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TABLE OF CONTENTS

1. Introduction…………………………………………………………………………………………. 1
1.1.Spot Vs Forward Transactions………………………………………………………………… 4
1.2.Limitations…………………………………………………………………………………...... 5
2. Company Profile……………………………………………………………………………………. 7
3. History of Commodity trading and Precious Metals……………………………………………….. 9
3.1. Commodity trading in India………………………………………………………………….... 9
3.2. Kabra committee report……………………………………………………………………...... 10
3.3. Forward Market Commission………………………………………………………………….. 12
3.4. Multi-commodity exchange of India……………………………………………………………13
3.5. National Commodity and Derivatives Exchange limited……………………………………… 15
3.6. History of Gold Market………………………………………………………………………... 19
3.6.1.Gold Trading…………………………………………………………………………….. 20
3.6.2.Production of the Gold……………………………………………………………………
20
3.6.3.Why central Banks Hold Gold……………………………………………………………
21
3.7.History of silver Market……………………………………………………………………….. 23
3.7.1.Production of silver……………………………………………………………………. ...
24
4. Pricing Commodity Futures……………………………………………………………………….. 26
4.1.Investment Vs Consumption Assets…………………………………………………………..... 26
4.2.Cost of Carry model………………………………………………………………………….... 27
4.3.Pricing Futures Contract on Investment commodities………………………………………… 29
4.4.Pricing Futures Contract on Consumption commodities……………………………………… 32
5. Clearing, Settlement and Risk Management……………………………………………………….. 35
5.1.Clearing………………………………………………………………………………………… 35
5.2.Settlement………………………………………………………………………………………. 37
5.3.Risk Management……………………………………………………………………………… 40
6. Fundamental and Technical Analysis………………………………………………………………. 42
6.1.Fundamental analysis………………………………………………………………………......
42
6.1.1.Demand and Consumption………………………………………………………………. 42
6.1.2.Consumption of gold in India……………………………………………………………..
44
6.1.3.Uses of Gold………………………………………………………………………………
44
6.2.Technical analysis……………………………………………………………………………… 46
6.2.1.Dow Theory……………………………………………………………………………… 46

6.2.2.Basic principles of Technical analysis…………………………………………………… 50


6.2.3.Line Chart…………………………………………………………………………………
51
6.2.4.Bar Chart…………………………………………………………………………………..
52
6.2.5.Japanese Candlestick Chart……………………………………………………………….
55
6.2.6.Chart Patterns…………………………………………………………………………......
59
6.2.6.1. Support and resistance patterns…………………………………………………. 59
6.2.6.2 Reversal pattern…………………………………………………………………. 62
6.3. Mathematical Indicators………………………………………………………………………. 64
6.3.1. Moving Average………………………………………………………………………… 64
6.3.1.1. Simple moving Average……………………………………………………
….. 64
6.3.1.2. Exponential moving Average………………………………………………….. 66

6.3.2. Oscillators……………………………………………………………………………….. 68

6.3.2.1. Rate of Change indicators……………………………………………………… 68

6.3.3. Market Indicators……………………………………………………………………….. 71

7. References………………………………………………………………………………………….. 72
ABSTRACT

Aim: An empirical study on precious metals based on fundamental and technical analysis.

Abstract: We study the gold and silver prices based on fundamental analysis like inventories in

the entire globe, central bank reserves and currency fluctuations. We study the Inventories which

will effect due to strikes, political conditions and demand & supply mismatch. According to

central Bank policies and central agreements reserves will various. Currency trading on Dollar

verses Euro or Dollar verses sterling pound causes volatility which leads to gold/silver price

fluctuations.

We forecast the gold and silver prices with advanced technical

analysis tools by using mathematical indicators and Market indicators like

Simple moving average, Exponential moving average. Market indicators are

the indicators used by technical analysts to study the trend of the market as a whole.

Oscillators like Rate of change Indicators. We use mathematical indicators to

know the average prices of the commodity, and we use Oscillators to identify

overbought and oversold conditions.


In this study we are applying both fundamental and technical

analysis for predicting the future price actions based on historical data and

previous trends.

LIST OF FIGURES

1. Consumption of Gold...................................................................................................... 43
2. Primary trend and secondary reactions............................................................................. 47
3. Three Phases of bull market.............................................................................................. 48
4. Three Phases of a bear market.......................................................................................... 49
5. Line chart.......................................................................................................................... 51
6. Bar Chart of silver............................................................................................................. 52
7. Bar chart of Gold.............................................................................................................. 54
8. Bar Chart of Crude oil...................................................................................................... 55
9. Japanese candlesticks of Silver......................................................................................... 56
10. Japanese candlesticks of crude oil.................................................................................... 57
11. Japanese candlesticks of Gold.......................................................................................... 58
12. Support and resistance levels............................................................................................ 61
13.Head and shoulder formation............................................................................................... 62
14. EMA Chart.........................................................................................................................
68
15. ROC Chart..........................................................................................................................
70
LIST OF TABLES

1. Active contracts traded in MCX……………………………………………………….. 14


2. Comparative Data for Three Periods Value of Turnover………………………………. 17
3. Active contracts traded in NCDEX…………………………………………………….. 18
4. NCDEX – indicative warehouse charges……………………………………………….. 30
5. Highest, Lowest and Closing prices of Silver……………………………………………52
6. Highest, Lowest and closing pricesof Gold………………………………………….... 53
7. Highest, Lowest and closing Prices of Crude oil.............................................................. 54
8. Prices of Silver.................................................................................................................. 55
9. Prices of Crude oil............................................................................................................ 56
10. Prices of Gold.................................................................................................................. 57
11. Highest, Lowest and Closing Prices of Gold................................................................... 59
12. Highest, Lowest and closing prices of Silver.................................................................... 63
13. Gold price Five days Simple Moving Average................................................................. 65
14. Gold price of Five – Day EMA.........................................................................................
66
15. 30 days gold price of 7 – day ROC................................................................................... 69
CHAPTER – 1

INTRODUCTION
Trading on derivatives first started to protect farmers from the risk of their values

against fluctuations in the price of their crop. From the time it was sown to the time it was ready

for harvest, farmers would face price uncertainty. Through the use of simple derivative products

the farmers can transfer their risk (i.e. fully or partially) by locking the price of their products.

This was developed to reduce the risk of the farmers. Let’s take an example when a farmer who

sowed his crop in June which he would receive his harvest in September may face uncertainty in

prices over the period because of the oversupply they are selling at a very low cost.

In 1848, the Chicago Board of Trade (CBOT) was established to bring farmers and

merchants together. A group of traders got together and created the `to-arrive' contract that

permitted farmers to lock in to price upfront and deliver the grain later. Today, derivative

contracts exist on a variety of commodities such as corn, pepper, cotton, wheat, silver, etc.

Besides commodities, derivatives contracts also exist on a lot of financial underlying like stocks,

interest rate, exchange rate, etc.

Due to the high volatility in Financial Market with high risk & low rate of return

had made investors to choose alternate investments such as Bullion market in Commodity

market. In India gold has traditionally played a multi-faceted role. Apart from being used for

armament purpose, it has also served as an asset of the last resort and a hedge against inflation

and currency depreciation. But most importantly, it has most often been treated as an investment.
Many people have become very rich in commodity markets. It is one of the areas

where people can make extraordinary profits within a short span of time. For example, Richard

Dennis borrowed $1600 and turned it into a $200 million fortune in about ten years.

Definition of Derivatives: A derivative is a product whose value is derived from value of one or

more underlying assets or variables in a contractual manner. The underlying asset can be equity,

forex, commodity or any other assets.

For example: A wheat farmers may wish to sell their harvest at a future date to eliminate

the risk of a change in prices by that date.

The Forwards Contracts (Regulation) Act, 1952, regulates the forward/ futures

contracts in commodities all over India. However when derivatives trading in securities was

introduced in 2001, the term security in the Securities Contracts Regulation Act, 1956 (SCRA),

was amended to include derivative contracts in securities.

Products and participants:

Derivative contracts are of different types. The most common ones are forwards, futures, options

and swaps. Participants who trade in the derivatives market can be classified under the following

three broad categories - Hedgers, Speculators, and Arbitragers.

1. Hedgers: Hedgers face risk associated with the price of an asset. They use the futures or

options markets to reduce or eliminate this risk.

2. Speculators: Speculators are participants who wish to bet on future movements in the

price of an asset. Futures and options contracts can give them leverage; that is, by putting in

small amounts of money upfront, they can take large positions on the market. As a result of this

leveraged speculative position, they increase the potential for large gains as well as large losses.

3. Arbitragers: Arbitragers work at making profits by taking advantage of discrepancy

between prices of the same product across different markets. If, for example, they see the futures
price of an asset getting out of line with the cash price, they would take offsetting positions in the

two markets to lock in the profit.

Spot versus forward transaction:

Let us try to understand the difference between spot and derivatives contract.

Every transaction has three components like trading, clearing and settlement. A buyer and seller

come together, negotiate and arrive at a price this is trading. Clearing involves finding out the net

outstanding, that is exactly how much of goods and money the two should exchange.

For example ‘A’ buys goods worth Rs.1000 from ‘B’ and sells goods worth Rs.400 to ‘B’.

On a net basis ‘A’ has to pay Rs.600 to ‘B’. Settlement is the actual process of exchanging

money and goods.

