the value of gold sales is concerned: 1996-2001. averaging 709 tonnes and fluctuating between 506-810 tonnes.224-316 billion a year.more than four times the 22 million square feet estimated in 2005. KPMG and the Federation of Indian Chambers of Commerce and Industry estimate that the amount of shopping centre space will have risen to90 million square feet by the end of 2007. and 20022005. held back by relatively weak income growth. The higher variability of volume as oppose to value spending is a function of both the retail price setting mechanism in Indian. A noticeable feature of India‘s development has been the strength of its domestic economy relative to most emerging markets in Asia.284 billion per annum and fluctuated in a relatively narrow range of Rs. as well as the origins of demand. During the first period. spending averaged Rs. Gold sales were broadly stable in the three years that followed. with the mergence of new large-scale retailing. Shopping centres are starting to spring up across urban India.Recent Economic Trends The Indian economy has enjoyed rapid growth over the past decade. The country‘s $200 billion retail industry is changing. This is particularly true of consumer spending. when sales accelerated strongly. Sales in tonnage were more volatile over the period.a for the past decade. which has accounted for the lion‘s share of growth over the past decade. when sales were broadly stable in value terms. thanks to the progressive liberalisation of its economy and the consequent inflow of foreign direct investment. something which is changing theface of retailing and will affect traditional gold retailers. which has allowed the economy to start reaping the benefits of globalisation on a truly massive scale. India is now the fifth largest economy in the world (on a PPP basis) having posted average annual growth rate of 6%p.

That Indian demand is not necessarily adversely impacted by rising prices is clear from the experience of the past few years (2002-2005). when gold demand rose steadily from Rs. with spending increasing from Rs. when the value of spending fell by 7%. What does seem to adversely impact on demand is a pick up in the pace of daily price fluctuations or volatility.The price of jewellery changes in line with changes in the international market price in India. Indians are enjoying a rapid acceleration in income growth. although the volume of gold they can afford each year will rise and fall with the price. who will usually purchase acertain monetary value of gold each month. as India continues to attract large volumes of foreign direct investment. The retail mark up is also normally relatively small in relation to the value of the piece. especially where gold is being used as a long-term savings vehicle. which is supporting discretionary spending on consumer goods.026 to Rs. the value of gold sales is often quite price inelastic. The same message would seem to come from H1 2006‘s experience.15. as gold price volatility spiked upwards. More workers are moving from low income to middle and high income quartiles. 25 .This has been underpinned by social and economic changes in the Indian economy– trends that look set to persist – alongside new and better marketing campaigns from 2004 and a growing perception that higher gold prices are here to stay. Last year.473 billion (or 571 tonnes to 750 tonnes)despite a coincident rise in the gold price from Rs.276 billion to Rs.599. as was the case in Q1 2006. when retail investment spending surged by 32% year-on-year despite an 11% rise in the gold price in rupee terms. especially into the outsourcing and IT sectors. a rising price can often stimulate investment demand for gold. Indeed. 276billion in 2002 to Rs. 473 billion in 2005. Consumers are wary about purchasing when the price is volatile for fear that they buy and then find the price falls. Still. This shows the relationship between the average annual 22-day rolling annualised volatility rate of the rupee denominated gold price and the change in the value of gold sales: the two show a clear inverse relationship over the sample period from 1993 to 2005. The main theme of the past few years has been a solid upswing in gold sales. A prime example would be the parents of a baby girl saving for a future Streedhan. with each item weighed then priced according to the prevailing daily market rate. including gold.19.

Of course. 26 . while tastes are becoming more international. especially with the relevant marketing initiatives targeted at India‘s new affluent young middle class. with the rise in gold sales outstripping the rise in general retail spending indices. This has increased the number of women falling into gold‘s core target group in India from 25 million in 2002 to 32 million in 2005 and contributing to the rise in gold purchases over the past few years. which means there are increasingly two bread winners in the family and there is more disposable income available for discretionary purchases than in the past. found that the increasing independence of woman in developing countries and shifts in attitudes and behaviours. Recent experience supports this premise. expects the number of people earning between $1330K. including India. Equally importantly. Global Insight. 16 million between$30-80K and just short of a 1 million earning over $80K. More women are seeking their independence by entering the workforce.estimated 110million households were earning between $10-30K. as there is a much bigger pool of money available. it seems likely that the net impact of these socio. conducted across six key gold markets. A recent WGC study. $30-80K and $80K+to increase by 52%.Social trends are also changing. with households increasingly demanding all the conveniences of the modern world. young middle class Indians are more willing to spend than their parents‘ generation was. has meant that gold has become a more relevant and desirable product to a greater number of women. gold must compete with a growing desire for other luxury goods too. 30 million and 3 million respectively by 2015. combined with a significant increase in their personal wealth. an economic forecasting agency. 87% and 200% in real terms to 167 million. such as mobile phones and home computers.economic changes will be positive for gold sales. These socio-economic changes have led to enormous growth in the potential market for gold jewellery. However.

