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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.
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. 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
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.
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.
during January-June 2011. The rise in the value of the deals so far (June 2011) recorded a growth of 52 per cent.24 billion) by companies through external commercial borrowings (ECB) or foreign currency convertible bonds (FCCB) for infrastructure projects in the financial years 2009-2011. 2011. It is the highest monthly inflow during the last 11 years. Exports during April-July 2011 reached US$ 108.3 billion. according to a release by the Ministry of Commerce and Industry.3 billion.14 billion in value terms.54 billion in various NRI deposit schemes during April-June 2011. according to a report on world investment prospects titled. Commerce Secretary.83 billion during January-June 2011. The increase in Forex is largely attributed due to valuation changes. India's FDI gathered momentum with the inflows growing by 310 % in June 2011 to touch US$ 5. according to data compiled by Chennai-based Venture Intelligence.65 billion. India's merchandise exports have registered an increase of nearly 82 per cent during July 2011 from a year ago to touch US$ 29. up 54 per cent over the same period a year ago. The total FDI stood at US$ 16. nearly 57 per cent higher than the US$ 10. Private equity (PE) investments in India stood at US$ 6. India's foreign exchange (Forex) reserves have increased by US$ 1. The Government has approved fund raising worth Rs 60.6 billion to register US$ 318 billion during the week ended August 19.04 billion raised during 2010. gems and jewellery and readymade garments. 'World Investment Prospects Survey 2009-2012' by the United Nations Conference on Trade and Development (UNCTAD). Exports in the referred period increased on back of demand for engineering and petroleum products. according to data released by the Reserve Bank of India (RBI). according to Mr Rahul Khullar.74 billion received during the same period last year. 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 2010-11.950 crore (US$ 13. as compared to US$ 4. NRIs invested US$ 1. 5 . while the number of deals increased by 33 per cent to 195.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.
It gives an overview on the investment scenario concerning gold in its various forms. 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. To study the role of gold in the Indian economy. RESEARCH DESIGN 3.2. 6 . Objectives To study the emergence of the gold standards and its decline. 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 report also throws a light on the gold standard. Title of the study ―The impact of gold on the Indian economy and its evolution as an investment option‖ – A Study 3. it rise in the international economy and its eventual fall.1. To study the relationship between that exists between gold prices and the various economic indicators.3. The study the evolution of gold as an investment option. 3.3.
such as monetary restraint and the facilitation of trade flows. Mosley. Sheraton Boston & Hynes Convention Centre. Boston. Boston Marriott Copley Place. Literature Review 3. however.5. Research Methodology This is partly a descriptive and partly a causal research study. Layna. in a way similar to present-day currency boards. magazines company websites are the key source of information. This research will be conducted mostly with the help of secondary data. I argue that the classical gold standard regime served as both a constraint and an opportunity for governments. 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. Governments? monetary policy autonomy was surrendered in service to the gold standard regime.4.5. At the same time. commitment to the gold standard allowed governments to access international capital 7 .3. Aug 28. Because it required automatic adjustment in response to balance of payments imbalances. 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. news papers. this paper focuses on the impact of the gold standard on sovereign borrowing. 3. or to Economic and Monetary Union. "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.1. White papers. as well as the free flow of capital and goods. Massachusetts. This is data collected from literature review. Further the so collected data will be processed with the help statistical tools. the gold standard privileged external commitments (the maintenance of par values) over nations? Internal conditions.
Hutti. There is ample market potential available in the country for indigenously produced gold as India is highly deficient in gold production. Gold exploration and mining scenario in India Raju k. India offers a good potential for 8 . 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. The repeal of the Gold Control Order and economic liberalisation have thrown open new vistas for growth of gold mining in the country. Modern gold mining dates from the year 1870.5. and the vast geological potential.2. 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. which was not thoroughly explored and mined. 3.272 tonnes. as well as future debt servicing capacity. K. Indian mine production has been insignificant and remained static between 1.. At present. and produced together about 2. Considering the big gap in ever increasing demand for gold and the insignificant indigenous supply from the mines. Ltd. While production has fallen to very low levels in recent years. are the two primary gold producing units in India.. Ltd. as evidenced by numerous ancient workings. INDE Abstract Gold. throughout the country testify the flourishing nature of the gold mining industry in India. Government of India liberalised the mineral policy.5 tonnes per annum during the last 10 years. Bharat Gold Mines Ltd. India was renowned for its gold from time immemorial. still dominates the world scene.5 tonnes of gold during 1995 as against the world's total of 2. the oldest metal known to man. Extensive and intensive ancient gold mining activity.6 and 2.markets at lower rates of interest. gold convertibility appeared to signal sound government finances. and Hutti Gold Mines Co. From the past history of gold mining and striking similarities in geological environment with the leading gold producing countries of the world. The Hutti Gold Mines Co. Gold production in India was not significant when compared to world standards.
however.3. gold. Abstract While gold is quite risky as an individual asset. This suggests that gold can play an important role in a diversified portfolio. and other 9 . 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.4. The experience of the past decade has been very different from the predictions of this theory: the prices of land. MA 02138. more than compensates for the increased risk. Jaffe 1989 CFA Institute. The Archaean greenstone belts and the other favourable geological horizons have to be thoroughly explored systematically by the latest state-of-art technology. 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. Inflation. Gold and Gold Stocks as Investments for Institutional Portfolios Jeffrey F. Cambridge. in equilibrium. The increase in returns. Adding a combination of these gold proxies to the hypothetical diversified portfolios raises their mean returns but also increases their standard deviations. 3. Feldstein Harvard University and the National Bureau of Economic Research. because they do not share gold's high liquidity. And The Prices Of Land And Gold M. Gold stocks might be expected to be better investment vehicles than gold itself.5. cause an equal change in the rate of inflation for each asset price.gold. Tax Rules. 3.5. Tests of four hypothetical portfolios of varying risk show that the addition of gold in each case increases average return while reducing standard deviation. consumption and convenience values. its returns are generally independent of those on other assets. A change in the general rate of inflation should.
in an economy with an income tax. 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. Announcements making a government auction more probable cause a sudden drop in the price. Market Anticipations of Government Policies and the Price of Gold Stephen W. Salant and Dale W.5. 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. pp. 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. 10 . 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. 627-648 Abstract This paper is an analysis of the effects of anticipations of government sales policies on the real price of gold. 4 (Aug. Vol.. Henderson The Journal of Political Economy. No. 86.5. 1978). Although the risk of a future government gold auction depresses the price. it also causes the price to rise in percentage terms faster than the real rate of interest and at an increasing rate. More specifically. 3. an increase in the expected rate of inflation causes an immediate increase in the relative price of such ‗store of value‘ real assets.such stores of value have increased by substantially more than the general price level.