In a spot transaction, the trading, clearing and settlement happens immediately, i.e.

on the spot. For example on 1March 2009, Suman wants to buy some gold. The goldsmith quotes

Rs.15000 per 10 grams. They agree upon this price and Suman buys 20grams of gold. He pays

Rs.30000 to the goldsmith and collects his gold. This is a spot transaction.

Now suppose Suman does not want to buy the gold on the 1 March, but wants to

buy it a month later. Then the goldsmith quotes Rs.15050 per 10 grams. They agree upon the

forward price for 20 grams of gold that Suman wants to buy and Suman leaves. A month later, he

pays the goldsmith Rs.30100 and collects his gold. This is a forward contract, a contract by

which two parties permanently agree to settle a trade at a future date, for a stated price and

quantity. No money changes hands when the contract is signed. The exchange of money and the

underlying goods only happens at the future date as specified in the contract. In a forward
contract the process of trading, clearing and settlement does not happen immediately. The trading

happens today, but the clearing and settlement happens at the end of the specified period.

A forward is the most basic derivative contract. We call it a derivative because it

derives value from the price of the asset underlying the contract, in this case gold. If on the

1st of April, gold trades for Rs.15100 in the spot market, the contract becomes more valuable to

Suman because it now enables him to buy gold at Rs.15050. If however, the price of gold drops

down to Rs.15000, he is worse off because as per the terms of the contract, he is bound to pay

Rs.15050 for the same gold. The contract has now lost value from Suman’s point of view. “Note

that the value of the forward contract to the goldsmith varies exactly in an opposite manner to its

value for Suman”.

Limitations of the Study:

1. The suggestion is based on the study on Fundamental and Technical

Analysis such as price movement, Relationship of gold with other

factors, Volumes and Open Interest (OI).

2. This analysis will be holding good for a limited time period that is

based on present scenario and study conducted, future movement on

gold price may or may not be similar.


CHAPTER – 2

GEOJIT BNP PARIBAS FINANCIAL


SERVICES LTD
Geojit BNP Paribas Financial Service was founded by Mr. C.J. George and Mr.

Ranajit Kanjilal as a partnership firm in the year 1987. And in the year 1993 Mr. Ranajit Kanjilal

retired from the firm and Geojit became a proprietary concern of Mr. C.J. George. It became a

Public limited company by the name Geojit Securities Ltd. in the year 1994. The Kerala State

Industrial Development Corporation Ltd (KSIDC) Became a Co-promoter of Geojit by taking

24% stake in the company in the year 1995. Geojit listed at The Stock Exchange, Mumbai (BSE)

in the year 2000. In 2003 the Company was renamed as Geojit Financial Services Ltd. (GFSL).

In July 2005, the company is also listed at The National Stock Exchange (NSE). Geojit is a

charter member of the Financial Planning Standards Board of India and is one of the largest DP

brokers in the country. On March 13, 2007 the formation of Geojit BNP Paribas Financial

Services Ltd., was announced in Mumbai and Paris. Through a preferential allotment, BNP

Paribas had taken 27% stake in Geojit, which will eventually increase to 34.35%. BNP Paribas

has one of the largest international banking networks with significant presence in Asia and the

United States. With presence in more than 85 countries the bank has a headcount of more than

138000. With this take over Geojit has become Geojit BNP Paribas Financial Services LTD in

April 2009. Currently Geojit BNP Paribas has more than 500 branches, 4.7 lakhs clients and

offers services in Equities, Futures and Options, Mutual Funds, Life and General Insurance,

Portfolio Management services, Loan against shares.

The online trading was first introduced by the Geojit BNP Paribas to their clients

that allows the customers to track the markets by setting up their own market watch, receiving
research tips, stock alerts, real-time charts and news and many more features enable the customer

to take informed decisions

CHAPTER – 3

HISTORY OF COMMODITY TRADING &


PRECIOUS METALS
Commodity trading in India:

The history of organized commodity derivatives in India goes back to the

nineteenth century when the Cotton Trade Association started futures trading in 1875, barely

about a decade after the commodity derivatives started in Chicago. Over time the derivatives

market developed in several other commodities in India. Following cotton, derivatives trading

started in oilseeds in Bombay (1900), raw jute and jute goods in Calcutta (1912), wheat in Hapur

(1913) and in Bullion in Bombay (1920). However, many feared that derivatives lead to

unnecessary speculation in essential commodities, and were harmful to the healthy functioning

of the markets for the underlying commodities, and also to the farmers.

With a view to restricting speculative activity in cotton market, the Government of Bombay

prohibited options business in cotton in 1939. Later in 1943, forward trading was prohibited in

oilseeds and some other commodities including food-grains, spices, vegetable oils, sugar And

cloth. After Independence, the Parliament passed Forward Contracts (Regulation) Act, 1952

which Regulated forward contracts in commodities all over India. The Act applies to goods,

which are defined as any movable property other than security, currency and actionable claims.

The Act prohibited Options trading in goods.

The Act envisages (imagine) three-tier regulation:

1) The Exchange which organizes forward trading in commodities can regulate

trading on a day-to-day basis,

2) The Forward Markets Commission provides regulatory oversight under the

powers delegated to it by the central Government,


3) The Central Government - Department of Consumer Affairs, Ministry of

Consumer Affairs, Food and Public Distribution - is the ultimate regulatory

authority.

In 1970s and 1980s the Government relaxed forward trading rules for some commodities.

The Kabra committee report

After the introduction of economic reforms since June 1991 and the consequent

gradual trade and industry liberalisation in both the domestic and external sectors, the

Government of India appointed in June 1993 a committee on Forward Markets under

chairmanship of Prof. K.N. Kabra.

The committee was setup with the following objectives:

1. To assess

• The working of the commodity exchanges and their trading practices in India

• To make suitable recommendations with a view to making them compatible

with those of other countries

2. To review the role that forward trading has played in the Indian commodity markets

during the last 10 years.

3. To examine the extent to which forward trading has special role to play in promoting

exports.

4. To suggest measures to ensure that forward trading in the commodities in which it is

allowed to be operative remains constructive and helps in maintaining prices within

reasonable limits.

The committee submitted its report in September 1994. The recommendations of the Committee

were as follows:
➢ The Forward Markets Commission (FMC) and the Forward Contracts (Regulation) Act,

1952, would need to be strengthened.

➢ Due to the inadequate infrastructural facilities such as space and telecommunication

facilities the commodities exchanges were not able to function effectively. Enlisting more

members, ensuring capital adequacy norms and encouraging computerisation would

enable these exchanges to place themselves on a better footing.

➢ In-built devices in commodity exchanges such as the vigilance committee and the panels

of surveyors and arbitrators are strengthened further.

➢ The FMC which regulates forward/ futures trading in the country should continue to act a

watch.dog and continue to monitor the activities and operations of the commodity

exchanges. Amendments to the rules, regulations and bye-laws of the commodity

exchanges should require the approval of the FMC only.

All the exchanges have been set up under overall control of Forward Market

Commission (FMC) of Government of India.


FORWARD MARKET COMMISSION:-Forward Markets Commission (FMC) headquartered

at Mumbai, is a regulatory authority which is overseen by the Ministry of Consumer Affairs and

Public Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward

Contracts (Regulation) Act, 1952.

The functions of the Forward Markets Commission are as follows:

1. To advise the Central Government in respect of the recognition or the

withdrawal of recognition from any association or in respect of any other

matter arising out of the administration of the Forward Contracts

(Regulation) Act 1952.

2. To keep forward markets under observation and to take such action in

relation to them, as it may consider necessary, in exercise of the powers

assigned to it by or under the Act.

3. To collect and whenever the Commission thinks it necessary, to publish

information regarding the trading conditions in respect of goods to which

any of the provisions of the act is made applicable, including information

regarding supply, demand and prices, and to submit to the Central

Government, periodical reports on the working of forward markets relating

to such goods;

4. To make recommendations generally with a view to improving the

organization and working of forward markets;

5. To undertake the inspection of the accounts and other documents of any

recognized association or registered association or any member of such

association whenever it considerers it necessary.


Commodity Exchanges in India: The two important commodity exchanges in India are Multi-

Commodity Exchange of India Limited (MCX), and National Multi-Commodity & Derivatives

Exchange of India Limited (NCDEX).

I. Multi-Commodity Exchange of India Limited (MCX)

MCX an independent multi-commodity exchange has permanent recognition from

Government of India for facilitating online trading, clearing and settlement operations for

commodity futures markets across the country. Key shareholders of MCX are Financial

Technologies (India) Ltd., State Bank of India, NABARD, NSE, HDFC Bank, State Bank of

Indore, State Bank of Hyderabad, State Bank of Saurashtra, SBI Life Insurance Co. Ltd., Union

Bank of India, Bank Of India, Bank Of Baroda, Canara Bank, Corporation Bank. Headquartered

in Mumbai, MCX is led by an expert management team with deep domain knowledge of the

commodity futures markets. Through the integration of dedicated resources, robust technology

and scalable infrastructure, since inception MCX has recorded many first to its credit.

Inaugurated in November 2003 by Shri Mukesh Ambani, Chairman & Managing

Director, Reliance Industries Ltd, MCX offers futures trading in the following commodity

categories: Agri Commodities, Bullion, Metals- Ferrous & Non-ferrous, Pulses, Oils & Oilseeds,

Energy, Plantations, Spices and other soft commodities. MCX has built strategic alliances with

some of the largest players in commodities eco-system, namely, Bombay Bullion Association,

Bombay Metal Exchange, Solvent Extractors' Association of India, Pulses Importers Association,

Shetkari Sanghatana, United Planters Association of India and India Pepper and Spice Trade

Association.

