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INDUSTRY PROFILE

Gold market in India.

Eternally attractive to mankind, gold has found its principal use as a store of value. Its beauty
has made it popular in decoration. Gold has also become an increasingly important industrial
metal. Because of its rarity and its durability, gold has been almost universally acceptable as
money for thousands of years. Gold is the most prominent of the noble metals (gold, silver,
platinum, and other platinum group metals), so termed because of their inertness, or reluctance to
enter into chemical reactions. Gold will not react with common acids. Gold, the most famous of
all precious metals, is widely sought after throughout the world for both its investment qualities
and industrial properties. Indeed, gold traditionally has served three functions: as a monetary
instrument, as a financial asset, and as a raw material primarily used in jewelry and decorative
objects. As an investment, gold typically is viewed as a financial asset that will maintain its
value during times of political, social, or economic distress. As such, gold can provide individual
and institutional investors alike with a portfolio safety net against sharp downward spikes in
complementary assets such as stocks and bonds. While investment demand is important, the
largest use for gold is in jewelry, with the majority of use occurring in the United States, Japan,
Italy, India, China, and Thailand. Jewelry production has been growing at a robust pace in the
developing countries of Southeast Asia and the Middle East since 1988. Gold also is used in
electronic connectors and dental alloys. Gold is mined in more than 76 countries around the
world, with the large number of development projects in these countries expected to keep
production growing well into the next century. Currently, South Africa is the largest gold
producing country, followed by the United States, Australia, and Canada. Millions of people all
over the world continue to use gold as a hedge against inflation and as a basic form of savings
and a reliable store of value during times of economic uncertainty or political upheaval.
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In 2003, the price of standard gold in the Mumbai market rose 11 per cent from Rs 5,580 per 10
grams to end the year at Rs 6,175. Continuing its unabated rally, gold now trades at about Rs 625
per gram. The year thus saw a sharp upswing in the price for ten grams, which had hovered
around the Rs 4,000 mark for the five years between 1996 and 2001. The quantum of rise in
2003 was, to an extent, checked by the appreciation in the value of the rupee and the steep cut in
import duties. The international price of gold moved at a much faster pace, gaining 20 per cent in
2003. It now quotes close to $419 per troy ounce (one troy ounce = 31.1035 grams). Behind the
price divergence India imports most of its gold requirements. Hence, price movements should
largely be in line with international prices. Interestingly, though, this has never been so. There
have been price variations, caused by the fluctuations in exchange rate and policy changes on the
import duty front. Between 1997 and 2002, international gold prices edged up just 1 per cent. In
contrast, in Mumbai the price rose 16 per cent. During this period there was a consistent
depreciation in the value of the rupee, which reached a low of Rs 49 to a dollar. The reversal of
this trend in 2003 was notable, with forex reserves crossing $100 billion. The 5 per cent
appreciation in the rupee vis-

-vis the dollar made dollar-denominated gold imported into India cheaper and capped the rise in
domestic prices. The steep cut in import duties over the years has also narrowed the gap
between international and domestic prices. Import duties on gold were slashed from Rs 400 per
10 gm in 1999 to Rs 100 per 10 gm in 2003. These two factors explain the wide divergence in
the returns from gold in the domestic and international markets. Shining performance The year
2003 was a bonanza for those who set much store by the traditional value of gold. Equities had a
dream year too. But it was the yellow metal that outperformed most fixed-income investment
options, gaining about 11 per cent in value. And this in a year when your savings or fixed deposit
earned just about five per centEven small saving schemes or bonds earned, at best, an 8.5 per
cent return. At the global level, too, gold regained fancy, even if just as a bulwark against the
dollar, which has been on a relentless decline. Gold prices are seldom governed by fundamentals.
The direction of its movement is governed by various external factors, such as central bank sales,
tendency to shift in and out of gold depending upon currency, speculative activity and the US
economy's strength.
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Gold price movements are determined by the perception of gold as a `store of value' rather than
its fundamentals as a commodity. The precious metal's value is also determined by such factors
as inflation, interest rates and the presence of lucrative alternative investment avenues in the
economy. In the past two years, gold has regained popularity as a `store of value'. The weakening
dollar and the prevailing low interest rates at the global level have left investors with limited
alternative investment avenues. The spectre of even a moderate increase in inflation levels,
fuelled by the spurt in commodity prices, would further squeeze the real rate of return on debt
investments. This has forced investors to look for a relatively risk-free investment option. In
these circumstances, there has been a rush towards gold as it is an eternal asset with an intrinsic
value. For long, dollar-denominated instruments were considered the favourite assets for central
banks and institutional investors. But, of late, the consistent depreciation in the value of the
dollar vis-

