INDIAN COMMODITY MARKET

A commodity market is a market that trades in primary rather than manufactured products. Soft
commodities are agricultural products such as wheat, coffee, cocoa and sugar. Hard commodities
are mined, such as (gold, rubber and oil). Investors access about 50 major commodity markets
worldwide with purely financial transactions increasingly outnumbering physical trades in which
goods are delivered. Futures contracts are the oldest way of investing in commodities. Futures
are secured by physical assets. Commodity markets can include physical trading and derivatives
trading using spot prices, forwards, futures, and options on futures. Farmers have used a simple
form of derivative trading in the commodity market for centuries for price risk management.
A financial derivative is a financial instrument whose value is derived from a commodity termed
an underlie. Derivatives are either exchange-traded or over-the-counter (OTC). An increasing
number of derivatives are traded via clearing houses some with Central Counterparty Clearing,
which provide clearing and settlement services on a futures exchange, as well as off-exchange in
the OTC market.
Derivatives such as futures contracts, Swaps (1970s-), Exchange-traded Commodities (ETC)
(2003), forward contracts have become the primary trading instruments in commodity markets.
Futures are traded on regulated commodities exchanges. Over-the-counter (OTC) contracts are
"privately negotiated bilateral contracts entered into between the contracting parties directly".
Exchange-traded funds (ETFs) began to feature commodities in 2003. Gold ETFs are based on
"electronic gold" that does not entail the ownership of physical bullion, with its added costs of
insurance and storage in repositories such as the London bullion market. According to the World
Gold Council, ETFs allow investors to be exposed to the gold market without the risk of
price volatility associated with gold as a physical commodity.

Indian markets have recently thrown open a new avenue for retail investors and traders to
participate: commodity derivatives. For those who want to diversify their portfolios beyond
shares, bonds and real estate, commodities are the best option.

Till some months ago, this wouldn't have made sense. For retail investors could have done very
little to actually invest in commodities such as gold and silver -- or oilseeds in the futures market.
This was nearly impossible in commodities except for gold and silver as there was practically no
retail avenue for punting in commodities.

However, with the setting up of three multi-commodity exchanges in the country, retail investors
can now trade in commodity futures without having physical stocks!

Commodities actually offer immense potential to become a separate asset class for market-savvy
investors, arbitrageurs and speculators. Retail investors, who claim to understand the equity
markets, may find commodities an unfathomable market. But commodities are easy to
understand as far as fundamentals of demand and supply are concerned. Retail investors should
understand the risks and advantages of trading in commodities futures before taking a leap.
Historically, pricing in commodities futures has been less volatile compared with equity and
bonds, thus providing an efficient portfolio diversification option.

In fact, the size of the commodities markets in India is also quite significant. Of the country's
GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related (and dependent)
industries constitute about 58 per cent.

Currently, the various commodities across the country clock an annual turnover of Rs 1, 40,000
crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities
market grows many folds here on.

Like any other market, the one for commodity futures plays a valuable role in information
pooling and risk sharing. The market mediates between buyers and sellers of commodities, and
facilitates decisions related to storage and consumption of commodities. In the process, they
make the underlying market more liquid


COMMODITIES TRADING IN INDIA

Indian markets have now started offering a new investment product for all retail investors,
commodities derivatives by setting up three multi-commodity exchanges. It is ideal for traders
and investors who wish to diversify their portfolio beyond stocks, bonds, mutual funds and real
estate. Besides the retail investors do not require to physically own the commodities they are
trading in.
Commodities have potential to become a distinct asset class for skillful investors and traders.
Understanding commodities is relatively simple for investors as they are more align with the
basic fundamental economics of demand and supply. However retail investors should understand
the risks associated with commodities trading before investing in this new asset class.
Historically, commodity prices have been less volatile compared to equities, thus can be a good
diversification option.
Like any other market, the one for commodity futures plays a valuable role in information
pooling and risk sharing. The market mediates between buyers and sellers of commodities, and
facilitates decisions related to storage and consumption of commodities. In the process, they
make the underlying market more liquid.