Today MCX is offering spectacular growth opportunities and advantages to a large

cross section of the participants including Producers / Processors, Traders, Corporate, Regional

Trading Centers, Importers, Exporters, Cooperatives, Industry Associations, amongst others


MCX being nation-wide commodity exchange, offering multiple commodities for trading with

wide reach and penetration and robust infrastructure, is well placed to tap this vast potential.

Active Contracts Traded in MCX


S.NO COMMODITIY Price/Unit Trading Lot Delivery Center Multiplier Initial
NAME Margin %
1 GOLD Rs / 1 KG MUMBAI 100 7
10Gms
2 GOLDM Rs / 100Gms MUMBAI 10 5
10Gms
3 GOLD GUINEA Rs/ 8Gms 8Gms MUMBAI 1 14.5
/AHMEDABAD
4 SILVER RS/ KG 30 KG AHMEDABAD 30 8
5 SIVERM Rs / 1 KG 5 KGS AHMEDABAD 5 8
6 MENTHA OIL Rs/KG 360 KG CHANDAUSI 360 11
7 KAPASIA KHALLI Rs/50 KG 10 MT AKOLA 200 6.5
8 ALUMINIUM Rs/KG 5 MT MUMBAI 5000 7
9 COPPER Rs/KG 1 MT MUMBAI 1000 12
10 NICKEL RS/KG 250 KG MUMBAI 250 15.5
11 ZINC RS/KG 5000 KG MUMBAI 5000 11
12 LIGHT SWEET Rs/Barrel 100/Barrel JNPT-MUMBAI 100 12
CRUDE OIL
13 NATURAL GAS Rs/mmBtu 1250/mmBtu 1250 10.5
II. National Commodity & Derivatives Exchange Limited (NCDEX)

National Commodity & Derivatives Exchange Limited (NCDEX) is a

professionally managed online multi commodity exchange promoted by ICICI Bank Limited

(ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for Agriculture and

Rural Development (NABARD) and National Stock Exchange of India Limited (NSE). Punjab

National Bank (PNB), CRISIL Limited (formerly the Credit Rating Information Services of India

Limited), Indian Farmers Fertiliser Cooperative Limited (IFFCO) and Canara Bank by

subscribing to the equity shares have joined the initial promoters as shareholders of the

Exchange. NCDEX is the only commodity exchange in the country promoted by national level

institutions. This unique parentage enables it to offer a bouquet of benefits, which are currently

in short supply in the commodity markets. The institutional promoters of NCDEX are prominent

players in their respective fields and bring with them institutional building experience, trust,

nationwide reach, technology and risk management skills.

NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act,

1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It has

commenced its operations on December 15, 2003.

NCDEX is a nation-level, technology driven de-mutualized on-line commodity exchange with an

independent Board of Directors and professionals not having any vested interest in commodity

markets. It is committed to provide a world-class commodity exchange platform for market

participants to trade in a wide spectrum of commodity derivatives driven by best global

practices, professionalism and transparency.

NCDEX is regulated by Forward Market Commission in respect of futures trading

in commodities. Besides, NCDEX is subjected to various laws of the land like the Companies

Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other

legislations, which impinge on its working. NCDEX is located in Mumbai and offers facilities to
its members in more than 390 centres throughout India. The reach will gradually be expanded to

more centres. NCDEX currently facilitates trading of thirty six commodities - Cashew, Castor

Seed, Chana, Chilli, Coffee, Cotton, Cotton Seed Oilcake, Crude Palm Oil, Expeller Mustard

Oil, Gold, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags, Mild Steel Ingot, Mulberry

Green Cocoons, Pepper, Rapeseed - Mustard Seed ,Raw Jute, RBD Palmolein, Refined Soy Oil,

Rice, Rubber, Sesame Seeds, Silk, Silver, Soy Bean, Sugar, Tur, Turmeric, Urad (Black Matpe),

Wheat, Yellow Peas, Yellow Red Maize & Yellow Soybean Meal. At subsequent phases trading

in more commodities would be facilitated.

Since 2002 when the first national level commodity derivatives exchange started,

the exchanges have conducted brisk business in commodities futures trading. In the last three

years, there has been a great revival of the commodities futures trading in India, both in terms of

the number of commodities allowed for futures trading as well as the value of trading. While in

year 2000, futures trading were allowed in only 8 commodities, the number jumped to 80

commodities in June 2004. The value of trading in local currency saw a quantum jump from

about INR 350 billion in 2001-02 to INR 1.3 Trillion in 2003-04. The data in the below Table

indicates that the value of commodity derivatives in India could cross the US$ 1 Trillion mark in

2006. The market regulator Forward Markets Commission (FMC) disseminates fortnightly

trading data for each of the 3 national & 21 regional exchanges that have been set up in recent

years to carry on the futures trading in commodities in the country. Exhibit presents comparative

trading data for three fortnightly periods in March, June and September 2005 and brings up some

interesting facts.

The market regulator Forward Markets Commission (FMC) disseminates

fortnightly trading data for each of the 3 national & 21 regional exchanges that have been set up

in recent years to carry on the futures trading in commodities in the country. Below Table
represents comparative trading data for three fortnightly periods in March, June and September

2005 and brings up some interesting facts.

Comparative Data for Three Periods Value of Turnover in USD Millions

Sl.No. Name of the Exchange 16 Mar 05 16 Jun 05 16 Sep 05

to 31 Mar 05 to 30 Jun 05 to 30 Sep 05


1 Multi-Commodity Exchange $m 3,503.69 $m 4,974.76 $m 11,042.25
of India Limited, Mumbai.

2 National Multi-Commodity $m 135.64 $m 113.13 $m 106.85


Exchange of India Limited,

Ahmadabad.
3 National Commodity & $m 5,360.45 $m 7,950.49 $m 10,694.29
Derivatives

Exchange Limited, Mumbai.


Total of three exchanges $m 8,999.78 $m 13038.38 $m 21,843.39

Active Contracts Traded in NCDEX

S.NO COMMODITIY Price/Unit Trading Delivery Multiplier Initial Margin


NAME Lot Center %
1 PURE KILO GOLD Rs / 10Gms 1 KG MUMBAI 100 8
2 PURE SILVER Rs / 1 KG 30 KGS DELHI 30 18
3 SILVER 5 (mini Lot) Rs / 1 KG 5 KG DELHI 5 9
4 GOLD 100 (mini Lot) Rs / 10 100 Gms MUMBAI 10 8
Gms
5 JEERA Rs / Quintal 3 MT UNJHA 30 8
6 PEPPER Rs / Quintal 1 MT KOCHI 10 15
7 TURMERIC FINGERS Rs / Quintal 10 MT NIZAMABAD 100 12
8 CHILLI LCA 334 Rs / Quintal 5 MT GUNTUR 50 33
9 MAIZE Rs / Quintal 50 MT NIZAMABAD 500 21
10 GUAR SEED Rs / Quintal 10 MT JODHPUR 100 15
11 GUARGUM Rs / Quintal 5 MT JODHPUR 50 15

History of Gold:

In India Gold is having a history of more than 7000 years which can find in

religious book of Hindu, where it is considered as a metal of immense value. But

looking at the history of world, gold is found at the Egypt at 2000B.C, which

is the first metal used by the humans value for ornament and rituals. Gold

has long been considered one of the most precious metals, and its value has

been used as the standard for many currencies in history. Gold has been

used as a symbol for purity, value, royalty, and particularly roles that

combine these properties.

As a tangible investment gold is held as part of a portfolio by the countries as a

reserves because over the long period gold has an extensive history of maintaining its value.

However, gold does become particularly desirable in times of extremely weak confidence and

during hyperinflation because gold maintains its value even as fiat money becomes worthless

when the value of currency depreciates.


It has a special role in India and in certain countries, gold Jewelry is worn

for ornamental value on all social functions, festivals and celebrations. It is the popular

form of investment in rural areas between the farmers after having bumper crop or after

harvesting, this all factor makes India as largest consumer (18.7% of world total demand

in 2004) and importer of gold due to its low production, which is negligible, and

untapped gold reserves. This is due to lack of new technology in finding gold reserves

and low interest shown by government in financing, encouraging for exploration

programs in gold mines.

HISTORY OF GOLD TRADING

Gold future trading debuted first at Winnipeg Commodity Exchange (know is Comex) in Canada

in 1972. The gold contract gain popularity among traders, led to many countries had too started

gold future trading. Which include London gold future, Sydney future exchange, Singapore

International Monetary Exchange (Simex), Tokyo Commodity Exchange (Tocom), Chicago

Mercantile Exchange, Chicago Board of Trade (CBOT), Shanghai Gold Exchange, Dubai Gold

and Commodity Exchange are some of the world Top recognized exchange, and in India,

National Commodity and Derivative Exchange (NCDEX) and Multi-Commodity Exchange

(MCX), and National Board of Trade (NBOT) are some Indian exchanges where Gold are traded.

History of gold trading in India is dates back to 1948 with Bombay Bullion Association, which is

formed by the group of Merchants.

PRODUCTION OF GOLD

Till now the total gold is extracted from the mines is about $1 trillion dollar, which is

accumulated in physical form is enough to built Eiffel tower.

