Gold as a Strategic Asset

Introduction
Gold, the most famous of all the precious metals, is acquired throughout the world for its beauty, liquidity, investment qualities, and industrial properties. Gold is a unique asset based on few basic characteristics. First, it is primarily a monetary asset, and partly a commodity.

As much as two thirds of gold’s total accumulated holdings relate to “store of value” considerations. Holdings in this category include the central bank reserves, private investments, and high-caratage jewelry bought primarily in developing countries as a vehicle for savings. Thus, gold is primarily a monetary asset. Less than one third of gold’s total accumulated holdings can be considered a commodity, the jewelry bought in Western markets for adornment, and gold used in industry. The distinction between gold and commodities is important. Gold has maintained its value in after-inflation terms over the long run, while commodities have declined.

Some analysts like to think of gold as a “currency without a country’. It is an internationally recognized asset that is not dependent upon any government’s promise to pay. This is an important feature when comparing gold to conventional diversifiers like T-bills or bonds, which unlike gold, do have counter-party risk. What makes Gold Special? Timeless and Very Timely Investment

N. L. Dalmia Institute of Management Studies and Research

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Gold as a Strategic Asset
For thousands of years, gold has been prized for its rarity, its beauty, and above all, for its unique characteristics as a store of value. Nations may rise and fall, currencies come and go, but gold endures. In today’s uncertain climate, many investors turn to gold because it is an important and secure asset that can be tapped at any time, under virtually any circumstances. But there is another side to gold that is equally important, and that is its dayto-day performance as a stabilizing influence for investment portfolios. These advantages are currently attracting considerable attention from financial professionals and sophisticated investors worldwide. Gold is an effective diversifier: Diversification helps protect your portfolio against fluctuations in the value of any one-asset class. Gold is an ideal diversifier, because the economic forces that determine the price of gold are different from, and in many cases opposed to, the forces that influence most financial assets. Gold is the ideal gift In many cultures, gold serves as a family treasure or a wealth transfer vehicle that is passed on from generation to generation. Gold bullion coins make excellent gifts for birthdays, graduations, weddings, holidays and other occasions. They are appreciated as much for their intrinsic value as for their mystical appeal and beauty. And because gold is available in a wide range of sizes and denominations, you don’t need to be wealthy to give the gift of gold.

Gold is highly liquid
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Gold as a Strategic Asset
Gold can be readily bought or sold 24 hours a day, in large denominations and at narrow spreads. This cannot be said of most other investments, including stocks of the world’s largest corporations. Gold is also more liquid than many alternative assets such as venture capital, real estate, and timberland. Gold proved to be the most effective means of raising cash during the 1987 stock market crash, and again during the 1997/98 Asian debt crisis. So holding a portion of your portfolio in gold can be invaluable in moments when cash is essential, whether for margin calls or other needs. Gold responds when you need it most Recent independent studies have revealed that traditional diversifiers often fall during times of market stress or instability. On these occasions, most asset classes (including traditional diversifiers such as bonds and alternative assets) all move together in the same direction. There is no “cushioning” effect of a diversified portfolio — leaving investors disappointed. However, a small allocation of gold has been proven to significantly improve the consistency of portfolio performance, during both stable and unstable financial periods. Greater consistency of performance leads to a desirable outcome — an investor whose expectations are met.

What makes Gold different from other commodities?
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However. all else being equal. L.Gold as a Strategic Asset The flow demand of commodities is driven primarily by exogenous variables that are subject to the business cycle. If this argument holds true. in the case of gold. N. such as GDP or absorption. Dalmia Institute of Management Studies and Research Page 4 . provided a mechanism for gold held by central banks and other major institutions to come back to the market. drive the price of the commodity upwards. Consequently. it is our contention that. no such upward price pressure will be observed in the gold market in the presence of a positive demand shock. buffer stocks can be supplied with perfect elasticity. over the past 15 years. The existence of a sophisticated liquid market in gold has. one would expect that a sudden unanticipated increase in the demand for a given commodity that is not met by an immediate increase in supply should.

because of the variability of demand. This is because. N. making them more vulnerable to cyclical price volatility. but rather that the large supply of inventory is likely to dampen any resultant spikes in price. the price responsiveness of each commodity will depend in part on precautionary inventory holdings. given low search costs and the well-developed leasing market.Gold as a Strategic Asset Although the demand for gold as an industrial input or as a final product (jewellery) differs across regions. One would expect that the time required to convert bullion into producer inventory is short. Of course. the inventory of aboveground stocks is astronomically large relative to changes in flow demand. This is not to say that exogenous shifts in flow demand will have no influence at all on the price of gold. In the gold industry such time lags are typically very short. whereas it is well known that stock and bond market returns are highly correlated with GDP. set it apart from other commodities: firstly. secondly. combined. Dalmia Institute of Management Studies and Research Page 5 . and thirdly. dividends can be expected to rise. Gold has three crucial attributes that. L. relative to other commodities which may be less liquid and less homogenous than gold and may require longer time scales to extract and be converted into usable producer inventory. gold is indestructible and fungible. GDP is a leading indicator of productivity: during a boom. assayed gold is homogeneous. One consequence of these attributes is a dramatic reduction in gestation lags. generally speaking. it is argued that the core driver of the real price of gold is stock equilibrium rather than flow equilibrium. There is low to negative correlation between returns on gold and those on stock markets. The extent of this dampening effect depends on the gestation lag within which liquid inventories can be converted in industrial inputs.

whereas returns on other financial assets. Nifty. and the term structure of interest rates on returns on gold. Assets that are not correlated with mainstream financial assets are valuable when it comes to managing portfolio risk. Dalmia Institute of Management Studies and Research Page 6 . is negligible. oil and zinc) than they do on gold. This research establishes a theoretical underpinning for the absence of a relationship that has been N. in contrast to the impact of cyclical demand on other commodities and financial assets. inflation. such as GDP. the increased demand for credit.Gold as a Strategic Asset On the other hand. such as the Sensex. inflation and interest rates. Using the gold price and macroeconomic and financial market quarterly data the following conclusions may be drawn: There is no statistically significant correlation between returns on gold and changes in Macroeconomic variables. The fundamental differences between gold and other financial assets and commodities give rise to the following “hard line” hypothesis: the impact of cyclical demand using as proxies GDP. L. are highly correlated with changes in macroeconomic variables. Returns on gold are less correlated with equity and bond indices than are returns on Other commodities. and 10-year government bonds. countercyclical monetary policy and higher expected inflation that characterize booms typically depress bond prices. Macroeconomic variables have a much stronger impact on other commodities (such as aluminum. nominal and real interest rates.

L. Gold never reacts with oxygen (one of the most active elements). It is benign in all natural and industrial environments. Resistance to Corrosion Gold is the most non-reactive of all metals. that between returns on gold and those on other financial assets. everyday appliances require gold to ensure perfect performance over a long period of time. Its chemical symbol. which literally means 'Glowing Dawn'. and oxygen. This unique combination of properties makes gold a vital component in many medical. industrial. Dalmia Institute of Management Studies and Research Page 7 . Properties of Gold Out of the earth comes a remarkable metal with an unparalleled combination of chemical and physical properties that make this metal invaluable to a wide range of everyday applications essential to our modern life. Thousands of common. which means it will not rust or tarnish. Au. is short for the Latin word for gold. notably its excellent conductive properties and its inability to react with water or oxygen. The gold deathN. 'Aurum'.Gold as a Strategic Asset demonstrated empirically for a number of years. These properties include: Gold is a rare metallic element with a melting point of 1064 degrees centigrade and a boiling point of 2808 degrees centigrade. namely. or corrode. This indestructible metal is completely recyclable and virtually immune to the effects of air. Gold will not tarnish. It has several properties that have made it very useful to mankind over the years. rust. and electrical applications. water.