Trading in Commodities market

Retail investors have three options to trade in commodities futures National Commodity and
Derivative Exchange (NCDEX), Multi commodity Derivative Exchange (MCX) and National
Multi Commodity Exchange of India Limited (NCME). All the three have electronic trading and
settlement systems and a national presence.

But before we begin trading in commodities, let us first understand the basic market structure
and mechanism. Commodities market like stock market works in spot or cash market and futures
market.

Spot market

Market where commodities are bought and sold in physical form by paying cash is a spot market.
The price on which commodities are traded in this market is called spot price. For example, if
you are a farmer or dealer of Chana and you have physical holding of 10 kg of Chana with you
which you want to sell in the market. You can do so by selling your holdings in either of the
three commodities exchanges in India in spot market at the existing market or spot price.


Futures Market

The market where the commodities are bought and sold by entering into a contract to settle the
transaction at some future date and at a specific price is called futures market. The unique feature
of futures market is that you do not have to actually hold the commodities in physical form or for
that matter take the delivery in physical form. Every transaction is settled on cash basis.


The prime objective of futures market is to hedge or mitigate the price risk in commodities. As
you are aware the prices in the spot market are volatile and are always fluctuating. And as a
trader or investor, you would want to eliminate or at least minimize your exposure to such price
risk. Hence you can use futures market to settle your contract.

For example, the current spot price of Gold is Rs 18000 per 10 grams. You expect the gold price
to reach Rs 18500 in next 1 month, but you do not want to miss this chance to earn money and at
the same time you dont even want to own any physical gold. Hence you enter into gold futures
contract with a futures price of Rs 18000 (the price at which the futures contract is currently
being traded in futures market) with an expiry date (the date on which the futures contract will be
settled at futures price) of 1 month from now. i.e. 30th June 2010. Hence you will make a profit
if the spot or market price of gold is more than Rs 18000 on the settlement date or the expiry date
of your futures contract.

Futures contract are standardized contracts made by the commodities exchange and come with
specific set of prices with minimum lot size to trade and with a specific expiry or settlement date



CRUDE OIL

Crude oil is the term for "unprocessed" oil, the stuff that comes out of the ground. It is also
known as petroleum. Crude oil is a fossil fuel, meaning that it was made naturally from decaying
plants and animals living in ancient seas millions of years ago -- most places you can find crude
oil were once sea beds. Crude oils vary in color, from clear to tar-black, and in viscosity, from
water to almost solid.

Crude oil accounts for 33% of the world's primary energy consumption.
The petroleum industry includes the global processes of exploration, extraction, refining,
transporting (often by oil tankers and pipe-lines), and marketing petroleum products. The largest
volume products of the industry are fuel oil and gasoline (petrol). Petroleum (oil) is also the raw
material for many chemical products, including pharmaceuticals, solvents, fertilizers, pesticides,
and plastics. The industry is usually divided as follows:

Upstream- includes the searching for potential underground or underwater crude oil and
natural gas fields, drilling of exploratory wells, and subsequently drilling and operating the wells
that recover and bring the crude oil and/or raw natural gas to the surface.

Downstream- refers to the refining of petroleum crude oil and the processing and purifying of
raw natural gas, as well as the market-ing and distribution of products derived from crude oil and
natural gas.

CRUDE OIL COMPONENTS

On average, crude oils are made of the following elements or compounds:
Carbon - 84%
Hydrogen - 14%
Sulfur - 1 to 3% (hydrogen sulfide, sul-fides, disulfides, elemental sulfur)
Nitrogen - less than 1% (basic com-pounds with amine groups)
Oxygen - less than 1% (found in organic compounds such as carbon dioxide, phenols, ketones,
carboxylic acids)
Metals - less than 1% (nickel, iron, vanadium, copper, arsenic)
Salts - less than 1% (sodium chloride, magnesium chloride, calcium chloride)









MAJOR VARIETY OF CRUDE TRADED:

There are three primary benchmarks, WTI, Brent Blend, and Dubai. Other well-known blends
include the Opec basket used by OPEC, Tapis Crude which is traded in inga-pore, Bonny Light
used in Nigeria and Mexico's Isthmus.