Annual gold production worldwide is about US$35 billion and by far the one of

the largest-trading world commodity. Worldwide, gold mines produce about 2,464 tonnes in the
year 2004 from total supply of 3328 tonnes but unable to meet identifiable demand of 3497

tonnes. Gold is mined in more than 118 countries around the world, with the large number of

development projects in these countries expected to keep production growing well into the next

century. Currently, South Africa is the largest gold producing country, followed by the United

States, Australia, Canada, Indonesia, Russia and others, some of these countries also account for

highest gold reserves from potential 50,000 tonnes of world-wide reserves.

Why central banks hold gold

Monetary authorities have long held gold in their reserves. Today their stocks amount to some

30,000 tonnes - similar to their holdings 60 years ago. It is sometimes suggested that maintaining

such holdings is inefficient in comparison to foreign exchange. However, there are good reasons

for countries continuing to hold gold as part of their reserves. These are recognized by central

banks themselves although different central banks would emphasize different factors.

Diversification: In any asset portfolio, it rarely makes sense to have all your eggs in one

basket. Obviously the price of gold can fluctuate - but so too do the exchange and interest rates

of currencies held in reserves. A strategy of reserve diversification will normally provide a less

volatile return than one based on a single asset.

Gold has good diversification properties in a currency portfolio. These stem from the fact that its

value is determined by supply and demand in the world gold markets, whereas currencies and

government securities depend on government promises and the variations in central banks’

monetary policies. The price of gold therefore behaves in a completely different way from the

prices of currencies or the exchange rates between currencies.

Physical Security: Countries have in the past imposed exchange controls or, at the worst,

total asset freezes. Reserves held in the form of foreign securities are vulnerable to such
measures. Where appropriately located, gold is much less vulnerable. Reserves are for using

when you need to. Total and incontrovertible liquidity is therefore essential. Gold provides this.

Unexpected needs: If there is one thing of which we can be certain, it is that today’s status quo

will not last forever. Economic developments both at home and in the rest of the world can upset

countries’ plans, while global shocks can affect the whole international monetary system.

Owning gold is thus an option against an unknown future. It provides a form of

insurance against some improbable but, if it occurs, highly damaging event. Such events might

include war, an unexpected surge in inflation, a generalised crisis leading to repudiation of

foreign debts by major sovereign borrowers, a regression to a world of currency or trading blocs

or the international isolation of a country.

In emergencies countries may need liquid resources. Gold is liquid and is

universally acceptable as a means of payment. It can also serve as collateral for borrowing.

Confidence: The public takes confidence from knowing that it’s Government holds gold - an

indestructible asset and one not prone to the inflationary worries overhanging paper money.

Some countries give explicit recognition to its support for the domestic currency. And rating

agencies will take comfort from the presence of gold in a country's reserves.

The IMF's Executive Board, representing the world's governments, has recognized that the

Fund's own holdings of gold give a "fundamental strength" to its balance sheet. The same applies

to gold held on the balance sheet of a central bank.

Income: Gold is sometimes described as a non income-earning asset. This is untrue. There is a

gold lending market and gold can also be traded to generate profits. There may be an

"opportunity cost" of holding gold but, in a world of low interest rates, this is less than is often

thought. The other advantages of gold may well offset any such costs.
Insurance: The opportunity cost of holding gold may be viewed as comparable to an insurance

premium. It is the price deliberately paid to provide protection against a highly improbable but

highly damaging event. Such an event might be war, an unexpected surge of inflation, a

generalized debt crisis involving the repudiation of foreign debts by major sovereign borrowers,

a regression to a world of currency and trading blocs, or the international isolation of a country.

History of Silver Market


Major markets like the London market (London Bullion Market Association), which started

trading in the 17th century provide a vehicle for trade in silver on a spot basis, or on a forward

basis. The London market has a fix which offers the chance to buy or sell silver at a single price.

The fix begins at 12:15 p.m. and is a balancing exercise; the price is fixed at the point at which

all the members of the fixing can balance their own, plus clients, buying and selling orders.

Trading in silver futures resumed at the Comex in New York in 1963, after a

gap of 30 years. The London Metal Exchange and the Chicago Board of Trade introduced futures

trading in silver in 1968 and 1969, respectively. In the United States, the silver futures market

functions under the surveillance of an official body, the Commodity Futures Trading

Commission (CFTC). Although London remains the true center of the physical silver trade for

most of the world, the most significant paper contracts trading market for silver in the United

States is the COMEX division of the New York Mercantile Exchange. Spot prices for silver are

determined by levels prevailing at the COMEX. Although there is no American equivalent to the

London fix, Handy & Harman, a precious metals company, publishes a price for 99.9% pure

silver at noon each working day.

Production of Silver
Silver ore is most often found in combination with other elements, and silver has

been mined and treasured longer than any of the other precious metals. Mexico is the world’s

leading producer of silver, followed by Peru, Canada, the United States, and Australia. The main

consumer countries for silver are the United States, which is the world’s largest consumer of

silver, followed by Canada, Mexico, the United Kingdom, France, Germany, Italy, Japan and

India. The main factors affecting these countries demand for silver are macro economic factors

such as GDP growth, industrial production, income levels, and a whole host of other financial

macroeconomic indicators.
CHAPTER – 3

PRICING COMMODITY FUTURES

The process of arriving a figure at which a person buys and another sells a futures

contract for a specific expiration date is called price discovery. The process of price discovery

continues from the market's opening until its close and also free flow of information is also very

important in an active future market. Futures exchanges act as a focal point for the collection and

distribution of statistics on supplies, transportation, storage, purchases, exports, imports,

currency values, interest rates and other relevant formation. As a result of this free flow of
information, the market determines the best estimate of today and tomorrow's prices and it is

considered to be the accurate reflection of the supply and demand for the underlying commodity.

Price discovery facilitates this free flow of information, which is essential to the effective

functioning of futures market.

We try to understand the pricing of commodity futures contracts and look at how

the futures price is related to the spot price of the underlying asset. We study the cost - of - carry

model to understand the dynamics of pricing that constitute the estimation of fair value of

futures.

Investment assets versus consumption assets

When we are studying futures contracts, it is essential to distinguish between investment assets

and consumption assets. An investment asset is an asset that is held for investment purposes by

most investors. Stocks, bonds, Gold and silver are examples of investment assets. However

investment assets do not always have to be held entirely for investment. As we saw earlier silver

for example, have a number of industrial uses. However to classify as investment assets, these

assets have to satisfy the requirement that they are held by a large number of investors solely for

investment. A consumption asset is an asset that is held primarily for consumption. It is not

usually held for investment. Examples of consumption assets are commodities such as copper,

oil, and pork bellies.

We can use arbitrage arguments to determine the futures prices of an investment

asset from its spot price and other observable market variables. For pricing consumption assets,

we need to review the arbitrage arguments a little differently. We look at the cost – of – carry

model and try to understand the pricing of futures contracts on investment assets.

The cost of carry model:-


For pricing purposes we treat the forward and the futures market as one and the

same. A futures contract is nothing but a forward contract that is exchange traded and that is

settled at the end of each day. The buyer who needs an asset in the future has the choice between

buying the underlying asset today in the spot market and holding it, or buying it in the forward

market. If he buys it in the spot market today it involves opportunity costs. He incurs the cash

outlay for buying the asset and he also incurs costs for storing it. If instead he buys the asset in

the forward market, he does not incur an initial outlay. The basis for the cost – of – carry model

where the price of the futures contract is defined as:

F=S+C
……………………………… Eq (1)

Where

F = Future price C = Holding cost or carrying cost S = Spot price

The fair value of future contracts can also be expressed as:

F = S (1+r) t .…………………………… Eq (2)

Where:

R = percentage cost of financing

T = time till expiration

Whenever the futures price moves away from the fair value, there would be

opportunities for arbitrage. If F > S (1+r) t or F < S (1+r) t arbitrage would exit. We know that

what is Spot price and what are future price. We should know that what are the components of

the holding cost? The components of holding cost vary with contracts on different assets.
Sometimes holding cost may even be negative. In case of commodity futures, the holding cost is

the cost of financing plus cost of storage and insurance purchased. In case of equity futures, the

holding cost is the cost of financing minus the dividends returns.

Equation – (2) uses the concept of discrete compounding, i.e. where interest rates

are compounded at discrete intervals like annually or semiannually. Pricing of options and other

complex derivative securities requires the use of continuously compounded interest rates. Most

books on derivatives use continuous compounding for pricing futures too. When we use

continuous compounding, equation – (2) is expressed as:

F = S erT ……………………………….. Eq (3)

Where:

r = Cost of financing (Using continuously compounding interest rate)

T = Time till expiration

e = 2.71828

Let us take an example of a future contract on commodity and we work out the

price of the contract. Let the spot price of gold is RS. 13763÷10gms. If the cost of financing is

15% annually, then what should be the future price of 10gms of gold one month later? Let us

assume that we are on 1 Jan 2009. How would we compute the price of gold future contract

expiring on 30 January? Let us first try to work out the components of cost – of – carry model.

1. What is the spot price of gold?


The spot price of gold, S = 13763/ 10gms.

2. What is the cost of financing for month?

e0.15 ×30/365
3. What are the holding costs?