and to buy and sell that interest through the trading of a security on regulated stock exchange. The increase in the irrigation. They are listed securities that are backed by allocated gold held in a vault on behalf of investors and are intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold. like real estate and public sector. has contributed to gold as store of value. the demand for gold as a store of value can be expected to rise. leading to more skewed income distribution. have generated large marketable surplus and a highly skewed rural income distribution is another factors contributing to additional demand for gold.  Black money originating in the services sector.Factors Influencing Demand for Gold   Following are the factors influencing the demand for gold. But there are new ways toinvest in gold. etc are alternative avenues for investing savings. the weighted return on these alternative assets can be considered as another influencing factors. Ways to buy gold Traditionally most investment has taken the form of physical gold. Hence income generated in these service sectors can be treated as a determining variable  Since bank deposits. 27 . These instruments give investors a relatively cost efficient and secure way to access the gold market. Inflation redistributes incomes in favour of non-wage income earners. With incremental income of non-wage earners. expected before he end of 2006. In 2005. The next major development is likely to be the arrival of Exchange Traded Funds(ETFs). Mutual funds. small savings. Since October 003 the government has allowed futures trading and there are now three futures exchanges. Indians bought 102 tonnes of gold coins and bars.UTI Asset Management Company Ltd and Benchmark Asset Management Ltd are currently seeking regulatory approval to sell a gold ETF. technological change in agriculture (through mechanization and high yielding varieties). the two largest being he Multi Commodity Exchange of India Ltd(MCX) and the National Commodity and Derivatives Exchange Ltd NCDEX).

Delhi prices command some prominence in some parts of the country. Delhi Gold market constitutes about 15% of total Indian gold trade.The Gujarat bullion market.000 crore worth of transaction in the previous year. The physical delivery in bullion for the both NCDEX and MCX also generally takes place in Ahmedabad. Ahmedabad The bullion market of Ahmedabad. price quoting in Mumbai market is taken as reference price in most other parts of the country. had hit a trough in the 2001 fiscal with volumes crashing by over 50 per cent to less than 140 tonnes. Delhi was gaining prominence when Mumbai was loosing its shine. but the rationalization of the local taxes in Maharashtra in April 2002 which brought sales tax level to 0. a slump from Rs 12. the Ahmedabad bullion juggernaut has slowed down perceptibly to Rs6000 crore worth of business in the last fiscal. Mumbai and Ahmedabad together account for about 45% Indian gold trade. 28 . after the VAT implication in Rajasthan and Gujarat there should not be major difference in the tax structure. Mumbai was losing its shine due to high sales tax of 2% prior to April 2002. became the largest landed destination in the country for the yellow metal after the Gold Control Act was scrapped in 1991-92. Delhi Delhi is another major gold market in the country.Major Markets in India Mumbai Mumbai is the major wholesale trading centre in India. which at 280 tonnes accounted for a high 40 per cent of the entire country's 700-tonne market in 2000-01.5% has it helped the gold trade to move back to Mumbai and it would not be a surprise to see Mumbai to re-emerge as one of the largest gold trading centres in India and maybe the world. In rupee terms. Still Ahmedabad is considered one of the important bullion markets in the country. However.

