impact of gold on economy

AN INTRODUCTION G

old

is a rare metallic element with a melting point of 1064 degrees centigrade and a boiling point of 2808 degrees centigrade. Its chemical symbol, Au Au,, is short for the Latin word for gold, gold, 'Aurum Aurum', ', which literally means 'Glowing Dawn'. Dawn'. It has several properties that have made it very useful to mankind over the years, notably its excellent conductive properties and its inability to react with water or oxygen. The word gold appears to be derived from the Indo-European root 'yellow', reflecting one of the most obvious properties of gold. This is reflected in the similarities of the word gold in various languages: Gold (English), Gold (German), Guld (Danish), Gulden (Dutch), Goud (Afrikaans), Gull (Norwegian) and Kulta (Finnish).

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IMPACT OF GOLD MARKET ON ECONOMY

WHA T IS A CA R RA A T ?

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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. The Carob seed is from the Carob or locust bean tree. The carat is still used as such for the weight of gem stones (1 carat is about 200 mg). mg). For gold, it has come to be used for measuring the purity of gold where pure gold is defined as 24 carats. How and when this change occurred is not clear. It does involve the Romans who also used the name Siliqua Graeca (Keration in Greek, Qirat in Arabic, now Carat in modern times) for the bean of the Carob tree. The Romans also used the t he name Siliqua for a small silver coin, which was one-twenty-fourth of the golden solidus of Constantine. This latter had a mass of about 4.54 grams, so the Siliqua was approximately equivalent in value to the mass of 1 Keration or Siliqua Graeca of gold, i.e the value of 1/24th of a Solidus is about 1 keratian of gold,i.e,1carat of gold.. gold

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W ORLD ORLD GOLD MARKETS 

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London as the great clearing house f utures trading New York as the home of futures Zurich as a physical turntab stanbul,, Dubai ubai,, Singapore and Hong Istanbul Kong as doorways to important consuming regions.. regions

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Tokyo

where TOCOM sets the mood of

Japan 

Mumbai

under

India's

liberalized

regime

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gold

HE STUDY OBJECTIVES OF T HE The financial asset market ± stock market, bond market and currency market has become increasingly notorious. Gone are the days when US Economy controlled the entire world economy. Even the US$ has shed significantly against all major currencies. Various countries are now increasingly shifting their reserves from Dollars ($) to Gold. The objective of the project study may be highlighted as follows: To study the techniques of pricing gold in the Indian markets and factors affecting the same. To analyze whether the upward trend in the Gold market will tend to continue forever«. To study the impact of retail jewelry on the Gold Market and its prices. To study the impact of ETF and Gold ETF on the Global Gold Markets. To study the impact of Gold Value rising and replacing $ and interference by US economy. To answer various questions like how to trade in Indian Gold Market, investment strategies, gold as a hedging tool, etc.

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METHODOLOGY AND ITS IMITATIONS L IMITATIONS The project is a detail study of the Gold Market of India as well as its relevance in the International Market. There have been various small areas that have been taken into consideration in the preparation of the project. The initial idea about the prevalent gold market is through extensive internet surfing, magazines from institutes like ICFAI and newspaper articles. There have been verbal interactive sessions with people dealing in Gold Market like retail jewelry shop owners and people dealing in commodity market. The various findings and observations have then been compiled together and divided into broad headings for the ease of the study and to help the fulfillment of the objectives. The main constraint in the preparation of the project was time. The project had to be worked in a very short span of time. Moreover appointment with Risk Managers and Financial Experts, for collection of Primary Data was not possible. 5


INTRODUCTION T O INDIAN MARKET

I

ndians have a huge fascination for gold. This is evident in the fact that India is the largest consumer as well as importer of gold in the world. Gold plays a very important role in the social, religious and cultural life of Indians. India Gold Market looks poised to achieve greater heights given the fascination for gold in the country. India consumes about 800 MT of gold which accounts to about 20% consumption of gold globally. More than 50% of this is used for making gold jewellery. The domestic India gold market is estimated to be more than US$15 billion and is expected to rise significantly in the coming years. During April 2008 to February 2009, gems and jewelry worth US$ 17.79 billion was exported from the country. United Arab Emirates imported more than 30% of gems and 6


jewelry from India, making it the largest importer from the country. Hong Kong was the second largest importer with 25% followed by United States with 20%. The gem and jewelry industry accounts for more than 10% of India¶s total commodities exports.