Let us assume that the storage cost = 0

F = S erT = 13763 e0.15 ×30/365 = 13933.73


If the contract was for a three months period i.e. expiring on 30th March, the cost of
financing would increase the futures price. Therefore, the futures price would be
F = 13763 e
0.15 ×90/365
= Rs 14281.58

Pricing futures contracts on investment commodities

In the example above we saw how a futures contract on gold could be raised

using cost – of – carry model. In the example we considered, the gold contract was for 10 grams

of gold, hence we ignored the storage costs. However, if the one month contract was for a

100kgs of gold instead of 10gms, then it would involve non-zero holding costs which would

include storage and insurance costs. The price of the futures contract would then be Rs.14281.58

plus the holding costs.

NCDEX – indicative warehouse charges

Commodity Fixed charges Warehouse charges per unit per week


(Rs.) (Rs.)
Gold 310 55 per kg
Silver 610 1 per kg
Soy Bean 110 13 per MT
Soya oil 110 30 per MT
Mustard seed 110 18 per MT
Mustard oil 110 42 per MT
RBD palmolein 110 26 per MT
CPO 110 25 per MT
Cotton - Long 110 6 per Bale
Cotton - Medium 110 6 per Bale
The above table gives the indicative warehouse charges for qualified warehouses that will

function as delivery centers for contracts that trade on the NCDEX. Warehouse charges include a

fixed charge per deposit of commodity into the warehouse, and as per unit per week charge. Per

unit charges include storage costs and insurance charges. We saw that in the absence of storage

costs, the futures price of a commodity that is an investment asset is given by F = S erT Storage

Costs add to the cost of carry. If U is the present value of all the storage costs that will be

incurred during the life of a futures contract, it follows that the futures price will be equal to

F = (S+U) erT
………………………………Eq (4)

Where:

r = Cost of financing (annualized)

T = Time till expiration

U = Present value of all storage costs

For understanding the above formula let us consider a one – year future contract of

gold. Suppose the fixed charge is Rs.310 per deposit up to 500kgs and the variable storage costs

are Rs.55 per week, it costs Rs.3170 to store one kg of gold for a year (52 weeks). Assume that

the payment is made at the beginning of the year. Assume further that the spot gold price is

Rs.13763 per 10 grams and the risk – free rate is 7% per annum. What would the price of one

year gold futures be if the delivery unit is one kg?

F = (S+U) erT
= (1376300 + 310 + 2860) e0.07 × 1
= 1379470 × e0.07 × 1

= 1379470 × 1.072508

= 1479493

We see that the one year futures price of a kg of gold would be Rs.1479493. The one year futures

price for 10 grams of gold would be about Rs.14794.93.

Now let us consider a three – month futures contract on gold. We make the same

assumptions that the fixed charge is Rs.310 per deposit up to 500kgs, and the variable storage

costs are Rs.55 per week. It costs Rs.1025 to store one kg of gold for three months (13 weeks).

Assume that the storage costs are paid at the time of deposit. Assume further that the spot gold

price is Rs 13763per 10 grams and the risk free rate is 7% per annum. What would the price of

three month gold futures if the delivery unit is one kg?

F = (S+U) erT
= (1376300 + 310 + 715) e0.07 × 0.25

= 1377325 × 1.017654

= 1401640.30

We see that the three – month futures price of a kg of gold would be Rs. 1401640.30. The three –

month futures price for 10 grams of gold would be about Rs. 14016.40
Pricing futures contracts on consumption commodities

We used the arbitrage argument to price futures on investment commodities. For

commodities that are consumption commodities rather than investment assets, the arbitrage

arguments used to determine futures prices need to be reviewed carefully. Suppose we have

F > (S+U) erT


……………………………… Eq (5)

To take advantage of this opportunity, an arbitrager can implement the following strategy:

I. Borrow an amount S + U. at the risk – free interest rate and use it to

purchase one unit of the commodity.

II. Short a forward contract on one unit of the commodity.

If we regard the futures contract as a forward contract, this strategy leads to a profit of

F - (S+U) erT at the expiration of the futures contract. As arbitragers exploit this opportunity, the

spot price will increase and the futures price will decrease until Equation (5) does not hold good.

Suppose next that

F < (S+U) erT ……………………………………. Eq (6)

In case of investment assets such as gold and silver, many investors hold the commodity purely

for investment. When they observe the inequality in equation 6, they will find it profitable to

trade in the following manner:


I. Sell the commodity, save the storage costs, and invest the proceeds at the risk –free

interest rate.

II. Take a long position in a forward contract.

This would result in a profit at maturity of (S+U) erT – F relative to the position that the investors

would have been in had they held the underlying commodity. As arbitragers exploit this

opportunity, the spot price will decrease and the futures price will increase until equation 6 does

not hold well. This means that for investment assets, equation 4 holds good. However, for

commodities like cotton or wheat that are held for consumption purpose, this argument cannot be

used. Individuals and companies who keep such a commodity in inventory, do so, because of its

consumption value – not because of its value as an investment. They are reluctant to sell these

commodities and buy forward or futures contracts because these contracts cannot be consumed.

Therefore there is unlikely to be arbitrage when equation 6 holds good. In short, for a

consumption commodity therefore

F ≤ (S+U) erT
………………………………………. Eq (7)

That is the futures price is less than or equal to the spot price plus the cost of carry.
CHAPTER – 4
CLEARING, SETTLEMENT AND RISK
MANAGEMENT

Clearing and settlement


Most futures contracts do not lead to the actual physical delivery of the underlying

asset. The settlement is done by closing out open positions, physical delivery or cash settlement.

All these settlement functions are taken care of by an entity called clearing house or clearing

corporation. National Securities Clearing Corporation Limited (NSCCL) undertakes clearing of

trades executed on the NCDEX. The settlement guarantee fund is maintained and managed by

NCDEX.
1. Clearing

Clearing of trades that take place on an exchange happens through the

exchange clearing house. A clearing house is a system by which exchanges guarantee the faithful

compliance of all trade commitments undertaken on the trading floor or electronically over the

electronic trading systems. The main task of the clearing house is to keep track of all the

transactions that take place during a day so that the net position of each of its members can be

calculated. It guarantees the performance of the parties to each transaction.

Typically it is responsible for the following:

➢ Effecting timely settlement

➢ Trade registration and follow up.

➢ Control of the evolution of open interest.

➢ Financial clearing of the payment flow.

➢ Physical settlement (by delivery) or financial settlement (by price

difference) of contracts.

➢ Administration of financial guarantees demanded by the participants.

The clearing house has a number of members, who are mostly financial institutions responsible

for the clearing and settlement of commodities traded on the exchange. The margin accounts for

the clearing house members are adjusted for gains and losses at the end of each day (in the same

way as the individual traders keep margin accounts with the broker). On the NCDEX, in the case

of clearing house members only the original margin is required (and not maintenance margin),

Every day the account balance for each contract must be maintained at an amount equal to the

original margin times the number of contracts outstanding. Thus depending on a day's

transactions and price movement, the members either need to add funds or can withdraw funds

from their margin accounts at the end of the day. The brokers who are not the clearing members
need to maintain a margin account with the clearing house member through whom they trade in

the clearing house.

1.1 Clearing banks: NCDEX has designated clearing banks

Through whom funds to be paid and / or to be received must be settled. Every clearing member

is required to maintain and operate a clearing account with any one of the designated clearing

bank branches. The clearing account is to be used exclusively for clearing operations i.e., for

settling funds and other obligations to NCDEX including payments of margins and penal

charges. A clearing member can deposit funds into this account, but can withdraw funds from

this account only in his self-name. A clearing member having funds obligation to pay is required

to have clear balance in his clearing account on or before the stipulated pay – in day and the

stipulated time. Clearing members must authorize their clearing bank to access their clearing

account for debiting and crediting their accounts as per the instructions of NCDEX, reporting of

balances and other operations as may be required by NCDEX from time to time. The clearing

bank will debit/ credit the clearing account of clearing members as per instructions received from

NCDEX. The following banks have been designated as clearing banks. ICICI Bank Limited,

Canarabank, UTI Bank Limited and HDFC Bank ltd

1.2 Depository participants: Every clearing member is required

To maintain and operate a CM pool account with any one of the empanelled depository

participants. The CM pool account is to be used exclusively for clearing operations i.e., for

effecting and receiving deliveries from NCDEX.

2. Settlement

Futures contracts have two types of settlements,

➢ The MTM settlement which happens on a continuous basis at the

end of each day


➢ And the final settlement which happens on the last trading day of

the futures contract.

On the NCDEX, daily MTM settlement and final MTM settlement in respect of admitted deals in

futures contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the

respective clearing bank. All positions of a CM, either brought forward created during the day or

closed out during the day, are marked to market at the daily settlement price or the final

settlement price at the close of trading hours on a day.

• Daily settlement price: Daily settlement price is the consensus closing price as arrived

after closing session of the relevant futures contract for the trading day. However, in the

absence of trading for a contract during closing session, daily settlement price is

computed as per the methods prescribed by the exchange from time to time.

• Final settlement price: Final settlement price is the closing price of the underlying

commodity on the last trading day of the futures contract. All open positions in a futures

contract cease to exist after its expiration day.

2.1 Settlement Methods: Settlement of futures contracts on the

NCDEX can be done in three ways. By physical delivery of the underlying asset, by closing out

open positions and by cash settlement. We shall look at each of these in some detail. On the

NCDEX all contracts settling in cash are settled on the following day after the contract expiry

date. All contracts materialising into deliveries are settled in a period 2.7 days after expiry. The

exact settlement day for each commodity is specified by the exchange.