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.1. the rates of exchange among national currencies effectively become fixed. The early development of paper money was spurred originally by the unreliability of transportation and the dangers of long voyages. and the notes issued are often called certificates. Why gold? Because of its rarity and durability. with a weight in gold used as the token to transport value. Banking began when gold deposited in a bank could be transferred from one bank account to another by a giro system. gold has long been used as a means of payment. When several nations are using such a fixed unit of account. 11 . reduce the possibility of debasement of coins. Early monetary systems based on grain used gold to represent the stored value. 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. uniformity. GOLD STANDARD The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. or lent at interest. density. as well as by the desire of governments to control or regulate the flow of commerce within their dominion. and avoid the reduction in circulating medium to hoarding and losses.4. DATA ANALYSIS 4. When used as part of a hard-money system. the function of paper currency is to reduce the danger of transporting gold. resistance to corrosion. The exact nature of the evolution of money varies significantly across time and place. to differentiate them from other forms of paper money. Money backed by specie is sometimes called representative money. though it is believed by historians that gold's high value for its utility.
which was approximately 7 grams of gold alloyed with silver. The Persian Empire collected taxes in gold and. the Byzantine empire continued to mint successor coins to the solidus called the nomisma or bezant. The Roman Empire minted two important gold coins: aureus. Early coinage The first metal used as a currency was silver. this gold became the basis for the gold coinage of his empire. and as a store of value. and the smaller solidus.2 was gold.Through most of human history. the coinage in circulation was only 25% gold by weight. as mentioned by Niccolò Machiavelli in The Prince two thousand years later. of which 4. They were forced to mix more and more base metal with the gold until. Gold would remain the metal of monetary reserve accounting until the collapse of the Bretton-Woods agreement in 1972. when silver ingots were used in trade. After the collapse of the Western Roman Empire and the exhaustion of the gold mines in Europe. before 2000 BC. 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 Roman mints were fantastically active — the Romans minted. This represented a tremendous drop in real value from the old 12 . and most prominently during the 19th century. which weighed 4. including the Islamic golden age. and remains an important hedge against the actions of central banks and governments. long before this time gold had been the basis of trade contracts in Akkadia. particularly for payment of armies. Silver remained the most common monetary metal used in ordinary transactions through the 19th century. and later in Egypt. however. millions of coins during the course of the Republic and the Empire. The paying of mercenaries and armies in gold solidified its importance: gold became synonymous with paying for military operations. and it was not until 1500 years later that the first coinage of pure gold was introduced. a means of maintaining general liquidity. Gold would supplant silver as the basic unit of international trade at various times. silver was the primary circulating medium and major monetary metal.4 grams. and circulated. the peak of the Italian trading states during the Renaissance. However. by the turn of the millennium. when conquered by Alexander the Great.
grosh. Thus. an idea advocated by David Hume. established standard references to Allah on the coins. The central thesis of the 13 .95% pure Roman coins. the Republic of Venice coined their first solid gold coin. The primary Spanish gold unit of account was the escudo. The ducat. which was to become the standard of European coinage for the next 600 years. 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. would remain the standard against which other coins were measured. and guinea. which was originally set at 27. The dinar and dirham were gold and silver coins. He removed depictions from coins. trade was increasingly conducted via the coinage in use in the Arabic world. Other 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. and that uncertainty over the future purchasing power of money depresses business confidence and leads to reduced trade and capital investment. using current measures. and was valued at 16 times the equivalent weight of silver. Spain had access to stocks of new gold for coinage in addition to silver. The circulation of Spanish coins would create the unit of account for the United States. 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. respectively. Beginning with the conquest of the Aztec Empire and Inca Empire. The Caliphates in the Islamic world adopted these coins. the "dollar" based on the Spanish silver real. zloty. produced from African gold: the dinar. noble. or "doubloon". were also introduced at this time by other European states to facilitate growing trade. originally minted by the Persians. and it continued to be one of the predominant coins for hundreds of years afterwards. and the basic coin the 8 escudos piece. and fixed ratios of silver to gold. 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. the florin.4680 grams of 22 carat gold. In 1284. and Philadelphia's currency market would trade in Spanish colonial coins. the ducat. because of Venice's preeminent role in trade with the Islamic world and its ability to secure fresh stocks of gold.
gold standard is that removing uncertainty. In an internal gold-standard system. friction between kinds of currency. advocates of the gold standard often believe that governments are almost entirely destructive of economic activity. 14 . and that a gold standard. Under the Bretton Woods system. Others. which may exist in the absence of any internal gold standard. gold or a currency that is convertible into gold at a fixed price is used as a means of making international payments. will increase personal liberty and economic vitality. gold coins circulate as legal tender or paper money is freely convertible into gold at a fixed price. or a full gold standard. the solidity of its credit. 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. then this is known as a 100% reserve gold standard. these were called "SDRs" for Special Drawing Rights. the benefits of enforcing monetary and fiscal discipline on the government are central to the benefits obtained. by expanding both the market for its own goods. 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. In an international gold-standard system. In much of gold standard theory. 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. Under such a system. and the markets from which its consumers may purchase goods. and possible limitations in future trading partners will dramatically benefit an economy. Differing definitions of "gold standard" If the monetary authority holds sufficient gold to convert all circulating money. International gold standards often limit which entities have the right to redeem currency for gold. Some believe there is no other form of gold standard. large inflows or outflows occur until the rates return to the official level. by reducing their ability to intervene in markets.
15 . have been major holders of gold for more than 100 years and are expected to retain large stocks in future. its reserves were 161 tonnes and by 1913 this had risen to a still moderate figure of 248 tonnes. during the period of the classical gold standard. they also started to accumulate gold so as to be able to maintain convertibility at a fixed price.030 tonnes. for countries on the gold standard. political and financial power. In 1870. 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. Central banks started building up their stocks of gold from the 1880s. The development of banking and credit meant that the amount of money in circulation was greater than the gold stock itself. France 1. Under that system. Russia 1. 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.293 tonnes. Even Australia had more than the UK.233 tonnes. and official international institutions. the amount of money in circulation was linked to the country's gold stock. Some other countries had by then accumulated much larger stocks: the United States had 2. As other countries decided to join the gold standard. Austria 378 tonnes and Italy 356 tonnes. Germany 439 tonnes.4. the then dominant economic. The world's total of official gold reserves is estimated to have been about 8. commanded such universal confidence that it actually needed very little gold.100 tonnes in 1913. compared with only 700 tonnes in 1870. The Bank of England.2. Argentina 440 tonnes. That at least was the case during the height of the gold standard for the UK. at 310 tonnes. as the central bank at the centre of the system. but everybody had sufficient confidence in convertibility that there was no danger of this option actually being exercised. They currently account for about 20% of above-ground stocks. GOLD AS A RESERVE ASSET Central banks. and paper money was convertible into gold at a fixed price.