As a result. one ounce of gold can be hammered into a 100 square foot sheet. High purity gold reflects up to 99% of infrared rays. Gold is able to convey even a tiny electrical current in temperatures varying from -55° to +200° centigrade. It can be shaped or extended into extraordinarily thin sheets. Infrared (Heat) Reflectivity Gold is the most reflective and least absorptive material of infrared (or heat) energy. Electrical Conductivity Gold is among the most electrically conductive of all metals. a single ounce of gold can be drawn into a wire five miles long. This makes gold a vital component for electrical connectors in computers and telecommunications equipment. L. Since electricity is essentially the flow of charged particles in a current. Thermal Conductivity N. For example. Ductility and Malleability Gold is the most ductile of all metals. Gold's malleability is also unparalleled. allowing it to be drawn out into tiny wires or threads without breaking. metals that are conductive allow this current to flow unimpeded. Dalmia Institute of Management Studies and Research Page 8 . as in life-saving face shields for astronauts and firefighters. This makes gold ideal for heat and radiation reflection.Gold as a Strategic Asset mask in the tomb of Tutankhamen looked as brilliant when it was unearthed in 1922 as when it was entombed in 1352 BC.

Since many electronic processes create heat. It looks at all the major aspects of demand and supply. L. a 35% gold alloy is used in the main engine nozzle of the Space Shuttle.Gold as a Strategic Asset Gold is also an excellent conductor of thermal energy or heat. Dalmia Institute of Management Studies and Research Page 9 . one that has expanded considerably during its period of liberalization. Domestic Scenario India is the world’s largest gold market in volume terms. the role of the Reserve Bank of India and on the supply-side. new ways to invest in gold. gold is necessary to transfer heat away from delicate instruments. This report provides a broad overview of the gold market within the context of India’s new supercharged economy. For example. where temperatures can reach 3300° centigrade. Gold alloy is the most tenacious and long-performing material available for protection at these temperatures. including how the jewellery sector is being affected by the current social and economic changes. mine production and the scrap market. N.

the beginning of a long relationship between London and Bombay (now Mumbai) merchants. Only once has India been a significant dishoarded. first sent gold to India in 1676 to pay for diamonds. which became a staple form of international payment for over three hundred years. India. tea and cotton. and still is.244 tons was shipped out in the 1930s due to distress selling from famine and the new high price for gold (up from $20. Dalmia Institute of Management Studies and Research Page 10 . has always been 'a sink for precious metals'. sought by Mediterranean and European merchants. In recent times India has remained faithful to gold. when 1. a great market for gold – and also for silver. and later diamonds. The first gold ducats struck by the mint in Venice in 1285.67 to $35). During the American Civil War in the 1860s India imported almost 420 tons in payment for cotton exports because of disrupted American cotton crops. Both metals are closely woven into the social fabric.Gold as a Strategic Asset Background An historical perspective is useful in understanding why India has been for so long. Ever since Roman times the 'east' has been a source of silk and spices. the oldest member of the London gold market. While demand has increased substantially since the early 1980s due to general economic growth. mostly just passed through Spain on its way to the east. Mocatta. The English East India Company shipped 20 tons. annual consumption is N. to India between 1660 and 1690. went to the Levant and on to India. after Columbus discoveries. almost three years' world output then. especially in the rural areas where they are the basic form of saving. In the 17th century the Dutch and English East India companies sent gold and silver to India and Java to pay for goods. The gold and silver from the Americas. the saying goes. L.

The smuggling was a highly professional business. with its effect on the harvest. Dalmia Institute of Management Studies and Research Page 11 . usually as ten tola bars. Bharat and Hutti. has increased substantially. Since 1990. at which between 20 and 200 grams may be worn by the bride. but it was limited and often amounted to keeping a few bars ready to be made into jewellery for a family wedding. uniquely preferred in India. Certainly gold has been used to conceal wealth. The official import of gold into India. and Hong Kong. In an auspicious year there are upwards of ten million marriages. There was physical investment in smuggled ten tola bars. Gold investment essentially was in 22 carat jewellery. GFMS estimate that investment has exceeded 100 tons in some years. although it is hard to segregate true investment from stocks held by the 16. In the 1990s. encouraged by a premium of 30 per cent over the London price. especially during the mid-1990s. involving up to 200 tons.Gold as a Strategic Asset dictated both by the monsoon. was banned from 1947. Over 3. the main demand was met by smuggling from the regional markets of Dubai. investment in small bars. the Gold Control Act forbade the private holding of gold bars in India. however. Singapore. deregulation of the market has finally taken place.000 tons has entered India unofficially since 1947. With local production of less than two tons from two small mines.000 or more gold dealers spread across India. when the local N. together with recycling. ushering in the modern market of today. which have proliferated from local refineries. L. The status of a family in its community is still often judged by the gold exchanged as the bride's dowry. Until 1990. however. The Gold Control Act of 1962 also forbade private holding of gold bars. both imported ten tolas and locally-made small bars. and the marriage season.

which is practiced by around 80% of the population. is said to have been bathed by elephants who carried pure water in golden vessels. Hindus consider gold an auspicious metal. L. the most widespread faith being Hinduism. which they like to buy or gift during religious festivals. who symbolises fertility. The goddess Lakshmi. The origins of gold demand Indian gold demand is firmly embedded in cultural and religious traditions. Gold is seen as a symbol of wealth and prosperity in the Hindu religion.Gold as a Strategic Asset rupee price increased steadily. The country has one of the most deeply religious societies in the world. with gold coins flowing from her hands. Dalmia Institute of Management Studies and Research Page 12 . Since it is suggested that those who worship her gain wealth. dressed in gold-embroidered red clothes. It was also augmented in 1998 when over 40 tons of gold from bonds originally issued by the Reserve Bank of India were restituted to the public. productiveness and prosperity. She is depicted as a beautiful woman of golden complexion. N.

falling in April or May. Gold also plays an important role in the marriage ceremony. as Hindu tradition dictates that the family’s assets are only passed down to sons. where around 70% of the population lives. N. Since 2005. Not all gold demand is allied with cultural and religious beliefs. Over the past five years. Akshaya Thrithiya. especially in the State of Tamil Nadu. where sales have reached record levels. would have been more than protected against inflation. Indeed. Most of this will be a gift from her parents as a way of giving her some inheritance. has also become an important day to buy gold. which has also resulted in a significant rise in gold sales in these regions. The gold (and other gifts) the bride receives or her “Streedhan” (“Stree” meaning woman and “dhan” meaning wealth) mean her parents can make sure she is financially secure and enjoys at least the same standard of living to which she was accustomed in her childhood. Dalmia Institute of Management Studies and Research Page 13 . L. Akshaya Thrithiya has become a major gold-buying occasion in the South of India. for example. Gold has the added virtue of being an inflation hedge. Purchases on this day are considered auspicious (it is the third most auspicious day in the Hindu calendar). The association between gold and “auspiciousness” has been used in recent years to promote the idea of buying gold. it is customary for the parents of a baby girl to start accumulating gold for this purpose soon after the child is born. the idea has been promoted across the North and West of the country. which marks the beginning of the Hindu New Year and usually takes place in October or November.Gold as a Strategic Asset The most important of these is Diwali. An investor who had bought gold in 1970. where brides are often adorned from head to toe in gold jewellery. Gold is also viewed as a secure and easily accessible savings vehicle by the rural community.

L. This is because the Rupee is not yet fully convertible – Indians are only allowed to hold financial assets in Rupees – whereas they have been allowed to hold gold since 1990 when the Gold Control Act was repealed. thanks to the progressive liberalization of its economy and the consequent inflow of foreign direct investment. A noticeable feature of India’s development has been the strength of its domestic economy relative to most emerging markets in Asia. Dalmia Institute of Management Studies and Research Page 14 . But there are new ways to invest in gold. India is now the fifth largest economy in the world (on a PPP basis). The major developments include arrival of Exchange Traded Funds (ETFs). which has accounted for the lion’s share of growth over the past decade Ways to buy gold Traditionally most investment has taken the form of physical gold. Recent Economic Trends The Indian economy has enjoyed rapid growth over the past decade. which has allowed the economy to start reaping the benefits of globalization on a truly massive scale. like UTI Asset Management Company Ltd and Benchmark Asset Management N. This is particularly true of consumer spending.Gold as a Strategic Asset Gold is also one of the limited ways in which Indian investors can diversify their currency exposure. the two largest being the Multi Commodity Exchange of India Ltd (MCX) and the National Commodity and Derivatives Exchange Ltd (NCDEX). Since October 2003 the government has allowed futures trading and there are now three futures exchanges.