very little supply comes from domestic sources. India‘s demand will continue to be satisfied almost entirely from imports. India looks poised to remain the world‘s foremost gold consumer in tonnage terms for many years to come. 29 . equivalent to about one eighth of merchandise exports and 8 percent of merchandise imports and the corresponding figures for 1997 was $ 7. the magnitude of FOREX expended on gold imports has been large and growing in 1970. For instance. with the main source of domestic supply coming from recycled jewellery.2 billion. notwithstanding temporary fluctuations associated with spikes in price volatility. the price of gold and price expectations. Over the past five years. should. intermediates and capital equipment) needed for current production and to expand productive capacity. rapid income growth. The harp increase inscrap5 in 2002 and 2003 (Figure 10) was driven by a combination of distress selling in rural areas because of the poor2002 monsoon and subsequent hit to agricultural incomes.Above ground stocks Supply from above ground stocks is much more important in India. In the Indian context. (Equivalent to about one fifth of exports and one sixth of imports). in the face of high prices and generally good economic conditions. the decline in scrap supply in 2005.In summary. thanks to the influx of foreign capital. Economic Implications of Gold Imports Gold by it self does not add much to production or productive capacity. as aside from the scrap market.5 billion.compared with $271-$279 in the previous three ears). Indians have recycled an average of 105 tonnes of gold per annum. Scrap supply is sensitive to general economic conditions. is attributed to expectations of still higher prices6. India‘s imports at the prices prevailing in the world market at that time. would have cost $ 2. Mean while. in tandem with new successful marketing campaigns. Its dynamic population growth and strong cultural and religious affinity to gold will continue to underpin structural demand. as well as a higher high gold price the gold price averaged$309.68 in 2002 and $363.32 in 2003. However the foreign exchange used for importing it in effect reduces the availability of this resource for other imports (including raw materials. continue to boost discretionary spending on gold. Price expectations also matter.

Its physical depreciation is negligible and it can be readily converted in to cash by sale in the world market by acquiring other resources both at domestic and international market. In any case. the availability of FOREX for other purposes and the health of the balance of payment. The nature and sources of the latter are not indicated for lack of information. It represents command over both at home and at abroad which can in principle be invoked whenever necessary. That the bulk of it is in the hands of private individuals who may or may not be willing to convert it into other 30 . not all gold is held in the form of ornaments. Clearly they. the fact that there is a very well developed world market for metal and that its prices have until recently increased much faster than the general price level makes it a attractive asset. But this function does not in any way dilute its advantage as liquid. risk free asset. the value of legal gold imports cleared through the customs are included as part of merchandise imports in the balance of payments data (but not in the trade statistics) an equivalent amount being recorded as transfer receipts under invisible. These transactions did not figure at all in the country‘s trade or payment statistics. Possibly their relative importance has changed in effect the hawala market continues to operate but with indirect legal sanction given by the gold import policy. are no different from FOREX holdings. a large part of it is held in the form of bars. must have been derived from one or the other of the extra legal sources cited earlier. over invoicing of imports. The magnitudes involved are large in relation to the size of the country‘s foreign trade and payments: The gold stock of the country at the end of 2000 was close to 14.Prior to 1992. So far Gold is treated as ornament. it can be treated as durable consumer good. gold‘s holding whether in the form of bars or ornaments. After 1992.000 tons valued at current price at $ 165 billion. as well as the resources needed for the still substantial smuggled gold. Their continued rapid growth can have significant consequences in the terms of scale and functioning of the hawala market. earning of migrant workers remitted through hawala channels and smuggling of silver and contra brand drugs. Though it does not earn any interest and though it is no longer used as the standard for fixing currency values. The other characteristics of gold are that it is a highly liquid store of value. Altogether from country‘s point of view. gold imports being illegal were financed by the proceeds of under invoicing of the exports.

More interestingly the location of the bulk of these holdings is believed to have shifted.220 per ten grams upto January 1999. a substitute for investment in other assets. 4. in principle. If accumulating gold. and does not detract from this feature.000 tonnes. it is important to such a context. The more so because investment in gold. Exclusion of gold from the estimates of domestic savings thus understates the household and overall domestic savings rate. and this bias has been increasing from the last two decades.1000 to Rs. in real sense. Private investment holdings amount to just under 25. which is held at least in part for decorative purposes. The amount of duty released from gold imports indicates an annual figure varying from Rs. Unlike jewellery. these holdings are purely a store of value. Investment demand can be split broadly into two.assets is another matter. a figure that has been growing slowly over time. It is significant that during the last five years. then they must be properly counted as part of the economy‘s savings. gold is the most popular as an investment. GOLD AS AN INVESTMENT INSTRUMENT Of all the precious metals.5. the value of additions to gold stock accounts for over 20% of private noncorporate sector‘s investment in financial instruments.after which it was increased to Rs400 per ten grams.000 crore per annum since 1997. Private sector holdings come in the form of bars and coins. Of course. a substantial portion of 31 . Whereas thirty years ago. Tariff Structure The import duty on Gold was Rs. private and public-sector holdings. As a result. India lost an estimated Rs6000 crores (Rs 60 billion) of foreign exchange. is no different from accumulation of FOREX reserves or investment in foreign financial assets. Smuggling gradually came down when the duty was reduced to Rs250 per ten grams on April 2001 and subsequently to Rs100 per ten grams.2. to understand why people prefer to hold gold and the conditions under which they will add or reduce the stock of it in their hands. this led to increased gold smuggling. although in the Middle East coins and small bars are often incorporated into jewellery.