16 .or perhaps slightly more .67 an ounce to $35 an ounce. was faced with the choice of deflating. came to be used as a weapon in economic competition and national rivalries.up to that point. devaluing or abandoning the system. official gold stocks reached about 38. and after several years of moderate but persistent inflation. raising the price from $20. circulating as currency among citizens and across borders in commercial trade transactions.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 . through the fixed official dollar price of gold. So gold provided the "anchor" to which all currencies of member countries were linked. most gold had always been held privately. US official holdings rose from 6. which had been the foundation of the first genuinely international monetary system during the period before World War 1. when it had about 60%of all the official stocks of gold. with President Nixon "closing the gold window". Gold can indeed play a crucial and strategic role in central bank reserve mobilisation in case of need. the United States under President Roosevelt devalued the dollar in terms of gold.000 tonnes at the end of World War II. as central banks created more money than was consistent with stable prices. Mobilising gold As the ultimate form of payment. the fixed official gold price again became unrealistic. it was still the foundation of the international monetary system.000 tonnes and probably accounted for about 50% . In August 1971. At their peak in the 1960s. Gold. it abandoned the system. directly or indirectly.of all above ground stocks. and the United States. gold has sometimes proved the only asset. In 1933-34. acceptable to counterparties. and dollar convertibility. as the pivot of the system. Although there was no direct link between gold holdings and national money supplies (as there had been under the classic gold standard).000 tonnes in 1925 to 18. This new higher price caused holders of gold around the world to sell their holdings to the United States. gold was still the primary "reserve asset". Central banks kept gold because. But gradually. Central banks could convert dollar balances into gold at the official price. when used either as cash or as collateral.
So the U. regards the US gold stock as part of our national patrimony and of value as a precautionary asset.S. later.S.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 gold collected was either placed directly in reserves. gold in the private sector can provide a vital support for public sector purposes. 17 . 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. First the government swapped 20 tonnes on the Swiss market and. Hit by a short-run foreign exchange crisis in 1991. shipped a further 46 tonnes to London as collateral for a loan from the Bank of Japan. As then Treasury Assistant Secretary Manuel Johnson went on to say in Congressional testimony in 1983 . in the 1981 Iranian hostage crisis. transferred 50 tonnes of gold instead. so there was no net cost to US reserves. In the aftermath of the 1997 Asian currency crisis several countries in the region announced plans to mobilise residents' gold holdings . dollars in return for releasing the American hostages it held. India had to rely on its bullion holdings to survive.Malaysia."The Treasury." Finally." The US government simultaneously took ownership of an equivalent quantity of Iranian gold that had been frozen at the New York Fed.and in the light of this recent experience . of course. 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. 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. Iran refused to accept U. thereby adding to credibility.
Official holdings are therefore generally more transparent and easier to track than those of other large holders such as most major private investors. there are good reasons for countries continuing to hold gold as part of their reserves. 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. A strategy of reserve diversification will normally provide a less volatile return than one based on a single asset. In addition holdings may not always be reported in a way that facilitates analysis. whereas currencies and government securities depend on government promises and the variations in central banks‘ monetary policies. Diversification In any asset portfolio.but so too do the exchange and interest rates of currencies held in reserves. These stem from the fact that its value is determined by supply and demand in the world gold markets. However. including gold. 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. 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 is sometimes suggested that maintaining such holdings is inefficient in comparison to foreign exchange. The price of gold therefore behaves in a completely different way from the prices of currencies or the exchange rates between currencies. However.000 tonnes . it rarely makes sense to have all your eggs in one basket.Tracking central bank gold holdings Most central banks place data on their reserve assets. Today their stocks amount to some 30. including reports made under the Standard Data Dissemination Standards. Obviously the price of gold can fluctuate . Gold has good diversification properties in a currency portfolio. 18 . in the public domain and report them regularly to the IMF.similar to their holdings 60 years ago.
total asset freezes. Owning gold is thus an option against an unknown future. 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. Reserves held in the form of foreign securities are vulnerable to such measures. a generalised crisis leading to repudiation of foreign debts by major sovereign borrowers. Physical Security Countries have in the past imposed exchange controls or. Unexpected needs If there is one thing of which we can be certain. if it occurs. It can also serve as collateral for borrowing. paper currencies always lose value in the long run and often in the short term as well. an unexpected surge in inflation. a regression to a world of currency or trading blocs or the international isolation of a country. while global shocks can affect the whole international monetary system. Where appropriately located. It provides a form of insurance against some improbable but. Such events might include war. In contrast. gold is much less vulnerable.Economic Security Gold is a unique asset in that it is no one else's liability. Reserves are for using when you need to. highly damaging event. at the worst. Nor is there any risk of the liability being repudiated. 19 . Gold provides this. Total and incontrovertible liquidity is therefore essential. In emergencies countries may need liquid resources. Gold is liquid and is universally acceptable as a means of payment. Its status cannot therefore be undermined by inflation in a reserve currency country. Economic developments both at home and in the rest of the world can upset countries‘ plans. it is that today‘s status quo will not last for ever.
a regression to a world of currency and trading blocs. There may be an "opportunity cost" of holding gold but. in a world of low interest rates. Income Gold is sometimes described as a non income-earning asset. Some countries give explicit recognition to its support for the domestic currency.an indestructible asset and one not prone to the inflationary worries overhanging paper money. Insurance The opportunity cost of holding gold may be viewed as comparable to an insurance premium. this is less than is often thought. The IMF's Executive Board.Confidence The public takes confidence from knowing that its Government holds gold . 20 . And rating agencies will take comfort from the presence of gold in a country's reserves. There is a gold lending market and gold can also be traded to generate profits. a generalised debt crisis involving the repudiation of foreign debts by major sovereign borrowers. or the international isolation of a country. The other advantages of gold may well offset any such costs. This is untrue. Such an event might be war. It is the price deliberately paid to provide protection against a highly improbable but highly damaging event. has recognised that the Fund's own holdings of gold give a "fundamental strength" to its balance sheet. an unexpected surge of inflation. The same applies to gold held on the balance sheet of a central bank. representing the world's governments.
with not less than Rs. which though small in comparison to total reserves (4. The system was later amended. viz. THE RESERVE BANK OF INDIA The Reserve Bank is required to hold a fixed amount of gold under the Reserve Bank of India Act.6 billion. is still he fifteenth highest of central banks in tonnage terms in the world.4% as at September2006).72 billion. as it moved from using an outdated gold price4 to valuing its reserves at close to he international market price.1150 million equates o just $24. under the Reserve Bank of India Amendment Act 1956. weaning away people from gold. 21 . Rs.3.28 billion to Rs. reducing the domestic demand and prices and curbing smuggling. RBI and Its Gold Policy Measures The Reserve Bank of India (RBI) holds 357. gold bullion and foreign securities. regulating the supply of gold. The RBI currently olds 357.1150 million of its assets in gold (this did not imply the need to acquire additional gold.. The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin. The funds were used to help India meet its short-term debt obligations and import bill. The RBI bought back all 67 tonnes of gold later that year. Between May and July. It also revalued its gold reserves from Rs.7 tonnes of gold.4. 400 million in value held in gold.75 tons of gold forming about 6 per cent of the current value of its total foreign exchange reserves. India mobilised its gold reserves during the 1991 balance of payments crisis. to the minimum reserve system. as the value of existing gold reserves were revised up at the time).7 million at today‘s exchange rate and is tiny in comparison to India‘s total foreign exchange reserves of 151. The evolution of the gold related policy since independence was centred around some major objectives. that required the bank to hold at least Rs. The move vastly improved India‘s reported import coverage ratio. 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.