West Texas Intermediate (WTI)

West Texas Intermediate is used primarily in the U.S. It is light (API gravity) and sweet (low-
sulfur) thus making it ideal for producing products like low-sulfur gasoline and low-sulfur diesel.
Brent is not as light or as sweet as WTI but it is still high-grade crude. The OPEC basket is
slightly heavier and sourer than Brent. As a result of these gravity and sulfur differences, WTI
typically trades at a dollar or two premiums to Brent and another dollar or two premiums to the
OPEC basket.

Brent Blend

Brent Crude is used primarily in Europe and the OPEC market basket, used around the world.
This benchmark is a mix of crude oil from 15 different oil fields in the North Sea.

Dubai and Oman

Dubai Crude is also known as Fateh is produced in the Emirate of Dubai, part of the United Arab
Emirates





CRUDE OIL PRICE MOVEMENTS

















Crude oil price movements are function of demand and supply. As the major holdings of oil is
with the gulf countries, so the political and social conditions in these countries determine the
supply and also the price. The other side of this is the demand factor, the health of major
manufacturing countries determine the demand and thus affects the prices. Any change in both/
one of these factors can affect the price of crude oil.


















MAJOR CHOKEPOINTS AND IMPACT OF
THEIR SHUT DOWN

Chokepoints are narrow channels along widely used global sea routes, some so narrow that
restrictions are placed on the size of the vessel that can navigate through them. They are a critical
part of global energy security due to the high volume of oil traded through their narrow straits.

STRAIT OF HORMUZ

Hormuz, the only exit from the Persian Gulf, lies between Iran on the northern side and Oman on
the southern. 20% of world oil passes through Strait of Hormuz. Saudi Arabia's about 31% of oil
passes through it. Iraqs dependence is about 55% of its total ex-port, UAEs dependence is
about 25% and Kuwait and Qatar are completely dependent on Hormuz for their exports. Almost
17 mil-lion barrels of oil pass through it daily, and five of the world's largest oil producers --
Saudi Arabia, Iran, Iraq, Kuwait, and the United Arab Emirates -- are largely or wholly
dependent on it, as is Qatar, the world's leading exporter of liquefied natural gas.




Alternative:

There are only two oil pipelines that could be considered ready alternatives. The first is the
Fujairah Pipeline. Abu Dhabi, the leading oil producer in the UAE, which would bypass the
Strait and deliver most of its oil exports to the Indian Ocean. But after years of setbacks,
including a six-month delay in 2010 for "design changes," the pipeline has yet to be finished,
now slated to start in May or June. Though it would make the UAE largely independent of
Hormuz, the pipeline can carry only about 10 percent of the total oil transiting the Strait.
The second is the Saudi Pipeline: The Iran rival's pipeline, known as Petrolane, was originally
built in 1981, running to the Red Sea port of Yanbu. During the infamous Tanker Wars of the
mid-1980s, when fighting between Iran and Iraq threatened to close the Strait, the Saudis
increased the capacity to more than 3 million barrels of oil each day and it could now carry 5
million barrels per day. Many experts, including researchers at Rice University, have long called
for a significant upgrade to Petro line to bring its capacity up to 11 million barrels per day,
enough to carry all Saudi exports with spare capacity for others. This option could take some 18
months to complete, so is not an emergency alternative. These two pipelines might offer hope for
one day bypassing Hormuz, but in the immediate future, the world is heavily dependent on
Hormuz for its oil.
And while oil gets all the attention, other key products must travel through the strait, including
28 percent of the world's liquefied natural gas. It's the only source of gas for Japan, South Korea,
and Taiwan, and a vital fuel for reducing European dependence on Russia. Iran's Arab neighbors
on the Gulf rely heavily on seaborne food and other imports.