The funds were used to help India meet N. under the Reserve Bank of India Amendment Act 1956. as the value of existing gold reserves were revised up at the time). The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin. 400 million in value held in gold. to the minimum reserve system. and to buy and sell that interest through the trading of a security on a regulated stock exchange. 1150 million equates to just $24. They are listed securities that are backed by allocated gold held in a vault on behalf of investors and are intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold. gold bullion and foreign securities.1150 million of its assets in gold (this did not imply the need to acquire additional gold. Dalmia Institute of Management Studies and Research Page 15 .Gold as a Strategic Asset Ltd. The Reserve Bank of India The Reserve Bank is required to hold a fixed amount of gold under the Reserve Bank of India Act. India shipped a total of 47 tones of the country’s gold reserves (the RBI is allowed to hold up to 15% of its total gold reserves outside the country) to the Bank of England as collateral against a $400 million loan and leased a further 20 tones of confiscated gold (not included in the reserve figures) to Union Bank of Switzerland with a six month buyback option to raise a $200 million loan.7 million at today’s exchange rate and is tiny in comparison to India’s total foreign exchange reserves. L. India mobilized its gold reserves during the 1991 balance of payments crisis. These instruments give investors a relatively cost efficient and secure way to access the gold market. The system was later amended. Rs. that required the bank to hold at least Rs. Between May and July. with not less than Rs.

The other major operation – the Kolar Gold Fields – closed in April 2000 having produced a total of 800 tones of gold. but its output is small.2 tones a year. should. Meanwhile. which produces around 3 tones of gold a year. Its dynamic population growth and strong cultural and religious affinity to gold will continue to underpin structural demand. the balance being made up by imports. L.Gold as a Strategic Asset its short-term debt obligations and import bill. and as the government has now opened the mining sector to foreign direct investment. thanks to the influx of foreign capital. It also revalued its gold reserves from Rs. 72 billion. 28 billion to Rs. at just 0. The RBI bought back all 67 tones of gold later that year. continue to boost discretionary spending on gold. rapid income growth. In summary. Hindustan Copper also produces some gold as a by-product. Still. notwithstanding temporary fluctuations associated with spikes in price N. Mine production There is a huge mismatch between demand and primary supply in India. Dalmia Institute of Management Studies and Research Page 16 . there is scope for some catch up in the future. as it moved from using an outdated gold price to valuing its reserves at close to the international market price. like South Africa and Australia. as the geological terrain of India is very similar to other major gold producing countries. India looks poised to remain the world’s foremost gold consumer in tonnage terms for many years to come. owned by state owned Hutti Gold Mines Company Limited. in tandem with new successful marketing campaigns. The only major gold mine currently in production is the Hutti mine.

assaying. as aside from the scrap market. but it is believed that at least 16. are insignificant.000 tons of gold rest in India – or approximately ten per cent of the worlds cumulative mine production.K. Switzerland.. Use of gold as a financial product is N. Hong Kong. L. A part of gold was used by RBI (in parallel with gold with Government) for raising foreign currency resources during the balance of payments crisis in the early 'nineties. India’s demand will continue to be satisfied almost entirely from imports. unlike many other countries including some developing economies.Gold as a Strategic Asset volatility. RBI is neither a speaking purchaser nor a seller of gold reserves. India and Global Gold Economy Estimates vary.6 per cent in world trade. The world gold trading is concentrated in the U. Dalmia Institute of Management Studies and Research Page 17 . These overseas gold holdings are being used as part of reserve management to yield a return. Government of India has in its possession some amount of gold mainly out of confiscation of smuggled gold remaining after transferring it to the Reserve Bank of India from time to time. very little supply comes from domestic sources. and India does not figure among them. especially in Asia. etc. as compared to the rest of the world. Facilities for refining. both qualitatively and quantitatively. making them into standard bars in India. Dubai. This should be viewed against its share of 0.

L. Indian jewellery off take is sensitive to price increases and even more so to volatility. Gold as Investment Vehicle Gold is valued in India as a savings and investment vehicle and is the second preferred investment behind bank deposits. Dalmia Institute of Management Studies and Research Page 18 . and coin and bar demand dropped to 67 tons. however. although this decline in tonnage since 1998 is also due in part to increasing competition from white and brown goods and alternative investment vehicles. in 2002. this dropped back to 490 tons. N. however. Commercial banks. but no advances are permitted for purchase of gold by their customers for non-productive use. In 1998-2001 inclusive. not least because inheritance laws in the middle of the twentieth century lent a great desirability to anonymity. annual Indian demand for gold in jewellery exceeded 600 tons. The hoarding tendency is well ingrained in Indian society.Gold as a Strategic Asset virtually non-existent in India except to a limited extent of issuing ‘Gold Bonds’ by Government of India from time to time coupled with occasional tax amnesty. India is the world’s largest consumer of gold in jewellery (much of which is purchased as investment). but is also a reflection of the increase in price. accept gold as security. due to rising and volatile prices and a poor monsoon season.

7 banks were selected for this purpose on the basis of certain specified criteria like minimum capital adequacy. previous experience in this area. L. 13 banks are active in the import of gold.Gold as a Strategic Asset Developments in India World Gold Council (WGC) has estimated that the annual Indian demand for the precious metal in recent years has been in excess of 800 tons. since five banks had not evinced adequate interest in this business in terms of activity. The quantum of gold imported through these banks has been in the range of 500 tons per year. the RBI did not find it appropriate to renew their licenses for this purpose. Initially. profitability. and the rest. The number of banks later went up to 18. is possibly meant to meet demand on account of investment and industrial processes. Most of it appears to be meant for jewellery fabrication. A major step in the development of gold markets in India was the authorization in July 1997 by the RBI to commercial banks to import gold for sale or loan to jewellers and exporters. risk management expertise. estimated at 10 to 15 percent. On a review. Dalmia Institute of Management Studies and Research Page 19 . N. etc. At present.

the system of assaying and hallmarking has not gained the desired importance. The major objectives of introducing a proper assaying and hallmarking system in the country are enabling consumer protection. which was Rs. In the recent past. Even though the country consumes more than 800 tons of the metal every year. which will help N. and with effect from April 2001 has been reduced to Rs. was increased to Rs.000 to Rs. Recent surveys conducted by the Bureau of Indian Standards (BIS) jointly with Central Consumer Protection Council in 5 major cities reveal that more than 80 per cent of the jewellery being sold in the market was of lower purity than claimed and charged for. In some cases.250 per ten grams. Dalmia Institute of Management Studies and Research Page 20 .000 crore per annum since 1997. 2. the gold articles sold were 38.6 per cent short in purity in monetary terms. It has also resulted in reducing the disparity between international and domestic prices of gold from 57 per cent during 1986 to 1991 to 8. developing export competitiveness of the gold jewellery industry. The import duty on gold. The estimates of duty realized from gold imports indicate an annual amount varying from about Rs. The low quality of gold jewellery being sold in the country and the resultant losses being incurred by the consumers are being recognized now.Gold as a Strategic Asset Import of gold by banks authorized by the RBI has succeeded to a large extent in curbing illegal operations in gold and in foreign exchange markets.5 per cent in 2001.220 per ten grams up to January 1999. The low purity results in a loss of around 16 per cent to gold jewellery. 1. L. introducing gold based financial products.400 per ten grams. RBI has been actively pursuing the issue of upgrading the quality of trade and products through a system of assaying and hallmarking with Government of India and BIS.

prominent among them being depositors’ losing the making charges spent on jewellery (as the banks would convert them into primary form before accepting as deposits). Dalmia Institute of Management Studies and Research Page 21 . The Government of India announced the Gold Deposit Scheme in 1999 and RBI issued guidelines to the banks intending to launch the scheme in October 1999. Unfortunately. A number of reasons can be cited for the low response. the scheme has not evoked the expected response. Here one could see three patterns: Producer nations like South Africa. have on the other hand. played significant roles in furthering the development of gold markets. N.Gold as a Strategic Asset in mopping up the vast dormant gold resources with the domestic sector and developing India into a leading gold market centre in the world. low rate of return on deposit (as seen by the depositors) and the absence of any amnesty. Five banks have launched their schemes under the guidelines and the quantum of gold mobilized so far has been about 7 tones. Role Played by International Authorities The authorities of different countries. the low caratage of jewellery. L. Australia and Brazil have shown keen interest in the development of spot and forward market in their respective countries mainly with the intention of providing financial products to the producers.