The country has one of the most deeply religious societies in the world. one that has expanded considerably during its period of liberalisation. 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. Accordingly.In the wake of the Chinese war.4. The measures met with lot of resistance and criticism. new ways to invest in gold. it did not have any major impact on smuggling. 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. ROLE OF GOLD IN INDIAN ECONOMY India is the world‘s largest gold market in volume terms. including how the jewellery sector is being affected by the current social and economic changes. productiveness and prosperity. 4. the role of the Reserve Bank of India and on the supply-side. banning the making and selling of jewellery above 14 carats. This part of the report provides a broad overview of the gold market within the context of India‘s new super charged economy. it was thought as an impossible proposition. is said 22 . which is practiced by around 80% of the population. This coupled with complexities resulted in the failure of the Gold Control order. mine production and the scrap market. Official imports to discourage smuggling was first mooted in 1977 but viewed against the forex reserves available then. the Gold Control Order 1962 was issued. The goddess Lakshmi. who symbolises fertility. However. The origins of gold demand Indian gold demand is firmly embedded in cultural and religious traditions. making it compulsory for gold smiths to be licensed and submit accounts of all gold received and utilized by them etc.. the most widespread faith being Hinduism. it was felt in some circles that it would be feasible to make a frontal attack on demand for gold in India. The Government decided to sell confiscated gold in small quantities through the RBI.
which has also resulted in a significant rise in gold sales in these regions. 23 . Since it is suggested that those who worship her gain wealth. Akshaya Thrithiya. Indeed. Much of this demand takes place in the wedding season. which falls between October and January. whereas she may not be privy to the family‘s other financial affairs. Hindus consider gold an auspicious metal. the idea has been promoted across the North and West of the country. especially in the State of Tamil Nadu. wedding-related demand is big business. 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. dressed in gold-embroidered red clothes. Since 2005. has also become an important day to buy gold. Over the past five years. it is customary for the parents of a baby girl to start accumulating gold for this purpose soon after the child is born. with gold coins flowing from her hands. Gold also plays an important role in the marriage ceremony. Gold is also viewed as a secure and easily accessible savings vehicle by the rural community. and April and May. where around 70% of the population lives. The most important of these is Diwali.to have been bathed by elephants who carried pure water in golden vessels. Not all gold demand is allied with cultural and religious beliefs. where brides are often adorned from head to toe in gold jewellery. She is depicted as a beautiful woman of golden complexion. which they like to buy or gift during religious festivals. Gold is especially important in this respect as it remains directly under her control. though a good many purchases will be made well in advance of the wedding. as Hindu tradition dictates that the family‘s assets are only passed down to sons. falling in April or May. 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. where sales have reached record levels. which marks the beginning of the Hindu New Year and usually takes place in October or November.. The association between gold and ―auspiciousness‖ has been used in recent years to promote the idea of buying gold. Akshaya Thrithiya has become a major gold-buying occasion in the South of India. Purchases on this day are considered auspicious (it is the third most auspicious day in the Hindu calendar). Most of this will be a gift from her parents as a way of giving her some inheritance. With an estimated 10 million marriages a year taking place in India.
This is particularly true of consumer spending. and 20022005. with the mergence of new large-scale retailing. when sales accelerated strongly. when sales were broadly stable in value terms. which has accounted for the lion‘s share of growth over the past decade.more than four times the 22 million square feet estimated in 2005. which has allowed the economy to start reaping the benefits of globalisation on a truly massive scale. Shopping centres are starting to spring up across urban India. 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. During the first period. The higher variability of volume as oppose to value spending is a function of both the retail price setting mechanism in Indian.a for the past decade. India is now the fifth largest economy in the world (on a PPP basis) having posted average annual growth rate of 6%p. 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. something which is changing theface of retailing and will affect traditional gold retailers. Sales in tonnage were more volatile over the period. A noticeable feature of India‘s development has been the strength of its domestic economy relative to most emerging markets in Asia. held back by relatively weak income growth.284 billion per annum and fluctuated in a relatively narrow range of Rs.224-316 billion a year. averaging 709 tonnes and fluctuating between 506-810 tonnes.Recent Economic Trends The Indian economy has enjoyed rapid growth over the past decade. thanks to the progressive liberalisation of its economy and the consequent inflow of foreign direct investment. Gold sales were broadly stable in the three years that followed. The country‘s $200 billion retail industry is changing. as well as the origins of demand. spending averaged Rs. Spending was especially strong in 1998 thanks to the release of pent up demand following the removal of import controls in November 1997. The economy shows no signs of slowing either. 24 .
which is supporting discretionary spending on consumer goods. especially where gold is being used as a long-term savings vehicle. The main theme of the past few years has been a solid upswing in gold sales.19. 25 . the value of gold sales is often quite price inelastic.The price of jewellery changes in line with changes in the international market price in India. The retail mark up is also normally relatively small in relation to the value of the piece. as gold price volatility spiked upwards.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. A prime example would be the parents of a baby girl saving for a future Streedhan. as was the case in Q1 2006.026 to Rs. Indians are enjoying a rapid acceleration in income growth.276 billion to Rs. 276billion in 2002 to Rs. Still.15. when the value of spending fell by 7%. Last year. That Indian demand is not necessarily adversely impacted by rising prices is clear from the experience of the past few years (2002-2005). especially into the outsourcing and IT sectors. Consumers are wary about purchasing when the price is volatile for fear that they buy and then find the price falls. What does seem to adversely impact on demand is a pick up in the pace of daily price fluctuations or volatility.599. Indeed. as India continues to attract large volumes of foreign direct investment. with spending increasing from Rs. with each item weighed then priced according to the prevailing daily market rate. 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. including gold. although the volume of gold they can afford each year will rise and fall with the price. More workers are moving from low income to middle and high income quartiles. who will usually purchase acertain monetary value of gold each month. The same message would seem to come from H1 2006‘s experience. 473 billion in 2005. when retail investment spending surged by 32% year-on-year despite an 11% rise in the gold price in rupee terms.473 billion (or 571 tonnes to 750 tonnes)despite a coincident rise in the gold price from Rs. a rising price can often stimulate investment demand for gold. when gold demand rose steadily from Rs.