STRAIT OF MALACCA

30 percent of world trade passes through the Straits. One quarter of the oil shipped around the
world is in supertankers that ply the narrow, 800 kilometer long sea lane. More specifically, 80
percent of oil transported to both Japan and China depends upon the Straits. In the light of the
rapid economic growth of countries such as China, India and Vietnam, it is estimated that by
2030, two-thirds of oil consumed in the continent will pass through the Straits.

Key concerns:

Although piracy in the strait has declined in recent years, the number of pirate attacks in the
region still ranks highly when compared with the worlds other important waterways [14]. While
piracy may be a diminished threat, terrorism may be a growing concern as numerous terrorist
organizations are present in the region.
Alternative:

The Lombok (3.5 days delay) Strait, and the Sunda (1.5 days delay) Strait. The actual delay
times for transiting from the two alternatives of the Straits (the Lombok Strait, and the Sunda
Strait) will vary with the sailing velocities, the weather condition, and the course selected, which
are not suited to be represented by a crisp delay time.


THE SUEZ CANAL AND SUMED PIPELINE

Closure of the Suez Canal and/or Sumed Pipeline would divert tankers around the southern tip of
Africa (the Cape of Good Hope), adding greatly to transit time and effectively tying up tanker
capacity. Closure of the Suez Canal and/or SUMED pipeline would require a 6,000 mile, 15 day
diversion. If the canal is to face closure this time round ...it would remove about 2 to 3 million
barrels of oil and about 2 million barrels of refined products a day, Barclays report estimates
(2012).

BAB-EL-MANDAB

The Strait of Bab el-Mandab is a chokepoint between the horn of Africa and the Middle East,
and a strategic link between the Mediterranean Sea and Indian Ocean. It is located between
Yemen, Djibouti, and Eritrea, and connects the Red Sea with the Gulf of Aden and the Arabian
Sea. Exports from the Persian Gulf must pass through Bab el-Mandab before entering the Suez
Canal.
The Strait of Bab el-Mandab could be bypassed through the East-West oil pipeline, which
crosses Saudi Arabia with a 4.8 million bbl/d capacity. However, southbound oil traffic would
still be blocked. In addition, closure of the Bab el-Mandab would block non-oil shipping from
using the Suez Canal, except for limited trade within the Red Sea region.

TURKISH STRAIT

The Bosporus and Dardanelles comprise the Turkish Straits and divide Asia from Europe. The
Bosporus connects the Black Sea with the Sea of Marmara, and the Dardanelles links the Sea of
Marmara with the Aegean and Mediterranean Seas. Bottlenecks and heavy traffic also create
problems for oil tankers in the Bosporus Straits. While there are no current alternate routes for
westward shipments from the Black and Caspian Sea region, there are several pipeline projects
in various phases of development underway.

PANAMA CANAL

The relevance of the Panama Canal to the global oil trade has diminished, as many modern
tankers are too large to travel through the canal. Some oil tankers, such as ultra-large crude
carriers (ULCC), can be nearly five times larger than the maximum capacity of the canal. The
largest vessel that can transit the Panama Canal is known as a PANAMAX-size vessel (ships
ranging from 50,000 80,000 dead weight tons in size and no wider than 108 ft.).
In 2007, the Panama Canal Authority (ACP) started work on its $5.25 billion expansion project,
which will change world trade pat-terns and open the waterway to new markets. The expansion
will double canal capacity by 2014 and allow for the transit of larger and wider vessels, with a
160 foot beam, 1200 foot LOA and 50 foot of draft.
Closure of the Panama Canal would greatly increase transit times and costs adding over 8,000
miles of travel. Vessels would have to reroute around the Straits of Magellan, Cape Horn and
Drake Passage over the tip of South America.
DANISH STRAIT

The Danish straits are the three channels connecting the Baltic Sea to the North Sea through the
Kattegat and Skagerrak. With Russian exports of oil beginning to form the basis of European oil
consumption, the Danish Straits prove a considerably vital chokepoint for the future of oil in
Europe.