Turkey has quite a few parallels with India in respect of gold i. Switzerland. In Turkey.500-10. The Istanbul Gold Exchange was set up in July 1995 to help bring into the economic mainstream the huge quantity of gold held by the private sector. Financial centers like the U. while in India the same is placed at 7.000 tons. N. these authorities have promoted this market also. the private sector holding is estimated at 5. and large private sector holding.000 tones. In Turkey. like India. Dalmia Institute of Management Studies and Research Page 22 .K. Turkey liberalized its gold control regime by throwing open imports. While in the UK and the USA. the market is designed to be used by residents and non-residents alike the focus in Singapore is on providing service to offshore entities in Singapore and non-residents. the USA. Turkey seems to have high income elasticity of demand for gold. since a liquid forward market in gold (for enabling the producers to sell their product forward) presupposes the existence of a leasing market.. L.e. There are direct benefits to the countries concerned in the form of value addition in the products. the gold market has recently been liberalized. In early 1995.Gold as a Strategic Asset Also. Further. Hong Kong and Singapore have actively promoted gold related products to be traded at these Centers. employment etc. no significant domestic output.

annually consuming all gold that is newly mined. gold jewellery is more a mass. L.market product. Jewellery fabrication is the crucial cornerstone of the gold market. As Pihder wrote nearly 2. it is usually mixed. "Gold is the child of Zeus.Gold as a Strategic Asset Gold-based paper is sought to be introduced there as also the setting up of a gold refinery with international accreditation for providing refining services to the gold producing countries in Central Asia. After liberalization of gold imports. now the right step forward would be to develop a forward market of gold in the country and thus integrate the same with the mainstream financial sector. not just for adornment. A harder alloy is made by adding nickel or a tiny percentage of titanium. but it tends to be vulnerable to scratching. white shades are achieved by alloying gold with silver. neither moth nor rust devoureth it". N. but as symbols of wealth and power.500 years ago. Today. with other metals. The skills of the goldsmith from ancient Egypt to Benvenuto Cellini or Carl Faberge still amaze us. Pure gold is used in those parts of the world where jewellery is purchased as much for investment as it is for adornment. its beauty and the ease with which it could be worked inspired craftsmen to create it into ornaments. red alloys contain mainly copper. While in India the concerned authorities are still yet to play an active role in developing gold market domestically on sound lines and linking such markets with the financial sector. or alloyed. Gold Jewellery From the first discoveries of gold in ancient times. although in many countries still treasured as a basic form of saving. nickel or palladium. Elsewhere. Not only do they harden it. but influence the colour. Dalmia Institute of Management Studies and Research Page 23 .

These craftsmen were producing exquisite items as early as 1200 BC and their art reached its zenith during the Chimu civilization from the 12th to the I5th centuries AD. whereby items are decorated with tiny granules of gold. In the 20th century gold jewellery has come within the pocket of most people. however.19th century ushered in a new dimension of gold supply. Articles displaying various techniques such as repousse. which inhabited what is now southern Iraq around 3000 BC.Gold as a Strategic Asset The earliest known gold jewellery dates from the Sumer civilization. The Minoans on Crete produced the first known cable chain. afforded only by the wealthy. L. The Italian Renaissance coincided with the discoveries of the New World sources of gold. still very popular today. with the development of machinery for making chain and other articles and of a much wider consumer market. halted only by the mass looting and slaughter by the "conquistadors". using over 400 tones of gold annually. by the 7th century BC. The Spanish acquisition of South American gold. But the gold rushes to California and Australia in the mid. Italy has remained at the forefront of the gold jewellery industry. which has become jewellery manufacturer to the world. They coincided. gold was a rare metal. was achieved at the expense of the ancient heritage of Pre-Columbian goldsmiths. alloying and casting have been found in ancient Egyptian tombs. Historically. Dalmia Institute of Management Studies and Research Page 24 . with the best known examples coming from the treasures of King Tutankhamen who died in 1352 BC. The way ahead was pointed by Italy. and wealthy Italian patrons encouraged goldsmiths as they did painters and sculptors. more than N. too. and the Etruscans in Italy had developed granulation. chain making.

22 carat articles are bought on a low mark-up of only 10-20 per cent over the gold price of the day. L. Measures of consumption and fabrication are made more difficult because N. for new articles. The continuing success of the mining industry is inextricably linked with the fortunes of the jewellery trade. which requires several hundred tones a year. Between 1970 and 1992 around 65 per cent of all gold available to the market was used in jewellery. Attitudes to jewellery still vary. Since 1991 over 2. more often.Gold as a Strategic Asset two. and may be traded in at a profit if the price rises or. Malaysia and Thailand. Bassoon del Grape and Vicenza. it absorbed much of the rise in production.000 tones of gold has been used annually.thirds of it for export. using around 100 tones a year. Indian Gold Jewellery Market India is the world's foremost gold jewellery fabricator and according to GFMS. In the industrial countries gold jewellery is primarily a fashion item. and from the late 1980's into the 1990's. Important new centers emerged in the early 1990s. But in the Middle East and much of Asia gold ornaments are seen equally as investment. Singapore. notably in Hong Kong. Dalmia Institute of Management Studies and Research Page 25 . In Japan jewellery fabrication for the domestic market has become a major industry. catering particularly for the rapidly growing market for chukka am (pure gold) jewellery in China. The importance of jewellery to the gold mining industry cannot be under-estimated. Factories often housing several hundred machines that "knit" gold wire into chain flourish in the towns of Aires.

Plain 22 carat jewellery is the core of consumption especially in the rural areas. A basic marriage set for a N. GFMS estimates are that official gold bullion imports in 2001 were 654 tons. Estimates for this recycled jewellery vary between 80 tons and 300 tons a year. 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. and in 2001 stood at over 60 tons.Gold as a Strategic Asset 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. L. Exports have increased dramatically since 1996. Dalmia Institute of Management Studies and Research Page 26 . where gold is so important in judging a family's status at a marriage.

mostly family-owned. The Bureau of Indian Standards has introduced a voluntary scheme which.2 oz). although not yet widely used. Dalmia Institute of Management Studies and Research Page 27 . one ring. charms and small gift items account for up to half of what is loosely called jewellery. is becoming more popular. one necklace and two bangles. installing the latest equipment.000 workshops supplying over 300. Gold thread.e.Gold as a Strategic Asset Bride is two earrings. These items are popular as gifts at weddings and other family events. Medallions. The industry is beginning to be modernized with large factories. in centers such as Mumbai. Studded (i. all in 22 carat gold and weighing up to 200 grams (6. gem-set) 18 carat jewellery is increasingly popular in the cities. Ahmadabad and Bangalore. The market is highly fragmented with an estimated 100. known as Jari used in high quality saris worn at weddings and special occasions requires somewhere in the region of 20 tonnes (0. The minimum legal caratage is 9 carat.000 retailers. Hallmarking does not exist in India and under-caratage is commonplace. Features of India’s Gold Economy N. The number of retail jewellery outlets has increased greatly since the abolition of gold control. as has the number of Indians possessing gold jewellery. L. single shop operations. one nose pin.6 m oz) annually.