26 . including India. combined with a significant increase in their personal wealth. especially with the relevant marketing initiatives targeted at India‘s new affluent young middle class.economic changes will be positive for gold sales. has meant that gold has become a more relevant and desirable product to a greater number of women. as there is a much bigger pool of money available. Global Insight. Recent experience supports this premise. with the rise in gold sales outstripping the rise in general retail spending indices. conducted across six key gold markets. A recent WGC study. found that the increasing independence of woman in developing countries and shifts in attitudes and behaviours.Social trends are also changing.estimated 110million households were earning between $10-30K. Of course. it seems likely that the net impact of these socio. 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. More women are seeking their independence by entering the workforce. while tastes are becoming more international. with households increasingly demanding all the conveniences of the modern world. 16 million between$30-80K and just short of a 1 million earning over $80K. These socio-economic changes have led to enormous growth in the potential market for gold jewellery. young middle class Indians are more willing to spend than their parents‘ generation was. Equally importantly. 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. gold must compete with a growing desire for other luxury goods too. However. such as mobile phones and home computers. $30-80K and $80K+to increase by 52%. expects the number of people earning between $1330K. 87% and 200% in real terms to 167 million. an economic forecasting agency. 30 million and 3 million respectively by 2015.
Mutual funds. Hence income generated in these service sectors can be treated as a determining variable Since bank deposits. technological change in agriculture (through mechanization and high yielding varieties).UTI Asset Management Company Ltd and Benchmark Asset Management Ltd are currently seeking regulatory approval to sell a gold ETF. expected before he end of 2006. small savings. leading to more skewed income distribution. These instruments give investors a relatively cost efficient and secure way to access the gold market. like real estate and public sector. etc are alternative avenues for investing savings. But there are new ways toinvest in gold.Factors Influencing Demand for Gold Following are the factors influencing the demand for gold. 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. The increase in the irrigation. The next major development is likely to be the arrival of Exchange Traded Funds(ETFs). the two largest being he Multi Commodity Exchange of India Ltd(MCX) and the National Commodity and Derivatives Exchange Ltd NCDEX). Black money originating in the services sector. and to buy and sell that interest through the trading of a security on regulated stock exchange. Ways to buy gold Traditionally most investment has taken the form of physical gold. Indians bought 102 tonnes of gold coins and bars. have generated large marketable surplus and a highly skewed rural income distribution is another factors contributing to additional demand for gold. the demand for gold as a store of value can be expected to rise. Since October 003 the government has allowed futures trading and there are now three futures exchanges. In 2005. has contributed to gold as store of value. Inflation redistributes incomes in favour of non-wage income earners. the weighted return on these alternative assets can be considered as another influencing factors. 27 . With incremental income of non-wage earners.
Mumbai was losing its shine due to high sales tax of 2% prior to April 2002. a slump from Rs 12. Delhi prices command some prominence in some parts of the country. The physical delivery in bullion for the both NCDEX and MCX also generally takes place in Ahmedabad. 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. had hit a trough in the 2001 fiscal with volumes crashing by over 50 per cent to less than 140 tonnes. 28 . In rupee terms. became the largest landed destination in the country for the yellow metal after the Gold Control Act was scrapped in 1991-92. the Ahmedabad bullion juggernaut has slowed down perceptibly to Rs6000 crore worth of business in the last fiscal.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. which at 280 tonnes accounted for a high 40 per cent of the entire country's 700-tonne market in 2000-01. after the VAT implication in Rajasthan and Gujarat there should not be major difference in the tax structure. Ahmedabad The bullion market of Ahmedabad. Mumbai and Ahmedabad together account for about 45% Indian gold trade.Major Markets in India Mumbai Mumbai is the major wholesale trading centre in India. Delhi Gold market constitutes about 15% of total Indian gold trade. Still Ahmedabad is considered one of the important bullion markets in the country. However.The Gujarat bullion market. price quoting in Mumbai market is taken as reference price in most other parts of the country.000 crore worth of transaction in the previous year. Delhi Delhi is another major gold market in the country.
2 billion. thanks to the influx of foreign capital. in the face of high prices and generally good economic conditions. the magnitude of FOREX expended on gold imports has been large and growing in 1970. with the main source of domestic supply coming from recycled jewellery.In summary. Indians have recycled an average of 105 tonnes of gold per annum. very little supply comes from domestic sources. rapid income growth. Its dynamic population growth and strong cultural and religious affinity to gold will continue to underpin structural demand. Over the past five years. India‘s demand will continue to be satisfied almost entirely from imports.compared with $271-$279 in the previous three ears). For instance.32 in 2003. would have cost $ 2.68 in 2002 and $363. as well as a higher high gold price the gold price averaged$309. 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. the price of gold and price expectations. is attributed to expectations of still higher prices6. in tandem with new successful marketing campaigns. India looks poised to remain the world‘s foremost gold consumer in tonnage terms for many years to come.5 billion. Mean while. Scrap supply is sensitive to general economic conditions. (Equivalent to about one fifth of exports and one sixth of imports). In the Indian context.Above ground stocks Supply from above ground stocks is much more important in India. Economic Implications of Gold Imports Gold by it self does not add much to production or productive capacity. Price expectations also matter. 29 . intermediates and capital equipment) needed for current production and to expand productive capacity. continue to boost discretionary spending on gold. as aside from the scrap market. the decline in scrap supply in 2005. should. India‘s imports at the prices prevailing in the world market at that time. notwithstanding temporary fluctuations associated with spikes in price volatility. However the foreign exchange used for importing it in effect reduces the availability of this resource for other imports (including raw materials. equivalent to about one eighth of merchandise exports and 8 percent of merchandise imports and the corresponding figures for 1997 was $ 7.
over invoicing of imports. gold‘s holding whether in the form of bars or ornaments. These transactions did not figure at all in the country‘s trade or payment statistics. 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. The other characteristics of gold are that it is a highly liquid store of value. as well as the resources needed for the still substantial smuggled gold. The nature and sources of the latter are not indicated for lack of information. the availability of FOREX for other purposes and the health of the balance of payment. 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. Though it does not earn any interest and though it is no longer used as the standard for fixing currency values. Altogether from country‘s point of view. Their continued rapid growth can have significant consequences in the terms of scale and functioning of the hawala market. it can be treated as durable consumer good. not all gold is held in the form of ornaments. earning of migrant workers remitted through hawala channels and smuggling of silver and contra brand drugs. 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. It represents command over both at home and at abroad which can in principle be invoked whenever necessary. So far Gold is treated as ornament. risk free asset. 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. 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 . gold imports being illegal were financed by the proceeds of under invoicing of the exports. In any case. are no different from FOREX holdings. Clearly they.000 tons valued at current price at $ 165 billion. 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. After 1992. 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. But this function does not in any way dilute its advantage as liquid.Prior to 1992.