POINTS TO BE NOTED: Gold is valued in India as a savings and investment vehicle and is the second preferred investment after bank deposits. India is the world's largest consumer of gold in jewellery as investment. i nvestment. In July 1997 the RBI authorized the commercial banks to import gold for sale or loan to jewellers and exporters. At present, 13 banks are active in the import of gold. This reduced the disparity between international and domestic prices of gold from 57 percent during 1986 to 1991 to 8.5 percent in 2001.

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The gold hoarding tendency ingrained in Indian society.

is

well

Domestic consumption is dictated by monsoon, harvest and marriage season. Indian Jewelry off take is sensitive to price increases and even more so to volatility. In the cities gold is facing competition from the stock market and a wide range of consumer goods. Facilities for refining, assaying, making them into standard bars in India, as compared to the rest of the world, are insignificant, both qualitatively and quantitatively.

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SIZE OF INDIAN GOLD MARKET

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he domestic India gold market is estimated to be more than US$15 billion and is expected to rise significantly in the coming years. During April 2008 to February 2009, gems and jewelry worth US$ 17.79 billion was exported from the country. United Arab Emirates imported more than 30% of gems and jewelry from India, making it the largest importer from the country. Hong Kong was the second largest importer with 25% followed by United States with 20%. The gem and jewelry industry accounts for more than 10% of India¶s total commodities exports.

GOLD INVESTMENT MARKET IN INDIA here were also some concerns r ais aised ed on t he dis disprop proportion ortiona ate gold consumption pattern in India versus the US. ³Though India is the largest consumer of 9


gold, its annual per capita consumption is half of that in the United States, as Indians invest mainly in the physical form of gold,´ gold,´ World Gold Council (WGC) Associate Director Keyur Shah said. According to WGC¶s µGold Demand Trends¶ report, released by precious metals consultancy GFMS, total identifiable tonnage demand for gold fell 19 percent in the second quarter of 2008 to nearly 736 tonnes, but in value terms it rose nine percent to a record level of over $21 billion. Second quarter jewelry demand was the biggest contributor to the overall decline, falling 24 percent to 504 tonnes. In the first quarter, the th e total tot al identif ident ifia iable ble tonn ton n ag age e demand for gold fell fell 16% to 701 tonnes, the lowest quarterly level on record since 1993 1993.. ³Jewelry has been and is the bedrock of the gold industry, and we see that the willingness to buy jewelry is at a very high level as the consumers have started to think prices will increase further. But imbalances in the market suggest that sooner or later the gold price will have to fall, fall,´ said Wa Walker lker..

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C HANG HANGING ING F AC ACE E OF W ELRY R ET AI AIL L JE W s Dow Theory Letters¶ Richard Russell Russe ll on once ce said said,, ³It¶s not about wh at t h e p r ice of gold is, it it¶¶s abou aboutt how many ounces you have.´ have. Tanishq¶s vice president, V Govindraj, shared some experiences with retailers on selling more ounces to their customers, and how they can revolutionize their businesses by putting in minor but significant efforts. He also explained the importance of making differentiation points in designs to make this aspect a unique selling point. Interestingly, he also raised a point on the industry¶s need to create more means of marketing, akin to creating new celebration days day s like Mot Moth hers Day and an d Rak Raksha sha Ban and d han han.. ³Th The e retail r etail space al also so sh ou ould ld sedu educe ce th the e customer, giving them the enjoyment of shopping. Products need to tell a story, and the product display too should communicate with the customer. Mean-while, retailers should create an interest among consumers through print, and outdoor banners. The best way to pre pr edic dictt our ou r future futu re is to inv invent ent it, it,´ Govindraj said. 11