In the near future. The annual consumption of gold which was estimated at 65 tons in 1982 has increased to 505 tons in 1995. however. while there are no authentic estimates. N. It will be difficult to prioritize them but it may be reasonable to conclude that it is a combined effect. What is of contemporary interest. There is reason to believe that a part of investment demand for gold assets is out of black money. relate to the demand.Gold as a Strategic Asset India has been known to possess large stocks of gold and studies show that they are mostly accumulations from centuries of trading rather than result of production of her mines. therefore. and to treat any major part as exclusively a store of value or hedging instrument would be unrealistic. on the demand side. the annual demand will continue to be high at around 400 to 500 tons. etc. Religious. 15 per cent is for investor-demand (which is relatively elastic to gold-prices. tax-policies.) and barely 5 per cent is for industrial uses. the available indications are that about 80 per cent is for jewellery fabrication (mainly of over 22 carat purity) for domestic demand. supply and price-movements and their link with policy. financial markets. Some broad generalizations on these aspects would be appropriate to review the policy and identify the issues. Dalmia Institute of Management Studies and Research Page 28 . real estate prices. ritualistic a preferred form of wealth for women and as a hedge against inflation. First. it would be made good by growing demand on account of prosperity in rural areas. particularly in urban areas. The demand for gold jewellery is rooted in the societal preference for a variety of reasons viz. Although it is likely that with prosperity and enlightenment. L. Nor would it be realistic to assume that it is only the affluent that create demand for gold. there may be deceleration in demand.

6 per cent during 1981-85 and further to 56. In the post-liberalization period. L. following the oil crisis. especially involving private sector. In the face of a virtual ban on official import of gold for domestic consumption till 1990.3 per cent during 1977-79 which rose to 46. around 2 tons per year.Gold as a Strategic Asset Second. the persistent weakening of the US dollar resulting in flight of dollar resources into gold and accelerating world-wide inflationary trends. While currently there are some efforts to promote gold mining domestically. the rising demand was met by illegal imports. smuggled gold into India varied in the wide range of 10 – 217 tons per year with the sole exception of 1980 when 9 metric tons were reported to have been smuggled out of the country to take advantage of the soaring gold prices in the international market. the rising demand has to be sourced from outside the country.6 per cent during 1986-91. During the period 1968 . with changes in the exchange rate regime N. The average spread was as high as 41. However. the strong domestic demand for gold and the restrictive policy stance are reflected in the higher price of gold in the domestic market compared to that in the international market at the available exchange rate. as the domestic production of gold is very limited. and supply from fabricated old gold scraps estimated at around 62 tons per year being not adequate. there are no indications that domestic supply would increase in any perceptible manner. the average spread between Mumbai and London market prices (Mumbai price less London price in rupee terms) of gold has been positive except for a brief period during 1980-81 when the international gold price zoomed briefly. Third. During the 19-year period from 1977-78 to 1995-96. Dalmia Institute of Management Studies and Research Page 29 .1995. the situation changed drastically during the ’nineties since the proportion of smuggled gold in our total supplies has gone down substantially.

4 billion in 1995 while that of smuggled gold was in the range of $ 1.25 billion in 1992 to $ 3. etc. and in the recent times. N.5 per cent in 1996 (up to October). In the absence of open import. storage cost. Fourth. Viewed from any angle. the value of gold imports through official channels increased from $ 1.6 per cent in 1993. transportation cost. 19.7 billion.9 per cent in 1995 and further to 17. especially mobilization of domestic gold has attracted attention. in terms of importance in our foreign trade.1 per cent in 1991 to 20. as the policy-debates would show. the domestic gold prices relative to international prices appear to have been governed by two factors: (i) the spread between the official and market exchange rate of the rupee and (ii) the customs duty. gold import has emerged. L. the average spread between domestic and international prices has come down from 53.2 to $ 1. use of gold as a financial instrument. the management of demand and supply of gold has important policy implications for fiscal policy and exchange rate management. only second to that of oil. Dalmia Institute of Management Studies and Research Page 30 .Gold as a Strategic Asset and some relaxations on the import regime of gold. risk premium. Fifth.1 per cent in 1994. 20.

making it compulsory for gold smiths to be licensed and submit accounts of all gold received and utilized by them etc. regulating the supply of gold. N. it was thought as an impossible proposition. Dalmia Institute of Management Studies and Research Page 31 . it was felt in some circles that it would be feasible to make a frontal attack on demand for gold in India. viz.70 tones.1 tones. the measures met with lot of resistance and criticism. The Government decided to sell confiscated gold in small quantities through the RBI. it did not have any major impact on smuggling. Accordingly. Official imports to discourage smuggling was first mooted in 1977 but viewed against the forex reserves available then. banning the making and selling of jewellery above 14 carats. Bullion imports and exports were also banned but restrictions on import of gold into the country resulted in the flourishing of smuggling and unofficial transactions in foreign exchange.Gold as a Strategic Asset Indian Gold Policy The evolution of the gold control policy since independence was centered on some major objectives. the Gold Control Order 1962 was issued. However. In the wake of the Chinese war.. weaning away people from gold. Various schemes for mobilization of idle gold holdings have been implemented by the Government and RBI in the past.. A second attempt to garner gold was made through the 7 per cent Gold Bond 1980 Scheme (March 1965) which could mobilize only 6. L. but with little success. The 15-year Gold Bonds at 6 1/2 per cent (November 1962) could mobilize only 16. reducing the domestic demand and prices and curbing smuggling. This coupled with administrative complexities resulted in the failure of the Gold Control order.

special import licenses. gold import is permitted through three official channels viz. It is but natural that NRI route had become less attractive after the banks have been permitted to import gold. non-resident Indians and authorized banks and institutions. attempts to mobilize gold under various schemes have not evoked the desired response. the elimination of large unofficial market in forex has improved the policy effectiveness. but this argument ignores the fact that gold has some characteristics of a currency. However. In this regard. there is another view which holds that both gold import and export should be totally freed. At the level of managing external sector and forex markets. Past experience does not seem to favor this negative view. The liberalized gold policy has certainly brought to the official sector what originally was an unofficial sector. Thus. Without doubt.Gold as a Strategic Asset The third series designated as National Defense Gold Bonds 1980 (1965) garnered 13. there are some who argue that ban on gold imports should be reimposed.7 tones and the Gold Bond Scheme 1993 garnered 41 tones of gold. Import of gold through Special Import License (SIL) has been negligible after gold import through banks was permitted. while a few others argue that the duty be hiked on the assumption that such measures would curb the total import bill on account of gold. N. it has eliminated illegal transactions and profiteers out of such illegal transactions with attendant socio-economic impact of such large scale and high value market involving cross-border operations. Dalmia Institute of Management Studies and Research Page 32 . Currently. L.. Even after two years of launching the scheme under the recent Gold Deposit Scheme (1997) the mobilization is around seven tones only.

In 1993 the Foreign Exchange Regulation Act was repealed. The first step in this process was to allow import and export of gold under Open General License and the banks involved had to fulfill certain specific criteria.56/ounce or 4. Meanwhile in 1997 the Committee on Capital Account Convertibility recommended that the market should be liberalized. The repeal of the Act was part of the economic reform process that took place in the wake of the balance of payments crisis of 1990 and 1991. but also that a well-regulated and transparent market should be developed. L. implemented in 1968 and abolished in 1990. but reflected a more pragmatic attitude towards gold and silver. had forbidden the holding of gold in bar form. There are currently approximately twenty such banks operating in the market. and allowed the government to restrict dealings therein prior to. Dalmia Institute of Management Studies and Research Page 33 . import). Also in 1993 the government permitted non-resident Indians to bring 5kg of gold into the country twice yearly on the payment of import tax of Rs. both executing international trade in gold and selling and leasing the metal for domestic Indian use. which had little tangible impact (the Act had treated gold and silver as foreign exchange for foreign exchange control purposes. The allowance was raised to 10 kg per trip in January 1997.2%).Gold as a Strategic Asset The Regulatory Steps The Gold (Control) Act. These include local banks ICICI Bank and N. 250 per 10 grams (at current rates this equates to US$14. or at the point of.