When a contract comes to settlement, the exchange provides alternatives like

delivery place, month and quality specifications. Trading period, delivery date etc. are all defined

as per the settlement calendar. A member is bound to provide delivery information. If he fails to

give information, it is closed out with penalty as decided by the exchange. A member can choose

an alternative mode of settlement by providing counter party clearing member and constituent.

The exchange is however not responsible for, nor guarantees settlement of such deals. The

settlement price is calculated and notified by the exchange. The delivery place is very important

for commodities with significant transportation costs. The exchange also specifies the accurate

period (date and time) during which the delivery can be made.

Closing out by offsetting positions

Most of the contracts are settled by closing out open positions. In closing out,

the opposite transaction is effected to close out the original futures position. A buy contract is

closed out by a sale and a sale contract is closed out by a buy. For example, an investor who took

a long position in two gold futures contracts on the January 30, 2009 at 14402 can close his

position by selling two gold futures contracts on February 27, 2004 at Rs.15445. In this case,

over the period of holding the position, he has gained an amount of Rs.1043 per unit. This loss

would have been debited from his margin account over the holding period by way of MTM at the

end of each day, and finally at the price that he closes his position, that is Rs. 15445 in this case.

Cash settlement
Contracts held till the last day of trading can be cash settled. When a contract is

settled in cash, it is marked to the market at the end of the last trading day and all positions are

declared closed. The settlement price on the last trading day is set equal to the closing spot price

of the underlying asset ensuring the convergence of future prices and the spot prices. For

example an investor took a short position in five long staple cotton futures contracts on

December 15 at Rs.6950. On 20th February, the last trading day of the contract, the spot price of

long staple cotton is Rs.6725. This is the settlement price for his contract. As a holder of a short

position on cotton, he does not have to actually deliver the underlying cotton, but simply takes

away the profit of Rs.225 per trading unit of cotton in the form of cash.

Risk management

NCDEX has developed a comprehensive risk containment mechanism for its commodity

futures market. The salient features of risk containment mechanism are:

✔ The financial reliability of the members is the key to risk management.

Therefore, the requirements for membership in terms of capital

adequacy (net worth, security deposits) are quite stringent.

✔ NCDEX charges an open initial margin for all the open positions of a

member. It specifies the initial margin requirements for each futures

contract on a daily basis. It also follows value-at-risk (VAR) based

margining through SPAN. The PCMs and TCMs in turn collect the

initial margin from the TCMs and their clients respectively.

✔ The open positions of the members are marked to market based on

contract settlement price for each contract. The difference is settled in

cash on a T+1 basis.


✔ A member is alerted of his position to enable him to adjust his exposure

or bring in additional capital. Position violations result in withdrawal of

trading facility for all TCMs of a PCM in case of a violation by the

PCM.

✔ A separate settlement guarantee fund for this segment has been created

out of the capital of members.

CHAPTER – 5

FUNDAMENTAL AND TECHNICAL


ANALYSIS
Fundamental Analysis
DEMAND AND CONSUMPTION OF GOLD

Gold produced from different sources and demanded for consumption in form of

Jewellery, Industrial applications, Government & Central bank Investment and Private investor,

which has been worth US$ 38 billion on average over the past five years in world.

Total of world gold produced is mostly consumed by different sectors are Jewelers

80%, Industrial application 11.5% and rest of gold is used as investment purpose 8.5%.

Considering the situation in India, the demand for Gold consumption is far more ahead than its

availability through production, scrap or recycled gold. Where gold production in India is only

2tonnes, where demand is 18.7% of world gold consumption, which make India a leading

consumer of gold followed by Italy, Turkey, USA, China, Japan. According to Countries wise

demand, the following graph shows the demand in each country. Large part constitute by Jewelry

consumption with 85.56% during 2004 by Indian consumers, who seem to spend a

disproportionate percentage of their disposable income on gold and gold jewelry.

Gold fabrication for domestic and international market, also formed large part of

business in India with 527 tonnes of gold fabricated in India in 2004, making world largest
fabricator which is 60% more than its closest competitor Italy, Turkey, USA. But this Jeweler

Fabrication is unable to generate much revenue, as most of its consumed in India (479 tonnes).

18.70%

In dia
Italy
42.20% 11.10% Turkey
US
China
Japan
Rest of world

8.50%

5.30% 7.30%
Consumption of Gold
6.90%
GOLD CONSUMPTION IN INDIA

India consumed around 18% of world Gold produced. Even though it only contribute 1.6% of

Global GDP.

“Traditionally, Gold has been a good safety net for Indian households. However, the

sharp rise in gold imports over the last three years when the rupee has started appreciating,

inflation is relatively low, banking facilities are improving And economic can confidence has

picked up, is surprising” say Market watchers.(Source: -Economic Times, Article, “ Forget

sensex, the Gold rush is on”, July 18 ‘05)

The demand is much that it consumed more than 1.5 times of US consumption of

gold. Increasing by nearly 60% in 2003-04, but during this fiscal Gold imports increased by

another 58%, with Import of gold and silver account around $11 billion consumption increased

by 88% during March’05quarter.

Uses of Gold

1. Jewellery fabrication: The largest source of demand is the jewelry industry. In

new years, demand from the jewelry industry alone has exceeded Western mine production. This

shortfall has been bridged by supplies from reclaimed jewelry and other industrial scrap, as well

as the release of official sector reserves. Gold's workability, unique beauty, and universal appeal

make this rare precious metal the favorite of jewelers all over the world.

India is the world's foremost gold jewellery fabricator and consumer with fabricator

and consumption annually of over 600 tons according to GFMS. Measures of consumption and

fabrication are made more difficult because Indian jewellery often involves the re-making by

goldsmiths of old family ornaments into lighter or fashionable designs and the amount of gold

thus recycled is impossible to gauge. Estimates for this recycled jewellery vary between 80 tons

and 300 tons a year. GFMS estimates are that official gold bullion imports in 2001 were 654

tons. Exports have increased dramatically since 1996, and in 2001 stood at over 60 tons. The US
accounted for about one third of total official exports. Manufacturers located in Special Export

Zones can import gold tax-free through various registered banks under an Export Replenishment

scheme.

2. Industrial applications: Besides jewelry, gold has many applications in a variety

of industries including aerospace, medicine, electronics and dentistry. The electronics

industry needs gold for the manufacture of computers, telephones, televisions, and other

equipment. Gold's unique properties provide superior electrical conducting qualities and

corrosion resistance, which are required in the manufacture of sophisticated electronic

circuitry. In dentistry, gold alloys are popular because they are highly resistant to corrosion

and tarnish. For this reason gold alloys are used for crowns, bridges, gold inlays, and partial

debenture.

3. Governments and central banks: The third source of gold demand is governments

and central banks that buy gold to increase their official reserves. Central banks holds 28,225.4

tons, the holdings of Reserve Bank of India are only a modest 397.5 tons.

4. Private investors: Finally, there are private investors. Depending upon market

circumstances, the investment component of demand can vary substantially from year to year.

TECHNICAL ANALYSIS
Prices of the commodities in the commodity market fluctuate daily because of the continuous

buying and selling of the commodities. Prices of the commodity prices move in trends and

cycles and are never stable. An investor in the commodity market is interested in buying

commodities at a low price and sells them at a high price, so that he can get good return on his

investment. He therefore tries to analyze the movement of the share prices in market. There are
two approaches that we use for analyze the price of the commodities. One of these is the

fundamental analysis wherein the analyst tries to determine the true worth or intrinsic value of

the commodity when its market price is below its intrinsic value. The second approach to analyze

the commodity is technical analysis. It is an alternative approach to study the commodity price

behavior.

Dow Theory

Whatever is generally being accepted today as technical analysis has its roots in

the Dow theory. The theory is so called because it was formulated by Charles H. Dow who was

the editor of the wall street journal in U.S.A. Charles Dow formulated a hypothesis that the

commodity market does not move on a random basis but is influenced by three distinct cyclical

trends that guides its direction. According t this theory, the market has three movements and

these movements are simultaneous in nature. These movements are primary movements,

secondary reactions and minor movements.

The primary movements are a long range cycle that carries the entire market up or

down. This is the long – term trend in the market. The secondary reactions act as a restraining

force on the primary movement. These are in the opposite direction to the primary movement

and last only for a short while. These are also known as correction. For example, when the

market is moving upwards continuously, this upward movement will be interrupted by

downward movements of short durations. These are called secondary reactions. The third

movement in the market is the minor movements which are the day – to – day fluctuations in the

market. The three movements of the market have been compared to the tides, the waves and the

ripples in the ocean.

According to Dow theory, the prices of the commodities can be identified by the

means of a line chart. In this chart, the closing prices of the commodities may be plotted against

the corresponding trading days. The below diagram shows a line chart of closing prices of the
commodity in the market, The primary trend is said to have three phases in it, each of which be

interrupted by a counter move or secondary reaction which would retrace about 33 – 66 % of the

earlier rise or fall.