INDIAN STAND

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ccording to the World Gold Council, India is the world¶s largest market for gold jewellery. In accordance with the global financial crisis, Indian stock market has also witnessed its worst hits in the last one month. The price of gold has been volatile with big swings. In spite of fluctuations in price, gold has consistently regressed to its historic purchasing power parity with other commodities and intermediate products. The high uncertainty in the financial markets together with the fall in gold prices enhanced the collections of the five listed gold ETFs in the country by 14 per cent in the month of August. Rajan Mehta, Executive Director, Benchmark AMC, said, ³Although a 14 per cent increase on a small base may not seem that significant, collections have gone up by 100 per cent in just a year¶s time.´ The Assets Under Management (AUM) for the five ETFs have risen to Rs 650 crore in August from Rs 547 crore in July. Average volumes in gold ETFs have increased by 111.12 12


per cent to 50,080 units per day in the last nine months. Analysts say that the demand for traditional gold jewelry is declining as an investment channel; instead, trade in paper form has more than doubled since January 2008. In the light of fall down of equity markets, investors realized that they need to have at least 10-15 per cent of their portfolio in gold. As a result, number of retail investors is growing. Besides, though gold has been volatile recently, the underlying trend is for it to rise. So, analysts say, it is better for investors whose portfolios include gold, to keep holding on to it.

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RADE IN INDIAN HOW T O T RADE GOLD MARKET ?

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he price of gold depends on a host of factors, which makes it very difficult to predict. In a fashion similar to shares, gold is an asset class by itself. In fact, in many villages and small towns of India, gold is preferred to bank deposits as a savings and investment instrument instrument.. Till a year ago, to gain from price volatility, one would have to hoard and trade in gold physically. Not any more, however. With the commodity futures market operating in full swing, one has the option of not physically stocking gold to gain from its price movements. Let us see how trading in futures is better than the option of hoarding gold. Firstly, there are several costs associated with the process of physically stocking gold. The costs include the cost of the gold itself, the cost of carrying, cost of physical storage, finance cost and last, but not the least, the safety element. 14


While futures might have some advantages, there is also a danger of losing big as your risks are also magnified and hence, one must tread carefully in this area. In this context, if the going cost of gold is Rs 6000 per 10 grams, with an investment of Rs 6 lakh, one can buy 1kg of gold. Now, suppose, three months hence, when the going price of gold is Rs 6,500 per 10 grams, the person decides to sell the gold. The gross profit made by the person is Rs 500 for every 10 grams and hence, for 1 kg, it stands at Rs 50,000. To arrive at the net profit, one would have to deduct the cost of financing; the cost of storage in a bank and transaction costs, including sales taxes. Now, let¶s see what the same Rs 6 lakh can achieve in a futures market, assuming the same sequence of prices. In Indian exchanges, currently, futures contracts up to four months are available. Let¶s assume that three-month gold futures are trading at a little over the spot price, with the market expecting gold prices to remain stable over the next three-month period. Let this price be Rs 6050.

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Since a futures contract is an obligation to buy or sell a specific quantity of the commodity, one does not have to pay for the entire value of the commodity. Buying futures obligates one to take delivery of the underlying commodity at a particular date in the future. This is also known as taking a long position. To trade in gold futures, one has to go to a brokerage house and open a trading account. A trading account involves keeping an initial deposit of Rs 50,000 to Rs 1 lakh. Part of the money accounts for the margin money, which is required by the exchange when one enters trading. For a high amount, however, the deposit amount is usually waived by the brokerage house. The whole investment is then generally treated as margin money. For commodity futures, there is usually a lot size or the minimum volume of the commodity of which one has to buy a futures contract. Let¶s assume, for our case, the minimum lot size si ze is 1 kg (lot sizes are usually 100gm or 1 kg). Thus, if the going futures rate is Rs 6,050 per 10 grams, the minimum value of a contract is Rs 6,05,000. The beauty of a futures contract is 16