Reasons for holding physical gold vary widely. Australia. Given the size of official reserves relative to consumption levels. The stability has been particularly marked among the larger holders . most notably by Argentina. 32 . anonymous and readily marketable anywhere. These differences can partly be explained by the way in which reserves are viewed nationally.including the United States. the largest being Taiwan and Poland. and also by the very large size of reserves relative to the underlying flow of production and consumption. and the way in which decisions on reserve policy are taken. In markets with poorly developed financial systems. Gold holdings twenty years ago are a good predictor of a central bank‘s holding today. the prime attraction of gold is as an investment which has very low or negative.000 ounces.this was held by Western investors. There have also been confirmed buyers. There have been substantial sales. Switzerland and the UK. Canada. Germany. Belgium. the possibility of changes in policy has had a substantial impact on the gold price. say. or where trust in the government is low. correlation with other assets. Current holdings by different countries are quite diverse both in terms of absolute quantity and as a proportion of their total external reserves. If gold is held primarily as an investment asset. 10. inaccessible or insecure banks. gold is attractive as a store of value which is portable. In countries with a stable political and financial system. the overwhelming majority is now thought to be held in other parts of the world. the Netherlands. the International Monetary Fund and France. will normally be able to achieve an increase in return of perhaps 1% by lending out his gold over the return he would gain by holding physical gold. suffice to observe here that an investor who wants exposure to gold. and which may hold or increase its value if for some reason investors flee from purely financial assets like bonds and equities. While proper discussion of the gold lending market is reserved to the second chapter of the report. particularly if his position is more than. In addition he will save on the storage costs. it does not need to be held in physical form. The investor could hold gold-linked paper assets or could lend out the physical gold on the market.

Theoretically in the latter case. In addition. This would include so-called ―investment jewellery‖ (generally high carat. Austria. these can easily be bought or sold "over the counter" of the major banks. It is subjective because purchase-motive is extremely difficult to measure on a scientific basis. there could be a problem with unallocated as opposed to allocated gold holdings. Alternatively. there are bullion dealers that provide the same service.Investment vehicles Retail Gold Investment The definition excludes so-called ―investment jewellery‖. for example in Europe these would typically be in 12.. although many other weights exist.15072 Troy ounces). however. wedding-related demand for high-carat jewellery in India has an important investment motive but it is also purchased for adornment. For example. impractical. Making an allowance for this is. For example. The problem with such a definition is that it is highly subjective as well as excessively elastic.5kg or 1kg bars (1kg = 32. low mark-up jewellery purchased with an investment motive). with these in turn defined by the standard adopted by the European Union. It is decided to only count physical bullion coins and bars. changing tastes in jewellery and the shift to lower-carat articles in some parts of the world. 1oz bar. one is dealing with a dynamic situation. Bars are available in various sizes. however. Liechtenstein and Switzerland. In counting such bullion. makes it impossible on a systematic and regular basis to measure ―investment jewellery‖ demand worldwide. 10oz. like Argentina. where highcarat was formerly predominant. as the part of the former would be lent out. Bars The most traditional way of investing in gold is by buying bullion gold bars. 10g. Finally. In some countries. The broadest definition of retail investment would incorporate any private sector demand for gold that was not related purely to adornment or industrial purposes. to complicate matters still further. private investor metal account holdings are included. or 1 33 . the definition of retail investment demand excludes all institutional investment. such as the Tael.

due to the fact that they are much easier to store. an increasingly popular method of investing in gold bars for the small investor is via allocated holdings using a gold account . Gold bars for sale include 1-oz gold bars.99 pure. kilo gold bars. [27] The PAMP certificate Coins Buying gold coins is a popular way of holding gold. as they carry lower premiums than gold bullions. Again.see 'Accounts' below. The most commonly available kilo gold bars are the PAMP and the Royal Canadian Mint (RCM) gold bars.15 troy ounces each. Because of the many difficulties of transporting. which is guaranteed by the United States Government and has been in circulation for over 300 years. 34 .9999 fine (99. held directly by you or in your own safe) or indirectly (held in a safe deposit box or bank vault on your behalf). PAMP kilo gold bars usually come with certificates. 10-oz gold bars. RCM bars do not come with either protective cases or certificates.). Kilo gold bars are . One of the most popular gold coins is the American Eagle bullion coin. Bars are increasing in popularity as investment vehicles. actually consists of the PAMP hallmark on the gold bars.e. and 100gram gold bars. the large Swiss and Liechtenstein banks buy and sell these coins over the counter. All these gold bars are . Typically bullion coins are priced according to their weight. Gold bars can be held either directly (i.Tola. The American Eagle coins contain a stated amount of pure gold and are made in four denominations. [26] It seems that the gold bars are primarily sold as kilo bars rather than 1-oz gold bars.99% pure) and contain 32. It is estimated that the premiums on kilo gold bars can be at least $50 per ounce less than the premiums on bars such as the American Gold Eagles.9999 fine (99. storing and verifying pure gold bars. by the Department of Treasury. plus a premium above the gold spot price.