or…. notably on some rough and half-cut stones. both of which are enthusiastic about the developments in the market and are looking to drive developments forward. accounting for 95% of imports. Additionally. 1997 Open General Licence (OGL) was introduced.Gold as a Strategic Asset HDFC bank.7 oz) on payment of a small duty of six per cent. Dalmia Institute of Management Studies and Research Page 34 . paving the way for substantial direct imports by local banks from the international market. The move. L. Ten tola bars are still the preferred form of gold in India. significant temporary imports are permitted under an Export Replenishment scheme for jewellery manufacturers working for export in designated special zones. pushing down the local premium and making smuggling less profitable. is designed to N. This allocation was raised to 10 kilos in 1997. which was accompanied by a reduction in customs duties on diamonds. Imports were then permitted in three stages. 1994 Gold dealers could bid for a Special Import Licence (SIL) which was issued for a variety of luxury imports. In the 2003 budget the Finance Minister reduced the customs duty on ‘serially numbered bars. 1992 Non-Resident Indians (NRIs) on a visit to India were each allowed to bring in up to 5 kilos (160. gold coins’ from Rs. thus partly eliminating the regional supplies from Dubai. The OGL system has also largely eclipsed imports by NRIs and SILs. 250 per 10 grams to Rs. 100 per 10g. Singapore and Hong Kong. In 2001 unofficial imports fell because of a reduction in import duties.

which would reduce the metal to scrap form. is rapidly coming to life. the development of gold-related financial instruments. after which premature encashment would be permitted. Dalmia Institute of Management Studies and Research Page 35 . If the deposit is made. L. This has however gathered little momentum as members of the public continue to show a preference for holding their gold in physical form rather than a paper representation. The slow N. including Saudi Arabia. At that stage. although there was also an initial lock in period of one year. or ‘TT’ bars are popular elsewhere. if the renderer does not agree with the assay results or wishes to withdraw for any reason then he may do so. The terms available offer interest rates over a range of lock-in periods from three to seven years. It does not include ten tola bars. To qualify for the lower tax.Gold as a Strategic Asset enhance India’s already important role in the world’s jewellery industry. which have for years been the favored bar for hoarding in India (this is partly historical because their design made them particularly suitable for carriage by smugglers). Under the scheme the State Bank of India takes local gold deposits and issues interestbearing gold term deposits in return (and allows local banks to lease the metal to jewellers). The lock in period has also deterred would be investors. which was launched in October 1999. then the metal is melted and subjected to full assay. the bank had been looking for 100t in the first twelve months of the scheme. The one blot is perhaps the poor performance of the Gold Deposit scheme. Gold in any physical form can be tendered and is subject initially to a non-invasive assay (no effect on the piece in question). Roughly eight tones have so far been mobilized. the bars should have their weights expressed in metric form. The second phase. many have now been melted down in favor of metric bars. Although ten tola.

small saving schemes etc. The study led to the conclusion that the first two factors i. Unaccounted income/wealth generated mainly in the service sector. 2. L. Price variation in gold and 5. 1999) the factors determining the demand for gold were studied. tested five factors for their influence on demand for gold. February 20. from 3-4% to 1. units of UTI. Price of other commodities. These five factors are 1. 3. In another analysis made by Shri Vaidyanathan in 1999. GDP N. Research in Gold Markets A DRG study (Gold Mobilization Instrument as an External Adjustment) prepared in the RBI in 1992.5% because of the low interest rates prevailing in the international gold market. which further suggests that uptake is likely to remain sluggish. 4. Dalmia Institute of Management Studies and Research Page 36 .e. rural surplus and unaccounted income in the service sector have far more influence on gold demand than the other factors.Gold as a Strategic Asset uptake of the scheme has meant that leasing to jewellers remains comparatively limited. domestic price of gold. ratio of household financial savings to national product. The State Bank of India (SBI) cut the rates payable on these deposits in April. Generation of large market surplus in rural areas as a result of all round increase in Agricultural production. The parameters taken into account were GDP. (Economic and Political Weekly. Comparative rate of return available on alternative financial assets like bank deposits.

N. but. He holds the opinion that the consequences of the gold liberalization policy could be alarming. has been holding the view that a capital starved country like India cannot afford to utilize foreign exchange on a commodity like gold. index of ordinary share prices and the difference between domestic and foreign price of gold as percentage of international prices.Gold as a Strategic Asset deflator. especially in view of the fact that such imports of gold are unrelated to India’s exports of jewellery.A. in many of his articles. Dr. a return of less than 6 per cent for a saving instrument would induce the saver to invest in gold. Saumitra Chaudhuri (Financial Express. Dalmia Institute of Management Studies and Research Page 37 . L. The study established that gold imports tend to be higher when domestic gold prices rise relative to those of ordinary shares and international gold prices. N. the effect of these two variables was pronounced during 1991-96 as compared to 1970-90. 2001) made an analysis of the possible choices for a saver between interest bearing financial instruments and gold. Mr. Mazumdar. He advocates that in Indian conditions. November 26.

33/oz to US$871. Dalmia Institute of Management Studies and Research Page 38 . L. Gold ended the year at US$869. amid one of the most tumultuous years in financial markets since the Great Depression.75/oz. while the average gold price rose by $175. on the London PM fix.Gold as a Strategic Asset Gold Price movement s The gold price rose for the eighth consecutive year in 2008. $36/oz higher than end-2007. N.85/oz.

Lehman N. The gold price traded lower for the next two months. on the London PM fix. with Lehman Brothers. before spiking back up to $905/oz on 29 September. It tested this record again in the third quarter. trading as high as US$986/oz on 15 July. The gold price reached a new record in the first quarter of the year. L. for example. Dalmia Institute of Management Studies and Research Page 39 . lost approximately half their value over the course of last year. the day after the US Treasury and Federal Reserve Bank announced plans for a joint bailout of mortgage giants Fannie Mae and Freddie Mac.Gold as a Strategic Asset Gold’s performance is especially impressive considering the massive wealth destruction that took place elsewhere in financial markets. This followed two weeks of disastrous news from the financial sector. of US$1011/oz on 17 March. Global equities and many commodities. Merrill Lynch. driven by safe-haven inflows in the run up to the Bear Stearns crisis. AIG and Washington Mutual all announcing that they could no longer function in the current credit environment. the day the US House of Representatives rejected a US$700 billion rescue plan for the US financial system.

50/oz on 8 October. nickel. on the London PM fix. gold ended the year on a firm footing. 57% and 56% respectively. N. to close at US$869. Dalmia Institute of Management Studies and Research Page 40 . up 4% from end-2007. gold spiked back to US$903.50/oz on 24 October. and AIG and Washington Mutual were bailed out by the US government. The sharpest declines were posted in lead. palladium –49% and platinum –39%). gold was the only one to increase in price last year. Each of the other precious metals also fell sharply (silver –27%. This was followed by a sharp sell off. Of the 17 commodities that we regularly monitor. Merrill Lynch was taken over by Bank of Amercia. as six of the world’s leading central banks made an unprecedented coordinated emergency cut in interest rates. in a clear signal of just how bad financial and economic conditions had become.Gold as a Strategic Asset Brothers was allowed to fail.75. rallying by around $150/oz in the final two months of the year. Gold’s price performance is especially impressive when juxtaposed against other commodities. taking the gold price to an annual low of US$712. copper and oil. 58%. After a brief pull back. which fell by 63%.oz. However. L.

Still. N. Although daily fluctuations in the gold price eased thereafter. measured on a 22-day rolling basis. L. gold traded in a tighter range than other financial assets and most other commodities.Gold as a Strategic Asset Volatility Gold price volatility increased in the early part of Q4. at 37% (gold’s long-run price volatility is around 12.5%). reaching an annual peak of 53% on 17 October. Dalmia Institute of Management Studies and Research Page 41 . price volatility remained high by historical standards at the end of the year.

Dalmia Institute of Management Studies and Research Page 42 . before ending the year at 50%. reached a high of 88% during Q4. N. to 51% by year end. and ending the quarter at 75%. with 22-day price volatility spiking to 84% during the quarter. Oil prices were also considerably more volatile than gold prices during Q4.Gold as a Strategic Asset Volatility in the S&P 500 index. which is heavily weighted towards energy prices. This also pushed up the price volatility of the benchmark GS Commodity Index. for example. L.

Dalmia Institute of Management Studies and Research Page 43 .Gold as a Strategic Asset Gold Demand JEWELLERY N. L.