Private sector holdings come in the form of bars and coins. gold is the most popular as an investment. although in the Middle East coins and small bars are often incorporated into jewellery. private and public-sector holdings.5. Private investment holdings amount to just under 25. The more so because investment in gold. this led to increased gold smuggling. As a result. a substantial portion of 31 . then they must be properly counted as part of the economy‘s savings. Investment demand can be split broadly into two.000 tonnes. 4. If accumulating gold. GOLD AS AN INVESTMENT INSTRUMENT Of all the precious metals. India lost an estimated Rs6000 crores (Rs 60 billion) of foreign exchange. the value of additions to gold stock accounts for over 20% of private noncorporate sector‘s investment in financial instruments. Tariff Structure The import duty on Gold was Rs. 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.220 per ten grams upto January 1999. these holdings are purely a store of value. a substitute for investment in other assets.after which it was increased to Rs400 per ten grams. in principle.assets is another matter. Smuggling gradually came down when the duty was reduced to Rs250 per ten grams on April 2001 and subsequently to Rs100 per ten grams. in real sense. a figure that has been growing slowly over time. It is significant that during the last five years.2. More interestingly the location of the bulk of these holdings is believed to have shifted. and this bias has been increasing from the last two decades.000 crore per annum since 1997. is no different from accumulation of FOREX reserves or investment in foreign financial assets. and does not detract from this feature. The amount of duty released from gold imports indicates an annual figure varying from Rs. Of course. it is important to such a context. Exclusion of gold from the estimates of domestic savings thus understates the household and overall domestic savings rate. which is held at least in part for decorative purposes.1000 to Rs. Whereas thirty years ago. Unlike jewellery.
the International Monetary Fund and France. Gold holdings twenty years ago are a good predictor of a central bank‘s holding today. The investor could hold gold-linked paper assets or could lend out the physical gold on the market. There have also been confirmed buyers. 32 . suffice to observe here that an investor who wants exposure to gold. There have been substantial sales. Switzerland and the UK. and also by the very large size of reserves relative to the underlying flow of production and consumption. particularly if his position is more than. say. the Netherlands. anonymous and readily marketable anywhere. Canada. These differences can partly be explained by the way in which reserves are viewed nationally. In countries with a stable political and financial system. The stability has been particularly marked among the larger holders . the possibility of changes in policy has had a substantial impact on the gold price. 10.including the United States. Germany. correlation with other assets. Given the size of official reserves relative to consumption levels. In markets with poorly developed financial systems. 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. most notably by Argentina. gold is attractive as a store of value which is portable.this was held by Western investors. If gold is held primarily as an investment asset. Australia. it does not need to be held in physical form. or where trust in the government is low. Current holdings by different countries are quite diverse both in terms of absolute quantity and as a proportion of their total external reserves. Reasons for holding physical gold vary widely. inaccessible or insecure banks.000 ounces. While proper discussion of the gold lending market is reserved to the second chapter of the report. the overwhelming majority is now thought to be held in other parts of the world. Belgium. In addition he will save on the storage costs. and the way in which decisions on reserve policy are taken. the largest being Taiwan and Poland. and which may hold or increase its value if for some reason investors flee from purely financial assets like bonds and equities. the prime attraction of gold is as an investment which has very low or negative.
Finally. like Argentina. these can easily be bought or sold "over the counter" of the major banks. For example. Making an allowance for this is. It is subjective because purchase-motive is extremely difficult to measure on a scientific basis. In addition.5kg or 1kg bars (1kg = 32. however. as the part of the former would be lent out. wedding-related demand for high-carat jewellery in India has an important investment motive but it is also purchased for adornment. Theoretically in the latter case. In counting such bullion. for example in Europe these would typically be in 12. makes it impossible on a systematic and regular basis to measure ―investment jewellery‖ demand worldwide. to complicate matters still further.Investment vehicles Retail Gold Investment The definition excludes so-called ―investment jewellery‖. 1oz bar. Alternatively. Austria. Bars The most traditional way of investing in gold is by buying bullion gold bars. impractical. there could be a problem with unallocated as opposed to allocated gold holdings. there are bullion dealers that provide the same service. Liechtenstein and Switzerland. such as the Tael. The problem with such a definition is that it is highly subjective as well as excessively elastic. where highcarat was formerly predominant. however. private investor metal account holdings are included. In some countries.15072 Troy ounces). changing tastes in jewellery and the shift to lower-carat articles in some parts of the world. The broadest definition of retail investment would incorporate any private sector demand for gold that was not related purely to adornment or industrial purposes. low mark-up jewellery purchased with an investment motive). For example. although many other weights exist. with these in turn defined by the standard adopted by the European Union. the definition of retail investment demand excludes all institutional investment. or 1 33 .. Bars are available in various sizes. 10g. 10oz. one is dealing with a dynamic situation. It is decided to only count physical bullion coins and bars. This would include so-called ―investment jewellery‖ (generally high carat.
RCM bars do not come with either protective cases or certificates.99% pure) and contain 32. by the Department of Treasury. Because of the many difficulties of transporting. PAMP kilo gold bars usually come with certificates.see 'Accounts' below.9999 fine (99. actually consists of the PAMP hallmark on the gold bars. due to the fact that they are much easier to store. Gold bars can be held either directly (i. Bars are increasing in popularity as investment vehicles. One of the most popular gold coins is the American Eagle bullion coin.99 pure. storing and verifying pure gold bars.  It seems that the gold bars are primarily sold as kilo bars rather than 1-oz gold bars.  The PAMP certificate Coins Buying gold coins is a popular way of holding gold. 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. an increasingly popular method of investing in gold bars for the small investor is via allocated holdings using a gold account .). Kilo gold bars are .15 troy ounces each. The American Eagle coins contain a stated amount of pure gold and are made in four denominations. The most commonly available kilo gold bars are the PAMP and the Royal Canadian Mint (RCM) gold bars. kilo gold bars. 34 . All these gold bars are . Again. the large Swiss and Liechtenstein banks buy and sell these coins over the counter. which is guaranteed by the United States Government and has been in circulation for over 300 years. held directly by you or in your own safe) or indirectly (held in a safe deposit box or bank vault on your behalf). and 100gram gold bars.9999 fine (99. plus a premium above the gold spot price. as they carry lower premiums than gold bullions.e. Typically bullion coins are priced according to their weight. 10-oz gold bars. Gold bars for sale include 1-oz gold bars.Tola.