SEASONAL IMPACT ON OIL PRODUCTION:

Sandstorms:

In areas in where sandstorms pose a threat, oil production can be affected as well. Kuwait is an
important exporter of oil, therefore this lack of production because of the sandstorms resulted in
higher prices for crude oil. Because so many of the largest exporters of oil are in the Middle East,
a region prone to this type of weather, sandstorm activity has the potential to be extremely
detrimental to the price of crude oil.

Hurricanes:

Hurricanes can have an impact on the offshore production of oil & gas, as safety measures
require the temporary shutdown of off-shore drilling and production platforms. Due to hurricanes
various offshore oil platforms are destroyed and drilling rigs were lost.












Key Gulf Coast Storage Facilities




CRUDE GLOBAL SCENARIO:

Demand Shift

From 2000 the increasing industrialization of the developing world has been the primary catalyst
driving the demand for global crude oil. Among non-OECD nations, China and India have led
the charge, with Chinese oil demand growing at a torrid 6.7% per annum rate and Indias oil
demand growing at 4.0% per annum. Overall non-OECD demand for oil has in-creased at a
comparable rate of 3.6% per annum, with the Asia/Pacific region growing oil demand at roughly
2.7%. Developed nations, however, have seen diminishing oil demand with a negative .04% per
annum growth rate.





Supply/Demand Imbalance

While demand is being driven by the developing nations, supply from both the OPEC and Non-
OPEC producing regions are struggling to meet demand. Since 2000, OPEC wellhead oil
production has increased at a per annum rate of 1.3%, and non-OPEC production has actually
declined slightly at a per annum rate of -0.3% combined, a yearly increase of 1.0%.
Despite global economic growth weakening in 2012, from the depths of the Great Worldwide
Recession in 2009, global oil demand has increased roughly 1.7% per annum, while supply has
increased about 1.5% over the comparable period maintaining our consumption/production gap.




POLITICAL RISKS:

With globalization and information revolution, new political risks are also coming into play in
the production of crude oil. The biggest political risk associated is the unrest in Arab world, after
Arab Springs. Many countries specially Saudi Arabia has managed to maintain peace in their
country, how long will this peace sustain is a big question and if any un-rest happens in the
worlds biggest oil producer then that is definitely going to affect the oil prices. In this majorly
all the oil producing gulf countries like Iran. UAE, Kuwait, Qatar, Nigeria, Libya lack in political
stability. Thus a huge political risk lies for crude oil.

FUTURE SCOPE:

The existing fields are being depleted at the rapid rate of 7 percent a year, and the search is on
for unconventional oil as alternative forms of energy are slow to reach critical mass. There are
many kinds of unconventional oil meaning hydrocarbons that are not found in fluid form,
but that can be fluidized in a straightforward way (unlike coal, for in-stance). These resources
include Venezuelan heavy oil and Canadian tar sands. But the big change in the last two decades
is shale gas and tight oil a liquid, trapped in shale (rock), where it doesnt flow naturally but
can be extracted by horizontal drilling and fracking
Apart from new discoveries there is possibility of shifting the consumption from oil to natural
gas. Potential gas-to-oil substitution could reduce global oil consumption by 2.3 million barrels
of oil equivalent per day by 2020 and 5.5 mmboe/d by 2025 in a low-case scenario, while a high-
case scenario could see the worlds oil use decline by 4.9 mmboe/d by 2020 and 13.6 mmboe/d
by 2025.