Primary trend and secondary reactions

Bullish Trend

During a bull market (upward moving market), in the first phase the prices

would advance with the revival of confidence in the future of business. The future prospects of

business in general would be perceived to be promising. This would prompt the investors to buy

the commodities. During the second phase, prices would advance due to inflation and

speculation. Thus during the bull market the line chart would exhibit the formation of three

peaks. Each peak would be followed by a bottom formed by the secondary reaction. According

to Dow theory, the formation of higher bottoms and higher tops indicates a bullish trend.

Three Phases of bull market

Bearish Trend

The bear market is also characterized by three phases. In the first phase the

prices begin to fall due to abandonment of hopes. Investors begin to sell their commodities. In

the second phase, the prices fall due to increased selling pressure. In the final phase, prices fall

still further due to distress selling.


The theory also makes certain assumptions which have been referred to as the

hypotheses of the theory. The first hypothesis states that the primary trend cannot be

manipulated. It means that no single individual or institution or group of individuals and

institutions can exert influence on major trend of the market. The second hypothesis states that

averages discount everything. The third hypothesis states that the theory is not perfect. The

theory is concerned with the trend of market and has no forecasting value as regards the duration

or the likely price targets for the peak or bottom of the bull and bear markets.

Three Phases of a bear market

BASIC PRINCIPLES OF TECHNICAL ANALYSIS

The basic principles on which analysis is based are as follows:

1. The market value of the commodity is related to demand and supply factors operating

in the market.

2. There are both rational and irrational factors which surrounded the supply and demand

factors of a security.

3. Commodity prices behave in a manner that their movement is continuous in a

particular direction for some length of time.

4. Trends in a commodity prices have been seen to change when there is a shift in the

demand and supply factors.

5. The shift in demand and supply can be detected through charts prepared specifically to

show market action.

Line Chart
It is the simplest price chart. In this chart the closing prices of the share are plotted

on the XY graph on a day to day basis. The closing price of each day would be represented by a

point on the XY graph. All these points would be concerned by straight line which would

indicate the trend of the market. A line chart is illustrated below.

Line chart of closing prices

Bar Chart

It is perhaps the most popular chart used by technical analysts. In this chart the highest price and

the lowest price and the closing price of each day are plotted on a day – to – day basis. A bar is

formed by joining the highest price and the lowest price of a particular day by a vertical line. The

top of the bar represents the highest price and the bottom of the bar represents the lower price

and the small horizontal hash on the right of the bar is used to represents the closing price of the

day. Sometimes the opening price of the day is marked as a hash on left side of the bar. This can

be explained by taking 10 days silver, Gold & Crude oil prices.

11 Days Highest, Lowest and Closing prices of Silver


Highest Price Lowest Price Closing Price
18358 17204 18200
18432 18000 18129
18208 17953 18062
18193 17975 18014
17990 16941 17060
17345 16837 17124
17203 16884 17062
17200 16900 17061
17116 16500 16770
17778 16556 17422
17380 17001 17203

Bar Chart

10Days Highest, Lowest and closing prices of Gold

Highest Price Lowest Price Closing Price

12030 11779 11903

11990 11780 11885

12100 11924 11997

12200 12080 12141

12820 12225 12797

13155 12830 12941

13226 12785 13105

13288 13004 13145

13192 13000 13051

13179 12985 13125

Bar Chart

10Days Highest, Lowest and closing Prices of Crude oil


Highest Prices Lowest Prices Closing prices

2485 2446 2474


2555 2448 2515

2582 2480 2507

2559 2438 2461

2559 2475 2496

2519 2482 2484

2470 2340 2360

2501 2300 2360

2374 2291 2348

2410 2289 2317

Japanese Candlestick Charts

The Japanese candlestick chart shows the highest price, the lowest price, the

opening price and the closing price of the commodities on day – to – day basis. The highest price

and the lowest price of a day are joining by a vertical bar. There are mainly three types of

candlesticks, like the white, the black and the doji or neutral candlestick. A white candlestick is

used to represents a situation where the closing price of the day is higher than the opening price.

A Black candlestick is used to represents a situation where the closing price of the day is lower

than the opening price. A White candlestick indicates a bullish trend while a black candlestick

indicates a bearish trend. A doji candlestick is the one where the opening price and the closing

price of the day are the same. This can be expressed below by taking prices of silver, Gold &

Crude oil i.e., (opening, closing, high, low)

19Days Prices of Silver


Open High Low Close
21725 23225 21000 23052
23075 23634 23000 23422
23481 23703 22800 22890
23100 23806 22933 23755
23625 23876 22987 23625
23400 23885 23100 23810
23555 23850 22621 22930
22950 23196 22354 22936
22664 22775 21780 21861
21950 22600 21803 22189
21954 22480 21954 22170
22279 22838 21916 22640
22526 22526 21583 21922
21976 23444 21344 21976
22051 22488 22050 22424

Japanese candlesticks

10Days Prices of Crude oil

Opening Price Highest Prices Lowest Prices Closing Prices


2446 2485 2426 2474
2460 2555 2448 2515
2568 2582 2480 2507
2491 2559 2438 2461
2500 2559 2475 2496
2519 2519 2482 2484
2460 2470 2340 2360
2354 2501 2300 2360
2374 2374 2291 2348
2289 2410 2219 2317
10Days Prices of Gold

Opening Price Highest Prices Lowest Prices Closing Prices

11880 11980 11779 11880


11890 11890 11880 11885

11925 12100 11924 11997

12127 12200 12080 12141

12437 12820 12225 12797

12955 12955 12930 12941

12868 13226 12785 13105

13102 13288 13004 13145

13192 13192 13000 13051

13055 13179 12985 13125

CHART PATTERNS:

When the price bar charts of several days are drawn close together, certain

patterns emerge. These patterns are used by technical analysts to identify trend reversal and

predict the future movement of prices. The chart patterns may be classified as support and

resistance patterns, reversal patterns.

1. Support and resistance patterns:

Support and resistance are the price levels at which the downtrend or

uptrend in price movements is reversed. Support occurs when price is falling but bounces back or
reverses direction every time it reaches a particular level. When all these low points are

connected by a horizontal line, it forms the support line. In other words, support level is the price

level at which sufficient buying pressure is exerted to stop the fall in prices.

Resistance occurs when the commodity price moves upwards. The price may fall

back every time it reaches a particular level. A horizontal line joining these tops forms the

resistance level. Thus, resistance level is the price level where sufficient selling pressure is

exerted to halt the ongoing rising in the price of a share.

If the scrip were to break the support level and move downwards it has bearish

implications signaling the possibility of a future fall in prices. Similarly, if the scrip were to

penetrate the resistance level it would be indicative of a bullish trend or a future rise in prices.

45Days Highest, Lowest and Closing Prices of Gold


Highest price Lowest Price Closing price
12088 12012 12050
12411 12200 12312
12383 12281 12332
12200 11962 12141
12820 12225 12797
12955 12930 12941
13226 12785 13105
13288 13004 13145
13192 13000 13051
13179 12985 13125
13199 13157 13172
13134 12640 12720
12727 12467 12636
12640 12451 12507
12600 12375 12403
12421 11981 12104
12193 12110 12134
12487 12175 12326
12430 12221 12385
12798 12374 12752
12973 12660 12845
12915 12690 12839
12851 12820 12830
13021 12800 12913
12974 12863 12960
13288 12968 13196
13276 12835 12960
12919 12671 12748
12797 12737 12757
13118 12816 13047
13235 13016 13084
13205 12907 13111
13500 13023 13357
13447 13380 13417
13825 13609 13660
13677 13392 13462
13690 13375 13646
13800 13670 13763
13730 13515 13580
13590 13552 13572
13582 13216 13351
13450 13116 13394

Support and resistance levels


\

2. Reversal patterns:

The trends reverse direction after a period of time. These reversal can be

identified with the help of certain chart formations that typically occur during these trend

revaesals. Thus reversal patterns are chart formations that trend to signal a change in direction of

the earlier trend.

Head and shoulder Formation: The most popular reversal pattern is Head and Shoulder

formation which usually occurs at the end of a long uptrend. This formation resembles the head

and two shoulders of a man and hence the name head and shoulder formation.

The first hump known as the left shoulder is formed when the prices reach the top

under a strong buying impulse. Then trading volume becomes less and there is a short downward

swing. This is followed by another high volume advance which takes the price to a higher top

known as the head. This is followed by another reaction on less volume which takes the price

down to a bottom near to the earlier downswing. A third rally now occurs taking the price to a

height the head but comparable to the left shoulder. This rally results in the formation of the right

shoulder. A horizontal line joining the bottoms of this formation is known as the neckline. This

head and shoulder formation usually occurs at the end of the bull phase and is indicative of a

reversal of trend. After breaking the neckline the price is expected to decline sharply.

Head and shoulder formation


Highest, Lowest and closing prices of Silver

Highest prices Lowest Prices Closing prices


16834 16800 16825
16987 16556 16898
17380 17001 17203
17649 17238 17536
17790 17471 17612
17572 17211 17465
17688 17234 17600
17690 17548 17610
17320 17100 17210
17200 16803 17010
17290 17215 17229
17118 16800 16915
17458 16653 16998
17649 17238 17536
17790 17471 17612
17572 17211 17465
17890 17509 17763
18095 17700 17886
17950 17378 17721
17901 17721 17792
18737 18002 18372
18500 17975 18329
18729 18113 18663
17963 17987 17580
17990 17990 17825
17844 17740 17773
17690 17500 17600
17580 17480 17543
17550 17440 17490
17649 17238 17536
17790 17471 17612
17672 17211 17465
17890 17509 17763
17410 17410 17410
17508 17246 17403
17320 17100 17210
17200 16803 17010
17190 17050 17110
17118 16800 16815
17158 16653 16998
MATHEMATICAL INDICATORS

Commodity prices do not rise or fall in a straight line. The movements are

unpredictable. This makes the investors difficult for the analyst to measure the underlying trend.