that to trade in them, one has to only invest the margin money. If we assume a flat 5% margin rate for the contract (margin rates vary from 510%), the margin money for a single lot is Rs 30,250. Add to that, a brokerage amount, which is usually .1% to .25% and some start-up charges. Applying these rates, which are prevalent in the market currently, a single lot of gold futures contract, should come at around Rs 32,000. Thus, with Rs 6 lakh, one can buy 19 lots of gold futures. One can , however, expect µmargin calls¶ from brokerage houses if the margin money falls short of the margin money required for trading in the exchange, determined at the end of the trading session each day. Now, suppose that at the end of 3 months, the spot price of gold actually reaches Rs 6,500 per 10 grams. The novelty of the futures market is that as long as there is sufficient liquidity in the markets, the futures price always converges to the price of the under lying. Such is the leverage of futures, that with the same investment of Rs 6 lakh, one is actually commanding 19 lots of gold futures or in effect, 19 Kgs of gold. 17


Thus, at the end of three months, assuming the above-mentioned course of events, on an investment of Rs 6 lakh, one can make a gross profit that is almost 17 times the profit made by physically stocking gold. At the same time, the downside risk is also multiplied. To avoid the hassles of delivery, one must offset the futures contract just before the maturity date is reached. Delivery would entail gold certification and accreditation by an exchange-appointed assayer and increased transaction costs in general, as various taxes come into the reckoning. The above example is about a case of taking a bullish view on the price of gold and hence, gaining from the price rise by buying futures. One can gain from a futures market even by having a bearish view on the price of gold. This aspect of gain is absent in the physical market for gold. If one believes that the spot price of gold is going to fall in the near future, all he needs to do is to sell gold futures. While all this seems pretty rosy, there are some things to be kept in mind. Firstly, any transaction in the futures market is possible 18


only if counterparty to whom the buy or sell order that is placed, exists. For unusually large investments, the exchange may find it difficult to find counterparty and so it may take some time to match it. Also, with any futures, there may be a problem in exiting from a position by buying or selling when one would like li ke to.

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ETF & GOLD ETF

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ut of the several options available for investing in gold, Gold ETFs is the recent avenue. An Exchange Traded Fund (ETF) is an open-ended fund that that can be traded like a share on a stock exchange. It is is a collective investment scheme that invests in a combination of asset classes. Consequently, prices are determined by the value of the assets the ETF holds. In Gold Exchange Traded Fund, the principal asset is exclusively gold bullion, and not a basket of stocks as is the case of equity ETFs. Gold ETFs are shares or units of gold that are owned by investors and are fully backed by gold bullion bars held by a custodian. They can be used for speculating in the short-term for betting on the price of gold, or they can be used for long-term investing. Gold ETFs allow investors to buy gold in small increments. In the international market, one unit stands for one-tenth of an ounce (28.35 grams) of fine gold. The value of a unit moves 20


in harmony with the price of gold. Similar Simil ar to mutual funds, the value per unit is the total value of the gold held divided by the number of units minus the expenses of the fund. Just like any share, Gold ETFs, can be traded and bought by investors through their stockbrokers.

POINTS TO REMEMBER Objective of the GOLD ETF is to generate returns that closely correspond to the returns provided by in vestment in physical gold in the market (domestic market), subject to track in g error. After the closure of NFO, the Units of the Scheme are listed on the Capital Market Segment of NSE or any other Stock Exchange. The Units can be purchased / sold in the stock exchange like any other publicly traded stock. (unlike other openended schemes which can be purchased/redeemed in MFSS of NSE or StAR MF of BSE) Units of the Scheme are available only in Electronic (dematerialized) form.