CRUDE OIL OUTLOOK:

As per our assumptions and calculations, the Brent Oil prices should find a support of $90 per
barrel in the next 12 months, because the fiscal break even of the major oil producing countries is
much higher and they wont be able to maintain their output level at such a low price. Drop in
prices will be due to increase in supply from Iraq and decrease in demand from Euro zone and
China, but the chances of it going below $90 are very less. We expect Brent to trade between
$90 110 for 2013; however we can expect the prices to spike up in of any geo political tension
and any action from central banks to stimulate growth in the economy.
The price of WTI should find a support of $70 per barrel, based on the break even prices of
company. This fall is due to the boom in oil production in the US and Canada, but the chances
for prices lower than that are very few as companies wont be able to cover their break even
prices.

IMPACT ON INDIA:

Reduction in oil prices will be beneficial for India in many ways. A USD10/bbl fall in oil prices
alone could cut India's current account deficit by about 50bp of GDP. This reduction in current
account deficit will reduce the fiscal deficit and will also strengthen rupee, which in turn could
improve the rating of India, which in turn could attract more and more FII into the country.


The Relationship between Gold and Crude Oil Price


In the financial markets, gold is usually ascribed to the commodities category. In this group of
assets you will find your good old friend, silver, along with several others metals like platinum,
palladium, copper etc. Apart from that, commodities encompass a broad range of other products
in the like of corn, but also crude oil, gas, minerals and other. Such groups of assets are usually
traded on commodity exchanges specialized in this kind of products, for instance on the Chicago
Mercantile Exchange or the London Metal Exchange.
Commodities differ from stocks or bonds in the fact that, usually they have significant
importance for some industry. For example, silver is used in the production of electrical
conductors and oil is used as fuel for various kinds of machines. The main difference from a
financial point of view is that, other than bonds and stocks, commodities do not give you cash
flows in the like of dividends, coupons or the principal. The only way in which commodities
generate returns (excluding industrial applications) is when their price changes in the direction
you bet on.
Since price changes are of crucial importance for commodities investors, relationships between
these commodities are often examined in detail to establish if prices of one commodity can fuel
prices of another. It is, for instance, almost universally acknowledged that there is a strong
relationship between prices of gold and silver, where the price of silver strongly depends on the
price of gold.
Most precious metals investors have probably analyzed the gold to silver ratio more than once in
their investment career, but such relationships can be found not only between metals. It is argued
that prices of gold and oil are also related. Higher price of oil would translate in higher prices of
gold. Since there is no apparent intuitive connection between what happens with oil and what
happens with gold, there is need for some explanations here.

The main idea behind the gold-oil relation is the one which suggests that prices of crude oil
partly account for inflation. Increases in the price of oil result in increased prices of gasoline
which is derived from oil. If gasoline is more expensive, than its more costly to transport goods
and their prices go up. The final result is an increased price level in other words, inflation. The
second part of the causal link is the fact that precious metals tend to appreciate with inflation
rising (in the current fiat monetary environment). So, an increase in the price of crude oil can,
eventually, translate into higher precious metals prices.

To see if this is actually the case, lets take a look at the chart below. It presents prices of gold
and Brent crude oil in the 1987-2012 periods.

As it turns out, both commodities tend to trade in the same direction. The relationship is far from
perfect but it seems to be there. We have measured this relationship by calculating the R-squared
for gold and crude oil in the above-mentioned period. R-squared is a statistical measure. The
basic idea is simply that if you have two quantities (e.g. price paths), R-squared shows you how
much of the changes in one of those quantities can be explained by the other quantity. To put it
simple, in our case R-squared shows you how much of the changes in the price of gold can be
explained by changes in the price of crude oil. The result is 78.7% which, quite intuitively, tells
you that, in fact, price levels of gold and crude oil are strongly related. This is further confirmed
by another chart.