the Creation Units may not be purchased with cash but a basket of securities that mirrors the ETF's portfolio. Gold Bullion Securities (ticker symbol "GOLD"). but that differ from traditional open-end companies and UITs. and originally represented exactly one-tenth of an ounce of gold. The main differences are that ETFs do not sell directly to investors and they issue their shares in what are called "Creation Units" (large blocks such as blocks of 50. The actual gold content of these coins is 1. ¼ and 1/10 ounce sizes. was launched in March 2003 on the Australian Stock Exchange. are investment companies that are legally classified as open-end companies or Unit Investment Trusts (UITs). Gold certificates may be described as the first paper bank notes. and management fees are charged by selling a small amount of gold represented by each certificate.0 troy ounce (31. the Creation Units are split up and re-sold on a secondary market. without the inconvenience of storing physical bars. They were first issued in the 17th century when they were used by goldsmiths in England and The 35 . Usually. Exchange-traded funds. Certificates A certificate of ownership can be held by gold investors. so the amount of gold in each certificate will gradually decline over time.000 shares). These US gold eagle coins are also minted in ½. insurance. Gold certificates allow investors to buy and sell the security without the inconvenience associated with the transfer of actual physical gold. Also. [28] Exchange-traded funds Gold exchange-traded funds (or GETFs) are traded like shares on the major stock exchanges including London. instead of storing the actual gold bullion. The first gold ETF. or ETFs. New York and Sydney.916 and have a face value of $50. Typically a small commission is charged for trading in gold ETFs and a small annual storage fee is charged. The annual expenses of the fund such as storage.103 grs).The standard gold eagle coins have a fineness of 0. Gold ETFs represent an easy way to gain exposure to the gold price.

such as gold forwards. 36 . CMC Markets.Netherlands for customers who kept deposits of gold bullion into their safe-keeping. Accounts Most Swiss banks offer gold accounts where gold can be instantly bought or sold just like any foreign currency. Gold accounts are typically backed through unallocated (fungible or pooled) or allocated (also known as non-fungible) gold storage. and NYSE Liffe US. the gold certificates began being issued in the United States when the US Treasury issued such certificates that could be exchanged for gold. Two centuries later. Derivatives. gold futures are traded on the National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX). The United States Government first authorized the use of the gold certificates in 1863. CFDs and spread betting Derivatives. gold certificates are still issued by gold pool programs in Australia and the United States. Different accounts impose varying levels of intermediation between the client and their gold. provide contract for difference (CFD) or spread bets on the price of gold. Nowadays. the gold certificates stopped circulating as money. currently trade on various exchanges around the world and over-the-counter (OTC) directly in the private market. gold futures are primarily traded on the New York Commodities Exchange (COMEX).S. for example through bailment or within a trust. In the early 1930s the US Government restricted the private gold ownership in the United States and therefore.. IG Index and City Index. In the U. all from the UK. and paying for the service. Firms such as Cantor Index. futures and options. In India. as well as by banks in Germany and Switzerland. Digital gold currency accounts and the BullionVault gold exchange work on a similar principle. Bailment is the legal action of a client entrusting their physical property to another party for safekeeping. a division of the New York Mercantile Exchange (NYMEX).