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Authorized Participant means the member of the National Stock Exchange of India Ltd. (NSE) or any other Stock Exchange(s) and their nominated entities/persons or any person who are appointed by the AMC/Fund to act as Authorized Participant. Participant. Creation Unit is fixed number of Units of Scheme which is exchanged against a predefined quantity of physical gold (of prescribed purity) called µPortfolio Deposit¶ and µCash Component.¶ After the NFO, units in less than Creation Unit Size cannot be subscribed/redeemed directly with the Fund. Authorized Participants and Large Investors can subscribe or redeem the Units of the Scheme directly with the Mutual Fund only in Creation Unit Size at applicable NAV in exchange of Portfolio Deposit and Cash Component. In addition to purchase and sale of Units on Stock Exchange, Authorized Participants and Large Investors can directly subscribe to or redeem the Units of the Scheme with the Mutual Fund in Creation Units size at NAV based prices. 22


Authorised Participants and large Investors may in vest in the fund by way of physical gold also. The price of the Units on the exchange depends on demand and supply at that point of time and underlying NAV and the units may trade at premium/discount to the NAV. Each Unit normally have a face value of Rs.100/- each and mostly, each unit is approximately equal to price of 1 (one) gram of gold If there is in sufficient liquidity in the secondary market on the Stock Exchanges, the AMC may, at its discretion allow redemption of units in other than Creation Unit size. Domestic price of Gold = (London Bullion Market Association AM fix in g in US $ /ounce) X (conversion factor for convert in g ounce in to k.g. for 0.995 f in eness x rate for US$ in to INR) + (custom duty for import of gold) + (sales tax / octroi and other levies applicable.) 23


Tax treatment of Gold ETF ± Similar to Debt funds. Authorized Participants and Large Investors have a choice of in vest in g through 1 kg gold per application and in multiples of 1 KG gold thereafter

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GOLD ETF - TO HEDGE YOUR PORTFOLIO Nov 14, 2008 "It is the greenback which is unstable, and not bullion´ bullion ´ - Dr. Franz Pick (Austrian economist and currency expert)

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he recent financial turbulence centered in the US has engulfed emerging financial markets. The global meltdown has affected huge amounts of shareholder wealth. It has literally devastated fortunes of all kinds of scrip, be it a large-cap, mid-cap or small-cap. Everything was so uncertain. The years of boom had trembled. The magical figures of market capitalizations of various companies reached below their real value. The giants in the financial services industry worldwide, like Lehman Brothers, City Bank tumbled amid the sub-prime fiasco. Equities tumbled worldwide. The relative worth of Greenback has concerned global commodity markets. Nevertheless, regardless 25


of recent hiccups, gold has remained as most popular investment. The uncertainties of the stock market have spawned the demand for investments in the yellow metal. Gold is a hedge against all kind of uncertainties, be it global slowdown or geopolitical risk. Over the past 2-3 years, global growth rates have averaged over 5.0% consistently. China and India have led the charge for global growth, and there is competition among various countries to maintain high growth rates. There will be situation wherein growth rates may fall, with the slight possibility of dome of the weaker countries getting busted. Gold demand by way of ETF increased sharply between August 2007 and November 2007 after the US subprime crisis. Gold is the best hedge not only against global slowdown and readjustment but also against geopolitical risk. Gold, despite an occasional fall, is bound to remain bullish due to the prevailing global political and financial uncertainty uncertainty..