Dalmia Institute of Management Studies and Research Page 44 .Gold as a Strategic Asset The third quarter witnessed a recovery in global jewellery demand after three quarters of relative weakness. The most compelling reason for the rise in jewellery demand was the price movement during the quarter. the Middle East (+15%) and China (+10%) were partly offset by large declines among other countries. A comparison with Q3 07 reveals a more subtle rise of 8%. especially in India where lower local gold prices. Consumers across many countries were eager to take advantage of more affordable gold prices. as strong rises in some countries – notably India (+29%). as well as a feeling of enhanced wealth among the rural community following a good monsoon rainfall. although in dollar terms this translates into a 38% increase. however. L. brought consumers flocking to the market. most notably the US (-29%).6 tonnes. N. Demand jumped 27% from Q2 to 647. The rise in jewellery demand was by no means universal.

is likely to have remained subdued in Q4. as consumers continue to adjust their spending patterns to take account of the past year’s wealth destruction. which runs from October to January.3 tonnes. with the annual decline a more accentuated 10%. Imports into India (a good proxy for overall demand. INDUSTRIAL APPLICATIONS Industrial demand for gold has been hit by the sharp slowdown in global economic growth. L. fell by 7% in Q3 relative to Q2 to 71. Dalmia Institute of Management Studies and Research Page 45 . as India mines only a very small amount of gold domestically each year) rose by 36% yearon-year in October and November. Demand for gold used in electronics. Western demand for jewellery. the largest component of industrial demand. N. on the other hand.Gold as a Strategic Asset India enjoyed buoyant sales during the mid-October Diwali festival and as the country entered the main wedding season.

in some cases. which slipped around a fifth relative to Q3 2007.7 tonnes. Demand for the other industrial and decorative segment was also weaker in Q3. over stocking of the supply pipeline has. N. the largest electronics market. driven prices down to below the cost of manufacturing. as demand for jari (gold thread) remains sensitive to price fluctuations. Dalmia Institute of Management Studies and Research Page 46 .8 tonnes. L. slumped almost 15% relative to year-earlier levels as fabricators reduced output due to an over supply of semi-conductor products. Gold used in dental applications is estimated to have declined by 11% relative to year-earlier levels to 12. particularly. to 19. Weakness was driven largely by the sharp fall in Indian off-take. slipping 16% relative to year-earlier levels.Gold as a Strategic Asset Demand in Japan. volatility was the catalyst for the decline. Indeed. Elevated gold prices and.

increasing by just 2% relative to year-earlier levels. A number of countries experienced a decline in production. reflecting. Dalmia Institute of Management Studies and Research Page 47 . the biggest of which was South Africa. the ongoing effects of power issues and the 6 month shutdown of the N. L. in part.Gold as a Strategic Asset Gold Supply MINE PRODUCTION Mine production is provisionally estimated to have been broadly stable in Q3.

Gold as a Strategic Asset
main shaft at Goldfields’ Kloof mine. Indonesia, Australia and the US experienced smaller declines in output.

Offsetting the reduced mine supply from these countries was an increase in production in China and Latin America, particularly Peru. De-hedging, which has had a downward impact on total supply for some years, reduced significantly in Q3. Producers cut hedge book positions by just 63 tonnes, compared with 128 tonnes in Q1 and 126 tonnes in Q2. With the outstanding hedge book now estimated, by GFMS, at just 526 tonnes, the downward effect on mine supply from de-hedging will continue to abate. However, the effect on total supply is likely to be offset by other factors. In particular, net central banks sales should remain at subdued levels and the constraints on mine supply are unlikely to ease. The credit crisis will continue to affect both exploration activity and potentially mine expansion, particularly among the smaller players.
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Gold as a Strategic Asset

CENTRAL BANKS Levels of official gold holdings continue to vary greatly by region. Asian central banks, for example, continue to hold little or none of their foreign exchange reserves in gold, and represent a source of potential growth in future gold holdings.

European central banks, on the other hand, who have vast amounts of gold as a legacy of the gold standard days, continue to reduce the percentage of gold in their reserves. These sales are covered by the second Central Bank Gold Agreement (CBGA2). In the fourth year of that agreement, which ended on 27 September 2008, signatories sold only 358 tonnes of the 500 tonnes annual ceiling the agreement provides for.

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Gold as a Strategic Asset
This was the lowest annual sales level since the first CBGA was signed in September 1999. So far in the final year of the agreement (sales announced as of January 9th), central banks have sold a further 48 tonnes. The main sellers have been France, which has sold 20 tonnes, and the Netherlands, which has sold 8 tonnes. A small amount of buying continues to take place outside of the agreement.

Performance of various Asset Classes
(Returns from 1st Jan 2008 till 29th Dec 2008)

EQUITY - BYE BYE BULL THE year 2008, saw a bad equity market in a very very long time! Here are the returns for a period of one year as on 29th December 2008. BSE Sensex: - 53.8 per cent NSE Nifty: - 52.9 per cent
N. L. Dalmia Institute of Management Studies and Research Page 50

had you been put in any of these debt instruments: Bank deposit: 8. The one-year returns as on 29th December 2008: Diversified equity funds: .48. Dalmia Institute of Management Studies and Research Page 51 . L. and the debt class in general.Gold as a Strategic Asset MUTUAL FUND . Here is what you would have made.35.75 per cent Public Provident Fund: 8 per cent Debt mutual fund (floating rate funds): 8.4 per cent THE HERO: DEBT PRODUCTS CLEARLY the winner was the good old fixed deposit.8 per cent N.NO LUCK WITH MUTUAL FUNDS THE loss in the stock markets was so large that no amount of fund management seemed to help! Mutual funds with exposure to the stock markets performed equally poorly.4 per cent Balanced mutual funds: .

L. the rupee only got weaker to the US Dollar. it is the traditional Indian favourite that has turned in handsome returns.81 per cent.Gold as a Strategic Asset THE SUPERHERO: GOLD THE undisputed winner . Dalmia Institute of Management Studies and Research Page 52 . The rupee started the year off with Rs 39 against the dollar but ended far weaker at Rs 49. N. However. it's cousin silver could not match up to the shine. USD: -19.GOLD! In these tough times.25 per cent Silver: -8 per cent CURRENCY: POOR PERFORMANCE THANKS to the collapse in the west. Gold: 29.

At the same time. the current account deficit has reached levels which have portended currency collapse in virtually every other instance in history. Alarming Financial Deterioration in the US In the space of two years. To facilitate this demand. a number of new vehicles like Central Gold Trust and gold Exchange Traded Funds (Elf's) are being created. which will see tangibles. which will persist as far as the eye can see.Gold as a Strategic Asset Fifteen Fundamental Reasons for bullish run of Gold Global Currency Debasement The US dollar is fundamentally & technically very weak and should fall dramatically. rise significantly in price. However. Investment Demand for Gold is Accelerating When the crowd recognizes what is unfolding. the federal government budget surplus has been transformed into a yawning deficit. we are in the early stages of a massive global currency debasement. L. Thus. they will seek an alternative to paper currencies and financial assets and this will create an enormous investment demand for gold. Negative Real Interest Rates in Reserve Currency (US dollar) N. other countries are very reluctant to see their currencies appreciate and are resisting the fall of the US dollar. Dalmia Institute of Management Studies and Research Page 53 . and most particularly gold.

interest rates have been dropped to rock bottom levels. Mine Supply is Anticipated to Decline in the next Three to Four Years Even if traditional demand continues to erode due to ongoing worldwide economic weakness. Dramatic Increases in Money Supply in the US and Other Nations US authorities are terrified about the prospects for deflation given the unprecedented debt burden at all levels of society in the US. due to a dearth of exploration in the post Bre-X era. Dalmia Institute of Management Studies and Research Page 54 . real interest rates are now negative and. Some of this gap has been filled by recycled scrap but central bank gold has been the primary source of above-ground supply. are expected to remain so for some time. There has been a very strong historical relationship between negative real interest rates and stronger gold prices. Fed Governor Ben Bernanke is on record as saying the Fed has a printing press and will use it to combat deflation if necessary. a shift away from high grading which was necessary for survival in N. industrial users. L. Mine supply will contract in the next several years. Other nations are following in the US's footsteps and global money supply is accelerating.) has exceeded this by a considerable margin for a number of years. according to statements from the Fed spokesmen.Gold as a Strategic Asset To combat the deteriorating financial conditions in the US. the supplydemand imbalance is expected to persist due to a decline in mine supply. irrespective of gold prices. etc. Existence of a Huge and Growing Gap between Mine Supply and Traditional Demand Gold mine supply is roughly 2500 tonnes per annum and traditional demand (jewellery. This is very gold friendly.