Gold is leased by central banks and other holders to commercial/bullion banks and thus earns for the lender a return in line with the gold lease rate. the producer delivers either newly-mined gold or gold purchased in the market to the bullion bank at the contract price. With respect to producer hedging. the transaction can be described as follows: 1.Gold derivatives: basic principles In its most simplified form. thus maintaining the liquidity to fund further derivative transactions. When the forward sale comes to delivery. It is this liquidity which then allows for the execution of all further derivative transactions. the bullion banks contract to buy gold forward from mining companies. In this case the bullion bank. the borrowed gold is sold. contracts to buy gold forward from a speculator (eg a hedge fund or a bank‘s proprietary trading desk). instead of contracting to buy gold forward from a mining company. The proceeds of this sale are invested and earn interest at money market rates. 3. which effectively adds to supply in the very short term. more commonly. This is why hedging of this nature is sometimes termed ―accelerated supply‖. Thus under these conditions. the bullion bank then repays its borrowed gold to the central bank and the transaction is unwound in its entirety. To fund the purchase. In theory. To fund the transaction it once again sells the gold borrowed from the central bank and invests the proceeds on the money market. The transaction in respect to speculative short-selling has an identical effect on the gold market to that of mining companies (except possibly that mining transactions typically involve a longer time horizon). 37 . 2. However. the bullion banks sell an equivalent amount of gold borrowed from central banks. In the absence of compensating factors. this can place pressure on the gold price. the central bank rolls over the loan. In essence it mobilises metal inventories by bringing this metal into the active market. 4.

The existence of an active lending market with rather stable and low interest rates is quite typical of financial assets. Liquid bonds can be borrowed at a rate only a small premium to their running yield. If gold were like any other financial asset the evidence in the preceding section suggests little reason to believe that the derivative market is likely to distort the cash market. 38 . Even if the derivatives market causes investors to rebalance their portfolios. can be borrowed at a rate close to zero. Most private and institutional investors hold little or no gold. which pays no dividends or coupons. but like financial assets.What is special about investing in gold? Gold is in many ways more like a financial asset than a commodity. and buy or sell the underlying asset. Most of the gold that has ever been produced is still available and could come back to the market under appropriate conditions. The pattern of investors who hold gold is not like that for other financial assets. gold is bought to be stored or kept rather than to be consumed. Demand for individual financial assets tends to be highly elastic. most of which are very close substitutes for each other. All these features of financial assets help ensure that the growth of a derivatives market is unlikely to have a destabilising effect on prices. large changes in holdings can be accommodated with very little shift in prices. Unlike most other commodities. In many markets equities can be borrowed at a rate which is only a small margin above the dividend yield. then a small price reduction would suffice to attract new investors into the market to take the opposite side of the transaction. There are very many different financial assets. Demand for financial assets tends to be measured as a stock – so many billion dollars – rather than as a flow – so many dollars per year– because investors who currently hold the asset can and will sell their holdings in their entirety if the expected return is too low. or that a moderate reduction in expected returns on gold would cause most holders to liquidate their portfolios. The lending market for gold is also far more developed than for a typical commodity. But there are reasons for doubting that the elasticity of demand for gold is so high. In classic portfolio theory. If gold behaves like a typical financial asset one would expect it too to have a very elastic price schedule. From this perspective it is not surprising that gold. If a derivatives market does make it easier for producers and speculators to sell gold short. Investors buy an asset if its risk adjusted return is higher than the market. demand depends not on the price of the asset but on its expected return.

Gold is also unlike a financial asset in that there is substantial consumption demand for gold. it is likely that both the price level of gold (for consumption) and the expected return on gold (for investment) play a part in determining demand. This means that the price elasticity of demand is close to unity. For example. For these investors. Their response to changes in expected returns may be relatively small. 39 . gold is not readily substitutable by other assets. someone who holds all their financial wealth in the form of gold will have a cash demand for gold which may be largely independent of either the price of gold or of the expected rate of return on holding gold. since a 10% increase in the gold price will reduce the volume of gold bought by 10%. While it is hard to separate consumption and investment motives for purchasing jewellery.Investors who hold gold do so at least in part because gold has certain properties which make it peculiarly attractive in the event of acute political or financial instability.

GOLD V/S INFLATION (CPI) Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. Inflation's effects on an economy are manifold and can be simultaneously positive and negative. A chief measure of price inflation is the inflation rate. the annualized percentage change in a general price index (normally the Consumer Price Index) over time. 40 . and debt relief by reducing the real level of debt.g. to name but a few. This can reduce overall economic productivity rates. and only for certain countries. When the price level rises. inventories and durable consumption.6. annual inflation is also erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. Financial asset prices have also been found to possess useful leading indicator properties since their rates of return should embed inflation expectations. Positive effects include a mitigation of economic recessions.4. Negative effects of inflation include a decrease in the real value of money and other monetary items over time. consequently. are closely monitoredand scrutinized in order to determine whether the economy is accelerating or decelerating in order to determine future movements in the rate of inflation.6. selling stocks and buying gold. Several leading indicators are monitored by central banks and other agents in the economy in order to forecast the inflation rate. uncertainty about future inflation may discourage investment and saving. or may lead to reductions in investment of productive capital and increase savings in non-producing assets. GOLD IN CORRELATION WITH THE ECONOMIC INDICATORS 4. as the capital required to retool companies becomes more elusive or expensive.1. each unit of currency buys fewer goods and services. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Variables such as exchange rates. but their predictive power has been found to hold only for some periods. e.