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A VIABLE OPTION

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he mantra is, is, ³Don't place all your bets on one sector or asset class." class." To maintain portfolios efficiently and to achieve better returns, there should be diversification across asset classes of a portfolio. Diversification protects the portfolio against fluctuations in the value of a single asset or group of assets. Comprising assets with low volatility in a portfolio will help decrease the overall risk. Significantly, since gold is an asset class that has negative correlation with the stocks, the gold ETF units offer stability to the overall return on the portfolio of investment. Preferring Gold ETFs to physical gold either in the form of bars, gold coins or jewellery eliminates the hassles of handling the precious metal. Furthermore, the quick and convenient dealing through demat account and no issues of storage and security make Gold ETFs stand apart from other kinds of investing avenues in gold. All in all, considering an option of diversifying the portfolio with gold is as µgood µgood as gold¶. gold¶.

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DETERMINATION OF GOLD PRICES y

SUPPLY DYNAMICS:

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ntil recently gold production was limited to a few mines in South Africa, the US, Australia and Russia. However, gold mines now operate in more than 55 countries, with China leading the race. Total supply in 2007 fell marginally by 1.6 percent, which comprised a 29 percent fall in supply from official sector sales and a 14 percent rise in old gold scrap sales. Mine production, which contributed the majority 63 percent to total supply in 2007, fell a modest 0.4 percent, pushi pus hing ng do dow wn total total output to an an 11 ye years ars lo low w.

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FIG 6.1 : COMPARISON OF MINE PRODUCTION BETWEEN SOUTH AFRICA AND CHINA. (SOURCE: GFMS)

Peru, South Africa and the US each suffered losses of more than 10 tonnes, which was somewhat compensated for by a 12 percent or 66 tonne-increase in Asia¶s mine production, supported primarily by China and Indonesia. GFMS expects the mine production to remain flat in 2008. A decline in the Indonesian and continued losses in the south Africa are expected to be broadly balanced by the Russian, west 29


Indian and Brazilian market. Official sales are expected continue at levels similar to 2007. ³Full year figure figures s will alm almost ost cert certain ainly ly be well u p year-on-year, although perhaps not quite beating the 2006 total.´ Increasing input costs in South African mines have resulted in declining production.

FIG 6.2 : ABOVE GROUND STOCKS OF GOLD. (SOURCE: GFMS) GFMS)

³South African mines are all mostly underground have rocks with high temperature, the country produces a huge amount of ice for cooling it, which leads to its high input costs,´ costs,´ Walker said. Meanwhile, 30

Chinese


production

has

increased manifold due to low input costs. ³China, which was the eighth largest gold producer in the 1990¶s, has now taken over South Africa and become the largest in the world.´ Changing supply from above-ground stocks is also one of the influencing factors on gold prices. The above ground stocks of gold were at 161,000 tonnes at the end of 2007, with the majority 52 percent comprising jewelry, followed by 18% as official gold holdings, holdin gs, 16% as as private investments.

FIG 6.3 : POSITION OF GOLD HOLDINGS OF DIFFERENT COUNTRIES. (SOURCE: GFMS) 31


y

DEMAND DYNAMICS:

istorically, high prices and volatility have hav e had a dr dramatic amatic imp impac actt on jew ewel elr ry dem eman and d. Som ome e pu purch rchas asing ing is ex exp pected on dips, but at levels far lower than in 2007. Other fabrication growth expected to feel the effects of the slowdown in the global economic growth. Investor interest in gold is expected to remain strong throughout this year and potentially through to early-2009.

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³Gold demand has been steadily increasing over the years, but fabrication demand is also not the key driver in that. Perhaps, without jewelry, gold prices would have probably been aroun round d $10 100 0/ oz oz,,´ Walker said. In 2007, jewelry accounted for 79 percent of the total global gold fabrication of 3,072 tonnes Rising gold prices have resulted in lowering demand from developed countries. However, consumption is on the rise in developing nations, with their demand standing at about 3,000 tonnes versus 1,000 tonnes from the industrial countries in 2007.

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FIG 6.4 : WORLD GOLD FABRICATION. (SOURCE: GFMS)

³Although the last four months saw a dramatic inflow of funds into gold demand for the rest of the 2007 was unimpressive. The 61 percent decline in implied net investments to 158 tonnes was largely driven by net selling that took place in the over-the- counter market, market ,´ Walker said. said.