was launched in March 2003 on the Australian Stock Exchange. New York and Sydney. Gold ETFs represent an easy way to gain exposure to the gold price. These US gold eagle coins are also minted in ½. without the inconvenience of storing physical bars. ¼ and 1/10 ounce sizes.The standard gold eagle coins have a fineness of 0. Gold certificates allow investors to buy and sell the security without the inconvenience associated with the transfer of actual physical gold.0 troy ounce (31. insurance. Gold Bullion Securities (ticker symbol "GOLD").000 shares).103 grs). The actual gold content of these coins is 1. Gold certificates may be described as the first paper bank notes. and originally represented exactly one-tenth of an ounce of gold. or ETFs. The first gold ETF.  Exchange-traded funds Gold exchange-traded funds (or GETFs) are traded like shares on the major stock exchanges including London. the Creation Units may not be purchased with cash but a basket of securities that mirrors the ETF's portfolio. Certificates A certificate of ownership can be held by gold investors. instead of storing the actual gold bullion.916 and have a face value of $50. The annual expenses of the fund such as storage. but that differ from traditional open-end companies and UITs. Usually. Also. They were first issued in the 17th century when they were used by goldsmiths in England and The 35 . and management fees are charged by selling a small amount of gold represented by each certificate. 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. are investment companies that are legally classified as open-end companies or Unit Investment Trusts (UITs). Typically a small commission is charged for trading in gold ETFs and a small annual storage fee is charged. so the amount of gold in each certificate will gradually decline over time. the Creation Units are split up and re-sold on a secondary market. Exchange-traded funds.
as well as by banks in Germany and Switzerland. In the U. the gold certificates began being issued in the United States when the US Treasury issued such certificates that could be exchanged for gold. The United States Government first authorized the use of the gold certificates in 1863. In India. Firms such as Cantor Index. Gold accounts are typically backed through unallocated (fungible or pooled) or allocated (also known as non-fungible) gold storage. currently trade on various exchanges around the world and over-the-counter (OTC) directly in the private market.. and NYSE Liffe US. such as gold forwards. all from the UK. Bailment is the legal action of a client entrusting their physical property to another party for safekeeping. and paying for the service. IG Index and City Index. CMC Markets. Derivatives. 36 . Digital gold currency accounts and the BullionVault gold exchange work on a similar principle. futures and options. CFDs and spread betting Derivatives. the gold certificates stopped circulating as money. a division of the New York Mercantile Exchange (NYMEX).Netherlands for customers who kept deposits of gold bullion into their safe-keeping. Two centuries later. gold futures are traded on the National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX). provide contract for difference (CFD) or spread bets on the price of gold. Different accounts impose varying levels of intermediation between the client and their gold. Nowadays. for example through bailment or within a trust. Accounts Most Swiss banks offer gold accounts where gold can be instantly bought or sold just like any foreign currency. gold futures are primarily traded on the New York Commodities Exchange (COMEX).S. In the early 1930s the US Government restricted the private gold ownership in the United States and therefore. gold certificates are still issued by gold pool programs in Australia and the United States.
It is this liquidity which then allows for the execution of all further derivative transactions. To fund the transaction it once again sells the gold borrowed from the central bank and invests the proceeds on the money market.Gold derivatives: basic principles In its most simplified form. the borrowed gold is sold. the bullion bank then repays its borrowed gold to the central bank and the transaction is unwound in its entirety. The proceeds of this sale are invested and earn interest at money market rates. contracts to buy gold forward from a speculator (eg a hedge fund or a bank‘s proprietary trading desk). This is why hedging of this nature is sometimes termed ―accelerated supply‖. 3.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. 2. In the absence of compensating factors. 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). the central bank rolls over the loan. When the forward sale comes to delivery. However. Thus under these conditions. thus maintaining the liquidity to fund further derivative transactions. the bullion banks sell an equivalent amount of gold borrowed from central banks. more commonly. In essence it mobilises metal inventories by bringing this metal into the active market. this can place pressure on the gold price. 4. 37 . the bullion banks contract to buy gold forward from mining companies. With respect to producer hedging. the transaction can be described as follows: 1. In theory. To fund the purchase. instead of contracting to buy gold forward from a mining company. which effectively adds to supply in the very short term. In this case the bullion bank. the producer delivers either newly-mined gold or gold purchased in the market to the bullion bank at the contract price.
The pattern of investors who hold gold is not like that for other financial assets. But there are reasons for doubting that the elasticity of demand for gold is so high. 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. In classic portfolio theory. can be borrowed at a rate close to zero. gold is bought to be stored or kept rather than to be consumed. which pays no dividends or coupons. The lending market for gold is also far more developed than for a typical commodity.What is special about investing in gold? Gold is in many ways more like a financial asset than a commodity. Liquid bonds can be borrowed at a rate only a small premium to their running yield. All these features of financial assets help ensure that the growth of a derivatives market is unlikely to have a destabilising effect on prices. In many markets equities can be borrowed at a rate which is only a small margin above the dividend yield. and buy or sell the underlying asset. 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. Investors buy an asset if its risk adjusted return is higher than the market. Most of the gold that has ever been produced is still available and could come back to the market under appropriate conditions. Unlike most other commodities. If a derivatives market does make it easier for producers and speculators to sell gold short. then a small price reduction would suffice to attract new investors into the market to take the opposite side of the transaction. most of which are very close substitutes for each other. Demand for individual financial assets tends to be highly elastic. large changes in holdings can be accommodated with very little shift in prices. demand depends not on the price of the asset but on its expected return. There are very many different financial assets. Even if the derivatives market causes investors to rebalance their portfolios. or that a moderate reduction in expected returns on gold would cause most holders to liquidate their portfolios. 38 . The existence of an active lending market with rather stable and low interest rates is quite typical of financial assets. Most private and institutional investors hold little or no gold. but like financial assets. From this perspective it is not surprising that gold. If gold behaves like a typical financial asset one would expect it too to have a very elastic price schedule.
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. since a 10% increase in the gold price will reduce the volume of gold bought by 10%.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. For example. 39 . gold is not readily substitutable by other assets. While it is hard to separate consumption and investment motives for purchasing jewellery. 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. This means that the price elasticity of demand is close to unity. For these investors. Their response to changes in expected returns may be relatively small.
the annualized percentage change in a general price index (normally the Consumer Price Index) over time.6.4. to name but a few. e. or may lead to reductions in investment of productive capital and increase savings in non-producing assets. A chief measure of price inflation is the inflation rate. GOLD IN CORRELATION WITH THE ECONOMIC INDICATORS 4.g. Several leading indicators are monitored by central banks and other agents in the economy in order to forecast the inflation rate. 40 . inventories and durable consumption.1.6. Variables such as exchange rates. each unit of currency buys fewer goods and services. as the capital required to retool companies becomes more elusive or expensive. selling stocks and buying gold. 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. but their predictive power has been found to hold only for some periods. consequently. This can reduce overall economic productivity rates. 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. uncertainty about future inflation may discourage investment and saving. Positive effects include a mitigation of economic recessions. Negative effects of inflation include a decrease in the real value of money and other monetary items over time. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. and debt relief by reducing the real level of debt. 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. and only for certain countries. Inflation's effects on an economy are manifold and can be simultaneously positive and negative. Financial asset prices have also been found to possess useful leading indicator properties since their rates of return should embed inflation expectations. When the price level rises.