-vis currencies such as the euro and the yen has forced a shift in the investment strategy. The
euro appreciated 20 per cent against the dollar during the year. The US' mounting current
account deficit has been eroding the value of the dollar.
As of 2002, the deficit, at $435.2 billion, was over 5 per cent of the US' GDP. A mounting
current account deficit means its debt obligation to foreign countries has been increasing,
weakening the purchasing power of the dollar. Asian countries, especially China and Japan, hold
over 30 per cent of the US' external debt. A weakness in the value of the dollar would dent the
returns on the dollar-denominated reserve assets held by them. To overcome this problem, China
has been investing a larger part of its reserves in gold. China is now one of the top ten countries
holding a large quantum of gold in its reserves, a distinction it has gained in the past two years.
Its gold reserves increased from 391 tons in December 2001 to 600 tons in December 2003.
China's unwillingness to let the Yuan appreciate, much to the discomfiture of the US, has also
played a significant role in the firm trend in gold prices. Empirical research proves that the value
of gold measured in terms of its purchasing power parity has remained unchanged in the long
run, even over about 2,500 years. Hence, in the current circumstances, gold has regained its
position as a `store of value.'
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The gold price rally could also be attributed to the lack of alternative investment options.
Globally, interest rates have fallen sharply. The US Fed rates are at a 45-year low of 1 per cent.
The Federal Reserve has not indicated that it will raise interest rates as it would hamper the
economic growth that is now picking up after a prolonged slowdown. A similar situation in most
other parts of the world has led to an increased investment demand for gold.
Outlook
In the near term, gold prices are likely to show a firm undertone. Their direction would hinge
largely on how the dollar moves. If it remains weak other currencies and if interest rates remain
stable, gold prices may get a boost. The trend of a rapidly widening US current account deficit
may get accentuated as its economy is now on a recovery path and needs more capital from the
rest of the world. This looming risk may ensure that the dollar continues to remain weak in the
near future. Interest rates appear to be stabilizing after the relentless rate-cutting over the past
three years; a sharp spike from the current levels, however, appear unlikely as central bankers
may not want to disturb the trends of economic revival in the US, Europe and Japan. The price
performance of gold over the past two years may, however, not be repeated. But even if returns
move into single-digit territory, the precious metal would still be competitive, at least for the
short term, as the yield on debt is unlikely to be vastly superior. For retail investors, though, it
may be better not to divert much of the portfolio into gold. Gold in a portfolio can be used for
diversification purposes to lend stability but it also tends to drag returns.









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Conclusion

The causal relationship was tested between the BSE index and gold . Gold price is included in
the model as an additional variable, to examine whether gold price contain any additional
significant information about price movements. Since gold is an important saving instrument in
India and is very often used as a hedge against inflation, it is expected that gold may be looked
upon as alternative asset for those holding idle money, for speculative purposes. After looking at
the following testing , we found the times series for the year 2005 for gold prices and stock
returns, which shows both the trends are deterministic, and the values are stationary, these trends
were tested for cointigration, and were found that the multi collinearity exits as the likelihood
ratio was high . The causality test proved that null hypothesis exits and thus proved there is no
relation between the gold prices and stock returns. Even though gold is considered to be the best
alternative source of investment. We find investors tendency to switch to gold investment when
they find the market to be too risky.