000 and 16. thus removing gold from the market. there isn't sufficient contango to create higher prices in the out years. Thus there is little incentive to hedge. sell it and reinvest the proceeds in a high yielding bond or Treasury bill. Low Interest Rates Discourage Hedging Rates are low and falling. The Central Banks are Nearing an Inflection Point when they will be Reluctant to Provide more Gold to the Market N. Rising Gold Prices and Low Interest Rates Discourage Financial Speculation on the Short Side When gold prices were continuously falling and financial speculators could access central bank gold at a minimal leasing rate (0.50% of all central bank gold) is currently in the market. the trade was viewed as a lay up.5 . Strong evidence suggests that between 10.1% per annum). these trades now make no sense with a rising gold price and declining interest rates.000 tonnes (30. which are the counter party in the transactions. and gold producers are not only hedging. With low rates. However. L.Gold as a Strategic Asset the sub-economic gold price environment of the past five years and the natural exhaustion of existing mines. Dalmia Institute of Management Studies and Research Page 55 . which facilitated producer hedging and financial speculation. they are reducing their existing hedge positions. This is owed to the central banks by the bullion banks. central bank gold has been mobilized primarily through the leasing mechanism. Large Short Positions To fill the gap between mine supply and demand. Everyone did it and now there are numerous stale short positions.

Far Eastern central banks who are accumulating enormous quantities of US dollars are rumored to be buyers of gold to diversify away from the US dollar. the US occupation of Iraq. China with its 1. Demand in China is expected to rise sharply and could reach 500 tonnes in the next few years. the new President of Argentina proposed. A fearful public has a tendency to gravitate towards gold.3 billion people recently established a National Gold Exchange and relaxed control over the asset.Gold as a Strategic Asset The central banks have supplied too much already via the leasing mechanism. Gold is Increasing in Popularity Gold is seen in a much more positive light in countries beginning to come to the forefront on the world scene. Rising Geopolitical Tensions The deteriorating conditions in the Middle East. which could explode at anytime. India and Russia have been accumulating gold. In fact. L. during his campaign. Dalmia Institute of Management Studies and Research Page 56 . In addition. the nuclear ambitions of North Korea and the growing conflict between the US and China due to China's refusal to allow its currency to appreciate against the US dollar headline the geopolitical issues. Gold as Money is Gaining Credence Islamic nations are investigating a currency backed by gold (the Gold Dinar). Prominent developing countries such as China. N. a gold backed peso as an antidote for the financial catastrophe which his country has experienced and Russia is talking about a fully convertible currency with gold backing.

Size of the Total Gold Market Provides Tremendous N. When the fundamentals ultimately encourage a strong flow of capital towards gold and gold equities. the trillions upon trillions worth of paper money could propel both to unfathomably high levels. Dalmia Institute of Management Studies and Research Page 57 . L.Gold as a Strategic Asset Limited Leverage All the physical gold in existence is worth somewhat more than $1 trillion US dollars while the value of all the publicly traded gold companies in the world is less than $100 billion US dollars.

which literally means 'Glowing Dawn'. Dalmia Institute of Management Studies and Research Page 58 . This is reflected in the similarities of the word gold in various languages: Gold (English). Its chemical symbol.000 tonnes. Guld (Danish). Goud (Afrikaans). is short for the Latin word for gold. How much gold is there in the world At the end of 2001. Gold (German). 'Aurum'. Why is gold measured in carats? N. Au. it is estimated that all the gold ever mined amounts to about 145.Gold as a Strategic Asset Frequently Asked Questions What is Gold and why is its chemical symbol Au? Gold is a rare metallic element with a melting point of 1064 degrees centigrade and a boiling point of 2808 degrees centigrade. Where does the word Gold come from The word gold appears to be derived from the Indo-European root 'yellow'. reflecting one of the most obvious properties of gold. notably its excellent conductive properties and its inability to react with water or oxygen. Gulden (Dutch). L. Gull (Norwegian) and Kulta (Finnish). It has several properties that have made it very useful to mankind over the years.

parts per thousand. i. The Carob seed is from the Carob or locust bean tree. The purity of gold is now measured also in terms if fineness. N. e. now Carat in modern times) for the bean of the Carob tree. The Romans also used the name Siliqua for a small silver coin. It does involve the Romans who also used the name Siliqua Graeca (Keration in Greek. Qirat in Arabic. This latter had a mass of about 4. i. so the Siliqua was approximately equivalent in value to the mass of 1 Keration or Siliqua Graeca of gold. Thus 18 carats is 18/24th of 1000 parts = 750 fineness. i.e the value of 1/24th of a Solidus is about 1 Keration of gold. L. What is a Carat? A Carat (Karat in USA & Germany) was originally a unit of mass (weight) based on the Carob seed or bean used by ancient merchants in the Middle East. which was one-twentyfourth of the golden solidus of Constantine. For gold. How and when this change occurred is not clear. when a carat became used as a measure of the purity of gold alloys (see next Question 5).Gold as a Strategic Asset This stems back to ancient times in the Mediterranean /Middle East.e 1 carat. The carat is still used as such for the weight of gem stones (1 carat is about 200 mg).54 grammes. Dalmia Institute of Management Studies and Research Page 59 . it has come to be used for measuring the purity of gold where pure gold is defined as 24 carats.

Gold Standard: A monetary system based on convertibility into gold. Bullion: Refined gold that is at least 99. wafers or ingots. or marks.000 parts of an alloy. Fineness.995 fineness contains 995 parts of gold and 5 parts of another metal. usually in the form of bars.9 (often referred to as “four nines”). One grain is equivalent to 0. Gold is produced in bars up to a purity of 999. etc.Gold as a Strategic Asset Glossary Assay: To test a metal for purity. Fine. 18-karat has 750. Hallmark: Mark. Dalmia Institute of Management Studies and Research Page 60 . Fine Gold: The quantity of pure gold contained in 1. etc. Grain: One of the earliest weight units used for measuring gold. which indicate the producer of a gold bar and its number.0648 grams. fineness. paper money backed and interchangeable with gold. rather than its rarity or face value. L.5% pure. parts pure gold and 250 parts alloy. N. Bullion Coin: A legal tender coin whose market price depends on its gold content. Karat: Unit of fineness. 24 karat gold (or pure gold) has at least 999 parts pure gold per thousand. scaled from one to 24. A normal “good delivery bar” of 0.

All the gold ever mined would easily fit under the Eiffel Tower. L. 1 troy ounce is equivalent to 31. refers to a troy ounce.1507 troy ounces. forming a cube of nearly 19 m each side! N. Dalmia Institute of Management Studies and Research Page 61 .1 avoirdupois (ordinary) ounces. The word ounce when applied to gold.1034768 grams.Gold as a Strategic Asset Kilo Bar: A bar weighing one kilogram – approximately 32. Troy Ounce: A unit of weight. equal to about 1. Liquidity: The quality possessed by a financial instrument of being readily convertible into cash without significant loss of value. acceptable for instance in the discharge of debts. Legal Tender: The coin or currency which the national monetary authority declares to be universally acceptable as a medium of exchange.

org N. Dalmia Institute of Management Studies and Research Page 62 .com  www.com  www.moneycontrol.silverinstitute.Gold as a Strategic Asset Bibliography Reference Books & Articles  Manual on Price-Risk Management in Bullion  MCCP Manual  Commodity Vision Papers  The Economic Times of India  Business Standard World Wide Web  www. L.karvycomtrade.org  www.com  www.gold.com  www.mcxindia.answers.

L.Gold as a Strategic Asset N. Dalmia Institute of Management Studies and Research Page 63 .

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