To get the correlation between the gold and the inflation the percentage changes were considered compared to the previous year.00 -20.00 30.00 20. Therefore we can safely assume that there is no prominent relationship that exists between gold and inflation.106131.00 The above graph shows the movement of returns on gold and the differential inflation 1981 to 2009.00 0.00 Gold price 10.037945. 4.037945. We can visibly infer that the correlation between the gold returns and the inflation differential is negligible. FIGURE SHOWING THE RETURN ON GOLD AND THE CHANGE IN INFLATION 40. Further the calculation of the regression gave the Beta as 0. indicating that with every one point of change in the gold price there is a very minimal change in the inflation (CPI) of 0. with peaks in the gold price tending to lead peaks in the CPI.A cursory glance at gold‘s performance in the years since The Golden Constant was first published shows an intuitive relationship between changes in the gold price and changes in the US consumer price index. 41 .00 change in inflation -10. The Correlation between the returns on gold and the differential annualised inflation CPI (with the base year of the year 2000) is 0.1.

Reflecting the increase in gold prices and the higher volume of gold imports on account of the economic recovery. The commodity-wise imports during April-September 2009 indicated slowdown in non-POL imports.3.0 per cent. exhibited reversal in trend in November 2009 with an increase of 2. oil imports have increased during the recent period.4. during 2009-10 (AprilFebruary). gold and silver. reflecting domestic supply constraints and higher prices 4. imports recorded a decline of 13.4. import growth averaged at 43. precious and semi-precious stones. Imports of edible oil and pulses. The uptrend in imports continued through February 2010. FIGURE SHOWING THE RETURN ON GOLD AND THE CHANGE IN THE IMPORTS OF INDIA 140 120 100 80 60 40 20 0 1971-72 1973-74 1975-76 1977-78 1979-80 1981-82 1983-84 1985-86 1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04 2005-06 -20 -40 -60 2007-08 gold prices Imports 0. which was mainly due to sharp decline in imports of capital goods.21502 is the correlation that exists between the returns on gold and the differential imports of India. chemicals.9 per cent a year ago. GOLD V/S IMPORTS India‘s imports. pearls.6. however. 42 . witnessed considerable growth. after declining since December 2008 for eleven months. iron and steel. which resulted from lower international crude oil prices during the period and slowdown in domestic economic activity. Between December 2009 and February 2010.6 per cent.5 per cent in contrast with a growth of 25. Cumulatively.

SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. STOXX. First compiled in 1986. The SENSEX captured all these events in the most judicial manner.6. FTSE. S&P and Dow Jones use the Free-float methodology. The Index was initially calculated based on the "Full Market Capitalization" methodology but was shifted to the free-float methodology with effect from September 1. The base year of SENSEX is 1978-79 and the base value is 100. Mumbai (BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market. GOLD V/S SENSEX For the premier Stock Exchange that pioneered the stock broking activity in India. Till the decade of eighties. The journey in the 20th century has not been an easy one. The Stock Exchange. As per this methodology. The "Free-float Market Capitalization" methodology of index construction is regarded as an industry best practice globally. liquid and representative companies. there was no scale to measure the ups and downs in the Indian stock market. SENSEX is a basket of 30constituent stocks representing a sample of large. A lot has changed since 1875 when 318 persons became members of what today is called "The Stock Exchange.4. 128 years of experience seems to be a proud milestone. Mumbai" by paying a princely amount of Re1.4. the country's capital markets have passed through both good and bad periods. 2003. All major index providers like MSCI. One can identify the booms and busts of the Indian stock market through SENSEX SENSEX is calculated using the "Free-float Market Capitalization" methodology. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs.Since then. The growth of equity markets in India has been phenomenal in the decade gone by. the level of index at any point of time reflects the Free-float 43 . The index is widely reported in both domestic and international markets through print as well as electronic media.

which is not a very strong relationship. Therefore it is apparent that the effect of gold prices in negligible when it comes to the BSE SENSEX.178412. The calculation of SENSEX involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. FIGURE SHOWING THE RETURN ON GOLD AND SENSEX RETURNS 100 80 60 40 20 0 -20 -40 gold prices annualized sensex The return on gold correlates to the return on the BSE SENSEX to the extent of 0. replacement of scrips etc.market value of 30 component stocks relative to a base period. The base period of SENSEX is1978-79 and the base value is 100 index points. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions.5. prices of the index scrips. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. at which latest trades are executed. This is often indicated by the notation1978-79=100. 4. 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 44 . The regration of the gold returns to that of the BSE comes up to 0. During market hours.069205. are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time.