00 The above graph shows the movement of returns on gold and the differential inflation 1981 to 2009.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. We can visibly infer that the correlation between the gold returns and the inflation differential is negligible.00 0.037945. To get the correlation between the gold and the inflation the percentage changes were considered compared to the previous year.106131.00 30. The Correlation between the returns on gold and the differential annualised inflation CPI (with the base year of the year 2000) is 0.00 -20. 4.1.00 Gold price 10.037945. Therefore we can safely assume that there is no prominent relationship that exists between gold and inflation. Further the calculation of the regression gave the Beta as 0.00 20. with peaks in the gold price tending to lead peaks in the CPI. 41 . FIGURE SHOWING THE RETURN ON GOLD AND THE CHANGE IN INFLATION 40. indicating that with every one point of change in the gold price there is a very minimal change in the inflation (CPI) of 0.00 change in inflation -10.
Imports of edible oil and pulses. witnessed considerable growth. after declining since December 2008 for eleven months. pearls. 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. chemicals. reflecting domestic supply constraints and higher prices 4. oil imports have increased during the recent period.0 per cent. The commodity-wise imports during April-September 2009 indicated slowdown in non-POL imports. exhibited reversal in trend in November 2009 with an increase of 2. The uptrend in imports continued through February 2010. 42 .4. gold and silver. Cumulatively. which resulted from lower international crude oil prices during the period and slowdown in domestic economic activity. which was mainly due to sharp decline in imports of capital goods. Between December 2009 and February 2010. import growth averaged at 43. Reflecting the increase in gold prices and the higher volume of gold imports on account of the economic recovery. iron and steel.4. precious and semi-precious stones.6 per cent.6. GOLD V/S IMPORTS India‘s imports.9 per cent a year ago.5 per cent in contrast with a growth of 25.3. during 2009-10 (AprilFebruary). imports recorded a decline of 13.21502 is the correlation that exists between the returns on gold and the differential imports of India. however.
The journey in the 20th century has not been an easy one.Since then. 2003. S&P and Dow Jones use the Free-float methodology. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. SENSEX is a basket of 30constituent stocks representing a sample of large. Mumbai (BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market. A lot has changed since 1875 when 318 persons became members of what today is called "The Stock Exchange. The "Free-float Market Capitalization" methodology of index construction is regarded as an industry best practice globally.6. STOXX. First compiled in 1986. The growth of equity markets in India has been phenomenal in the decade gone by. The SENSEX captured all these events in the most judicial manner. The Stock Exchange. Mumbai" by paying a princely amount of Re1. All major index providers like MSCI. liquid and representative companies. Till the decade of eighties. One can identify the booms and busts of the Indian stock market through SENSEX SENSEX is calculated using the "Free-float Market Capitalization" methodology. 128 years of experience seems to be a proud milestone.4. there was no scale to measure the ups and downs in the Indian stock market. 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 level of index at any point of time reflects the Free-float 43 . GOLD V/S SENSEX For the premier Stock Exchange that pioneered the stock broking activity in India. FTSE. The index is widely reported in both domestic and international markets through print as well as electronic media.4. The base year of SENSEX is 1978-79 and the base value is 100. As per this methodology. SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. the country's capital markets have passed through both good and bad periods.
The Divisor is the only link to the original base period value of the SENSEX. The regration of the gold returns to that of the BSE comes up to 0. 4. are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization. During market hours. prices of the index scrips. This is often indicated by the notation1978-79=100. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company.market value of 30 component stocks relative to a base period.178412. Therefore it is apparent that the effect of gold prices in negligible when it comes to the BSE SENSEX. replacement of scrips etc. at which latest trades are executed. which is not a very strong relationship. 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 .069205. 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. The base period of SENSEX is1978-79 and the base value is 100 index points.5. The calculation of SENSEX involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions.
Here we can clearly see that the interrelationship between gold and silver is quite strong.740537. 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. which is about where we are now. From 1998 through 2008. FIGURE SHOWING THE RETURN ON GOLD AND 70 60 50 40 30 20 10 0 Silver Mumbai Rupees per kg.1998. As fear replaced confidence. stabilizing and narrowing towards a mean of 60.6. Gold began to be accumulated more than Silver.6. the commodity was considered to be much more valuable to gold & hence preferred to gold. This is because in a booming economy where silver has a number of industrial uses. Gold relative to Silver increased in value. through the start of the Iraq war. 45 2006-07 . GOLD V/S SILVER The prices of gold & silver are viewed differently in different market environments. through the Y2K scare and the economic collapse of 2000. From early 2004 to now.4. the price of silver was rising consistently.Silver ratio varied between 50 and 70. Suddenly Gold as money was deemed an important crisis commodity.5. the Gold. Gold Mumbai Rupees per 10gms. to 80 times silver in 2003 & 60 times silver in 2005. doubling from 40 times silver in 1998. During the period between 1990. starting with the Hedge Fund and Asian crises. 4.
Traditionally most investment has taken the form of physical gold. Gold can play a crucial and strategic role in central bank reserve mobilisation in case of need.5. and official international institutions. have been major holders of gold for more than 100 years. one that has expanded considerably during its period of liberalisation. gold bullion and foreign securities. The Reserve Bank of India (RBI) holds 357. Role of Gold in Indian Economy India is the world‘s largest gold market in volume terms.1. 400 million in value held in gold. 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. with not less than Rs.75 tons of gold forming about 6 per cent of the current value of its total foreign exchange reserves. The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin. Findings Gold Standards The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. Sales have averaged 676 tonnes per annum over the past decade Indian gold demand is firmly embedded in cultural and religious traditions. in theory. The main producers of Gold are Hutti Gold Mines and Bharat Gold mines Ltd 46 . FINDINGS AND CONCLUSION 5. limits the power of governments to cause price inflation by excessive issue of paper currency Gold as a Reserve Asset Central banks.
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. 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. Investment vehicles o Bars o Coins o Certificates o Exchange-traded funds o Accounts and o Derivatives.21502 is the correlation that exists between the returns on gold and the differential imports of India. Here we can clearly see that the interrelationship between gold and silver is quite strong. The regration of the gold returns to that of the BSE comes up to 0.069205.740537. 47 . private and publicsector holdings. Private sector holdings come in the form of bars and coins.178412.106131. which is not a very strong relationship. Gold V/S Imports 0.Gold as an Investment Instrument Gold investment demand can be split broadly into two.
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. investors turn towards gold when there is a bearish trend. the gold prices do not really indicate the course of the economy. its rise to its eventual fall. 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 same thing holds true for the relationship between gold returns and the returns on SENSEX.5. We observed how gold affected the world economy during the prevalence of the gold standards. as emotional sentiments play a major role where gold is considered.2. Conclusion Throughout the report we can clearly make out the importance of gold in India. as gold is perceived as an hedging instrument. 48 . The relationship that gold has with inflation is nothing but a perceptual link that exists only in the minds of the investors and buyers. Not only economical but also culturally.
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