On this chart, we have plotted prices of gold in relation to prices of Brent crude oil. This chart
can be interpreted in the following way: the horizontal axis shows you the price of oil on a given
day and the vertical axis shows the price of gold on the same day. So, if you look at the
horizontal axis and find oil at, say, $70, looking up in a straight line will tell you what gold cost
when oil was at $70. We see that the cloud of points is generally rising in the price of oil. This
suggests, just as the previous chart did, that there is a relation between the two price levels:
higher prices of oil coincide with higher prices of gold.
One puzzle here is that it usually takes some time for higher oil prices to materialize as higher
prices in goods and services. But it does not seem to take too long for gold you have in your
portfolio to trade in line with oil. One explanation can be that, once oil appreciates, precious
metals investors discount the expected future higher prices o goods in the price of gold and gold
goes up.
With such results on the table, it would be tempting to proclaim that you can trade this
relationship. But to see if this is really the case, well turn to a different chart.

This chart is similar to the previous one but it differs from it in two ways: we plot weekly gold
and oil returns instead of prices and we shorten the analyzed period to start with the year 2002.
The results here are completely different than before. The cloud of points does not seem to reveal
any coincidence or relationship it does not follow any visible trend and the points look like
plotted randomly in the middle of the chart, around 0% returns for both gold and oil. R-squared
suggests that 7.2% of the changes in gold returns can be explained by changes in oil returns. The
conclusion might be that higher weekly oil returns dont necessarily imply anything meaningful
for weekly returns of gold as far as long-term analysis is concerned. We have obtained similar
results for daily, monthly and quarterly returns.
The main point is that, even though the general price level of gold evolves in a similar direction
to oil, the relationship may not be tradable based on data for the long term. Over longer periods
of time and on average, opening long speculative positions in gold based on expected
appreciation of oil may simply not be profitable.
Having said that, its still possible for short-term patterns to emerge occasionally. So, even
though there seems to be no relationship between gold and oil returns over the long term, it may
happen that a relationship unveils itself in a short period of time offering trading opportunities.
A popular way to analyze gold in terms of crude oil is the gold: oil ratio in which the price of
gold is divided by the price of oil. We present historical levels of the ratio along with prices of
gold on the chart below.

Peaks in the ratio signalize periods when gold was expensive relative to oil. Troughs point out
periods when gold was relatively cheap compared with oil. The ratio does not reveal any striking
patterns or relationships. As is with charts, it can be interpreted differently by different persons.
Quick calculations yield an R-squared of 3.4%, which suggests that the ratio on its own may not
have any particular impact on gold prices at the same point in time.
In light of the mixed results obtained so far, we have checked the relationship between gold and
oil price levels for stability. We have calculated R-squared values for gold and oil prices in a
one-year window for each day in the 1987-2012 periods (subject to data availability). The results
are presented on the chart below.

The red line shows the R-squared values calculated in a one-year window ending on the day for
which the value is shown. The changes in the R-squared can be perceived as the stability of the
gold-oil relationship. High values indicate that for a one-year period prior to the day for which
the value is reported the link between gold and oil was relatively strong and they traded in the
same directions. Low values indicate that for one year the relationship was questionable and gold
and oil traded independently. We can see that the stability of the relation has been fluctuating
dramatically for the last 25 years.
It is considerably difficult to find any apparent relationship between the behavior of R-squared
values and the price of gold. To check for any such link, we have applied two thresholds to the
R-squared values. The first threshold would be one that was broken when R-squared went up.
The other one was one that was broken when R-squared was declining. We have checked for
different values of the thresholds, values that would coincide with highest or lowest past returns
of gold. Altogether, we have answered four questions:
If the R-squared was going down, what threshold would have coincided with highest returns?
If the R-squared was going down, what threshold would have coincided with lowest returns?
If the R-squared was going up, what threshold would have coincided with highest returns?
If the R-squared was going up, what threshold would have coincided with lowest returns?
The answers:
For R-squared going down, a threshold of 63.8% would have coincided with monthly returns of
5.4%.
For R-squared going down, a threshold of 80.8% would have coincided with monthly returns of -
7.2%.
For R-squared going up, a threshold of 81.1% would have coincided with monthly returns of
10.8%.
For R-squared going up, a threshold of 86.2% would have coincided with monthly returns of -
11.0%.