4. Suddenly Gold as money was deemed an important crisis commodity. stabilizing and narrowing towards a mean of 60. Gold relative to Silver increased in value.740537. starting with the Hedge Fund and Asian crises. This is because in a booming economy where silver has a number of industrial uses. FIGURE SHOWING THE RETURN ON GOLD AND 70 60 50 40 30 20 10 0 Silver Mumbai Rupees per kg. the price of silver was rising consistently. through the start of the Iraq war.4. 45 2006-07 . As fear replaced confidence. Gold Mumbai Rupees per 10gms.5. Gold began to be accumulated more than Silver. 1974-75 2002-03 1970-71 1972-73 1976-77 1978-79 1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2004-05 -10 -20 The price relationship with silver is 0. From 1998 through 2008. the commodity was considered to be much more valuable to gold & hence preferred to gold. doubling from 40 times silver in 1998. to 80 times silver in 2003 & 60 times silver in 2005. GOLD V/S SILVER The prices of gold & silver are viewed differently in different market environments. During the period between 1990. the Gold. Here we can clearly see that the interrelationship between gold and silver is quite strong.1998. through the Y2K scare and the economic collapse of 2000.Silver ratio varied between 50 and 70.6.6. which is about where we are now. From early 2004 to now.

75 tons of gold forming about 6 per cent of the current value of its total foreign exchange reserves. FINDINGS AND CONCLUSION 5.   Gold can play a crucial and strategic role in central bank reserve mobilisation in case of need. The main producers of Gold are Hutti Gold Mines and Bharat Gold mines Ltd 46 .5.1. 400 million in value held in gold. Traditionally most investment has taken the form of physical gold. one that has expanded considerably during its period of liberalisation. Findings Gold Standards The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. with not less than Rs. in theory.  The Reserve Bank of India (RBI) holds 357. limits the power of governments to cause price inflation by excessive issue of paper currency Gold as a Reserve Asset  Central banks. and official international institutions. The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin.   The essential features of the gold standard in theory rest on the idea that inflation is caused by an increase in the quantity of money The gold standard. Role of Gold in Indian Economy      India is the world‘s largest gold market in volume terms. Sales have averaged 676 tonnes per annum over the past decade Indian gold demand is firmly embedded in cultural and religious traditions. gold bullion and foreign securities. have been major holders of gold for more than 100 years.

private and publicsector holdings.106131. The regration of the gold returns to that of the BSE comes up to 0.178412.21502 is the correlation that exists between the returns on gold and the differential imports of India. 47 . Gold V/S Silver  The price relationship with silver is 0.\ Gold V/S Sensex   The return on gold correlates to the return on the BSE SENSEX to the extent of 0.740537. Gold V/S Imports  0. which is not a very strong relationship. CFDs and spread betting Gold V/S Inflation (Cpi)  The Correlation between the returns on gold and the differential annualised inflation CPI (with the base year of the year 2000) is 0. Private sector holdings come in the form of bars and coins. Investment vehicles o Bars o Coins o Certificates o Exchange-traded funds o Accounts and o Derivatives.Gold as an Investment Instrument    Gold investment demand can be split broadly into two. Here we can clearly see that the interrelationship between gold and silver is quite strong.069205.

We observed how gold affected the world economy during the prevalence of the gold standards.5. its rise to its eventual fall.2. 48 . Conclusion Throughout the report we can clearly make out the importance of gold in India. as gold is perceived as an hedging instrument. The same thing holds true for the relationship between gold returns and the returns on SENSEX. The relationship that gold has with inflation is nothing but a perceptual link that exists only in the minds of the investors and buyers. as emotional sentiments play a major role where gold is considered. Through the studies done in tis report we can conclude that the gold price is not the best of the indicators of the economy. the gold prices do not really indicate the course of the economy. investors turn towards gold when there is a bearish trend. By establishing the relationship between the return on gold over a period of years and the various economic indicators we can come to the conclusion that though gold is one of the most valuable metal and the most sought after commodity. Not only economical but also culturally.

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