We can use the mathematical tool of moving averages to smoothen the unpredictable movements

of the commodity prices and highlight the underlying trend.

Moving Averages: moving averages are mathematical indicators of underlying trend of

price movement. There are two types of moving averages (MA) are commonly used by

the analyst.

1. Simple Moving Average.

2. Exponential moving average.

The closing prices of the shares are generally used for the calculation of moving averages.

I. Simple moving average: An average is the sum of prices of a

Commodity for a specified number of days divided by the number of days, in a simple moving

average, a set of averages are calculated for a specified number of days, each average being

calculated by including a new price and excluding an old price.

In the below table the first total of 67022 in column 3 is obtained by adding the prices

of the first five days, i.e. (13611+13124+13124+13433+13730). The next Total of 67448 in

column 3 is obtained by adding 6th day and deleting first day price from the first total i.e.

(67022+14037-13611) this process is continued. The moving average in column 4 is obtained by

dividing the total figure in column 3 by the number of days i.e. 5.

Calculation of gold price Five days Simple Moving Average


Days Close Prices(Rs) Total prices of 5 Days 5 Days Moving Avg(MA)
1 13611 - -
2 13124 - -
3 13124 - -
4 13433 - -
5 13730 67022 13404.4
6 14037 67448 13489.6
7 14037 68361 13672.2
8 14283 69520 13904
9 14283 70370 14074
10 13140 69780 13956
11 13145 68888 13777.6
12 13405 68256 13651.2
13 13247 67220 13444
14 12742 65679 13135.8
15 12742 65281 13056.2
16 12742 64878 12975.6
17 12600 64073 12814.6
18 12277 63103 12620.6
19 11976 62337 12467.4
20 12050 61645 12329
21 12099 61002 12200.4
22 11940 60342 12068.4
23 12050 60115 12023
24 12312 60451 12090.2
25 12332 60733 12146.6
26 11962 60596 12119.2
27 11962 60618 12123.6
28 11962 60530 12106
29 11603 59821 11964.2
30 11841 59330 11866
31 11841 59209 11841.8
32 11841 59088 11817.6
33 11841 58967 11793.4
34 11753 59117 11823.4
35 11766 59042 11808.4

II. Exponential Moving Average(EMA): It is calculated by using the

Following formula: EMA = (Current closing price – Previous EMA) × Factor + Previous EMA

Where Factor = 2/n+1 and n = number of days for which the average is to be calculated.

Calculation of 30 days gold price of Five – Day EMA

Days Closing price EMA


1 13611 13611
2 13124 13450.29
3 13124 13342.61
4 13433 13372.44
5 13730 13490.44
6 14037 13670.8
7 14037 13791.65
8 14283 13953.79
9 14283 14062.43
10 13140 13758.03
11 13145 13555.73
12 13405 13505.99
13 13247 13420.52
14 12742 13196.61
15 12742 13046.59
16 12742 12946.07
17 12600 12831.87
18 12277 12648.76
19 11976 12426.75
20 12050 12302.42
21 12099 12235.29
22 11940 12137.85
23 12050 12108.86
24 12312 12175.89
25 12332 12227.41
26 11962 12139.82
27 11962 12081.14
28 11962 12041.83
29 11603 11897.01
30 11841 11878.53

Factor = 2/ n+1 = 2/ 5+1 = 2/6 = 0.33

The EMA for the first day is taken as the closing price of that day itself. The EMA for the second

day is calculated as

EMA = (closing price – Previous EMA) × Factor + Previous EMA

= (13124 – 13611) × 0.33 + 13611 = 13450.29

EMA = (13124 – 13450.29) × 0.33 + 13450.29 = 13342.61

If we are calculating the five day exponential moving average, the correct five day EMA will be

available from the sixth day onwards. A moving average represents the underlying trend in

commodity price movement. The period of the average indicates the type of trend being
identified. For example, Five day or Ten day average would represent the short – term trend; a 50

day average would indicate the medium term trend and a 200 day average indicates the long term

trend.

The moving averages are plotted on the price charts. The curved line joining these moving

averages represent the trend line. When the price of the commodity intersects and moves below

or above this trendline, it may be taken as the first sign of trend reversal. Sometimes, two moving

averages – one short-term and the other long term are used in combination. In this case, trend

reversal is indicated by the intersection of the two moving averages.

Oscillators:

Oscillators are the mathematical indicators calculated with the help of the closing

price data. They help to identify overbought and oversold conditions and also the possibility of

trend reversals. These indicators are called oscillators because they move across a reference

point.

Rate of change Indicators (ROC): It is a very popular oscillator which measures the rate of

change of current price as compared to the price a certain number of days or weeks back. To

calculate a 7 day rate of change, each day’s price is divided by the price which prevailed 7 days

ago and then 1 is subtracted from this price ratios

ROC = (Current price / Price ‘n’ period ago) – 1

Let’s take an example of 30 days Gold price.

Calculation of 30 days gold price of 7 – day ROC


Days Closing Price Closing Price 7 Days ago Price Ratio ROC = ratio - 1
1 13611 - - -
2 13124 - - -
3 13124 - - -
4 13433 - - -
5 13730 - - -
6 14037 - - -
7 14037 - - -
8 14283 13611 1.04937183 0.049371832
2
9 14283 13124 1.08831149 0.08831149
10 13140 13124 1.00121914 0.001219141
1
11 13145 13433 0.97856026 -0.021439738
2
12 13405 13730 0.97632920 -0.023670794
6
13 13247 14037 0.94372016 -0.056279832
8
14 12742 14037 0.90774382 -0.09225618
15 12742 14283 0.89210950 -0.107890499
1
16 12742 14283 0.89210950 -0.107890499
1
17 12600 13140 0.95890411 -0.04109589
18 12277 13145 0.93396728 -0.066032712
8
19 11976 13405 0.89339798 -0.106602014
6
20 12050 13247 0.90963991 -0.090360082
8
21 12099 12742 0.94953696 -0.050463036
4
22 11940 12742 0.93705854 -0.062941453
7
23 12050 12742 0.94569141 -0.054308586
4
24 12312 12600 0.97714285 -0.022857143
7
25 12332 12277 1.00447992 0.004479922
2
26 11962 11976 0.99883099 -0.001169005
5
27 11962 12050 0.99269709 -0.007302905
5
28 11962 12099 0.98867675 -0.01132325
29 11603 11940 0.97177554 -0.028224456
4
30 11841 12050 0.98265560 -0.017344398
2
The ROC values may be positive, Negative and also be zero. An ROC chart is shown below

where the X – axis represents the time and the Y – axis represents the values of the ROC. The

ROC values oscillate across the zero line. When the ROC line is above the zero line, the price is

rising and when it below the zero line, the price is falling.

Ideally, one should buy a commodity that is oversold and sell a commodity that is

overbought. In the ROC chart, the overbought zone is above the zero line and the oversold zone

is below the zero line. Many analysts use the zero line for identifying buying and selling

opportunities. Upside crossing (from below to above the zero line) indicates a buying

opportunity, while a downside crossing (from above to below the zero line) indicates a selling

opportunity.

The ROC has to be used along with the price chart. The buying and selling signals

indicated by the ROC should also be confirmed by the price chart.

MARKET INDICATORS:

Technical analysis focuses its attention not only on individual commodity price behaviour, but

also on the general trend of market, Indicators used by technical analysts to study the trend of the

market as a whole are known as market indicators.

Technical Analysis Vs Fundamental Analysis: Fundamental analysis tries to estimate the

intrinsic value of a commodity by evaluating the fundamental factors affecting the economy,

industry and company. This is a tedios process and takes a rather long time to complete the

process.

Thecnical analysis studies the price and volume movements in the market and by careful

examining the pattern of these movements, the future price of the commodity is predicted. Since
the whole process involves much less timeand data analysis, compared to fundamental analysis,

it facilitates timely decision.

Fundamental analysis helps in identifying undervalued or overvalued securities. But

technical analysis helps in identifying the best timing of an investment, i.e. the best time to buy

or sell a security identified by fundamental analysis as undervalued or overvalued. Thus,

technical analysis may be used as a supplement to fundamental analysis rather thanas a substitute

to it. The two approaches, however, differ in terms of their databases and tools of analysis.

Fudamental analysis and technical analysis are two alternative approaches to predicting stock

pricebehaviour. Neither of them is perfect nor complete by itself.

Technical analysis has several limitations. It is not an accurate method of analysis. It is

offen difficult to identify the patterns underlying commodity price movements. Moreover, it is

not easy to interpret the meaning of patterns and their likely impact on future price movements.

REFERENCES

Books:

• Security Analysis And Portfolio Management

- S.kevin

E – Books:

• Ncfm module for commodity market

• COMDEX Educational series

• Investors Educational series - Angel commodities

• Nair C.K.G. (2004): Commodity Futures Markets in India: Ready for Take

Off”? www.nseindia.com

Websites:

• www.geojit.com

• www.bseindia.com
• www.mcx.com

• www.kitco.com

• www.ncdex.com