Even if the above might seem slightly complicated, they imply two straightforward points:

When the relationship between gold and oil was strong but deteriorating, gold returns tended to
be considerably low.
When such a relationship was significant and strengthening, gold returns tended to be extreme
either considerably high or considerably low.

The above results do not imply that such relationships were tradable. But they point out that the
degree to which gold and oil traded in the same direction could have had influence on gold
returns.
To sum up, there seems to be a relatively strong relationship between gold and oil prices but not
between gold and oil returns. The strength of the relationship between gold and oil coincides
with high or low gold returns. This relationship may not be useful for speculation over the long
term but its possible that patterns emerge locally, in short time spans. Results of our analysis of
the relationship between gold and oil show that if you are considering entering the gold market
and the relationship between gold and oil is strong but deteriorating, you may want to double
check the current situation on the market. Additionally, if you are to enter the market and the
above-mentioned relationship is strengthening, this could coincide with considerable movements
in gold to either side. You might want to check additional factors to confirm which side it might
be.




CRUDE OIL PRICE IN INDIA
MONTH PRICE RETURN
JULY 2009 30136.03 -
AUGUST 2009 3461.09 10.37%
SEPTEMBER 2009 3312.26 -4.30%
OCTOBER 2009 3461.10 4.49%
NOVEMBER 2009 3611.89 4.36%
DECEMBER 2009 3491.65 -3.33%
JANUARY 2010 3541.88 1.44%
FEBRUARY 2010 3461.46 -2.27%
MARCH 2010 3607.99 4.23%
APRIL 2010 3744.14 3.77%
MAY 2010 3457.51 -7.66%
JUNE 2010 3479.77 0.64%
JULY 2010 3492.91 0.38%
AUGUST 2010 3533.47 1.16%
SEPTEMBER 2010 3503.86 -0.84%
OCTOBER 2010 3629.80 3.59%
NOVEMBER 2010 3793.46 4.51%
DECEMBER 2010 4008.37 7.25%
JANUARY 2011 4205.30 3.37%
FEBRUARY 2011 4442.32 5.64%
MARCH 2011 4888.11 10.04%
APRIL 2011 5162.95 5.62%
MAY 2011 4856.74 -5.93%
JUNE 2011 4747.57 -2.25%
JULY 2011 4791.52 0.93%
AUGUST 2011 4548.23 -5.08%
SEPTEMBER 2011 4812.40 5.81%
OCTOBER 2011 4920.00 2.24%
NOVEMBER 2011 5340.76 8.55%
DECEMBER 2011 5488.30 2.76%
JANUARY 2012 5475.69 -0.23%
FEBRUARY 2012 5540.75 1.19%
MARCH 2012 5927.55 6.98%
APRIL 2012 5892.63 -0.59%
MAY 2012 5659.74 -3.95%
JUNE 2012 5083.60 -10.18%
JULY 2012 5372.19 5.68%
AUGUST 2012 5841.31 8.88%
SEPTEMBER 2012 5800.66 -0.83%
OCTOBER 2012 5475.37 -5.61%
NOVEMBER 2012 5536.01 1.11%
DECEMBER 2012 5525.53 -0.19%
JANUARY 2013 5705.06 3.25%
FEBRUARY 2013 5786.01 1.11%
MARCH 2013 5580.74 -3.55%
APRIL2013 5375.04 -3.69%
MAY 2013 5467.56 1.72%
JUNE 2013 5817.69 6.40%
JULY 2013 6289.39 8.11%
AUGUST 2013 6830.35 8.60%
SEPTEMBER 2013 6928.11 1.43%
OCTOBER 2013 6499.62 -6.18%
NOVEMBER 2013 6432.65 -1.03%
DECEMBER 2013 6534.90 1.59%
JANUARY 2014 653.32 -2.78%
FEBRUARY 2014 6528.65 2.76%
MARCH 2014 6343.00 -2.84%
APRIL 2014 6333.82 -0.14%
MAY 2014 6274.31 -0.94%
JUNE 2014 6471.05 3.14%