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FIG 6.5 : CHART SHOWING WORLD GOLD FABRICATION OF DEVELOPING AND INDUSTRIAL COUNTRIES. (SOURCE: GFMS)

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P RICE O UTLOOK ³As

risk aversion has increased considerably with no material signs of easing despite intervention from monetary authorities, the effects of the sub-prime credit crisis will continue to pr prov ovide ide a str tron ong g inves inv estm tment ent ca cas se for g o l d , ´ Walker said. He expected the interest rate scenario in the US to put an already weak currency under further pressure. Persistence of the twin-deficits in the US will not prove of any help hel p to th the e dolla dollar r ei either. ther. Althou lthoug gh cur urrent rent account deficit will improve with probable decline in US consumer spending and recession, the fiscal positions will deteriorate dramatically. ³The US federal budget deficit is set to soar from an already poor level. An economic slowdown and problematic financial markets point to a further decline in equity prices and hence, commodity prices in general are expected to remain strong, strong,´ Walker said. This along with continued investor interest will be the principal driver of gold¶s continued rally to cro ros ss th the e $1 $1,10 ,100/ 0/oz oz-- mark mark.. ³In the medium term prices could move sideways or even retrace a little litt le m or ore; e; the mid m id-- $8 $800 00/ / oz is a possible possible low 35


for the rest of the year, with prices below that level most likely to be bid up by bargain hunting and stock replenishment, replenishment,´ Walker said, adding: adding: ³Nevertheless, this is most unlikely to occur in 2008 and potentially not until well into 2009. 2009.´

GOLD PRICES W ILL ILL THE UPW ARD ARD TREND CONTINUE?? Precious Metal Prices ± The Issues Behind Present Rally

Decline in US economic growth and rise in growth of other nations including Brazil, Russia, India and China (BRIC) nations: Before the start of 21st century most of the countries were dependent on US retail demand for their growth. Japan and other countries were also dependent on US demand. Higher growth rates and subsequently higher demands from China, India and other nations have resulted in a world less dependent on US economy for growth. The world is now less dependent on the US economy for growth than it was at the beginning of the century. Structural decline of US dollar and search for investment away from the US dollar. The US economy needs more than $2 bn a day of 36


foreign investments to run its economy. Its trade deficit and budget deficit are on the rise. Foreign investors are apprehensive of investing in non-dollar investments. Even retail investors are investing in instruments which are not priced in US dollar. As a result, emerging market equities like India, China are witnessed continuous rise in foreign portfolio flows. Continuous rise in physical demand for gold and lack of new mine supplies. Global goldmine production peaked in 2003 and is experiencing gradual decline currently. The problems are perhaps best typified by the world¶s largest producer, South Africa, where mines face declining ore grades and rising costs as they push the extremes at depths of 2.5 miles down. In 1970, South Africa produced 1000 tons of gold, but by 2007, it had fallen to a quarter of this level. Where new mines have been beset by red tape, resources nationalism and AIDS (afflicting roughly a third of mineworkers). In short, new deposits are neither being found nor developed to replace the ageing and largely depleted mines. Indian gold demand is expected to rise even as gold prices near $900 per ounce. The start of gold futures trading in Shanghai stock exchanges will result in a greater demand 37


from China. As the Chinese economy switches to domestic demand-led growth from exportled growth, the Chinese gold demand will rise. The US subprime financial crisis had a direct impact on the global gold market in the quarter of 2007, as safe haven investors spurred record inflows into gold exchange traded funds helping to push total demand to a new record of $20.7 bn, up 30% a year earlier. Central bank diversification of Foreign exchange reserves: Some of the central banks have started to increase a portion of their gold reserves and reduce a portion of their gold reserves and reduce a portion of US dollar reserves, namely China, Russia and some of the oil producing nations. There are other central banks, which have been steadily increasing their huge foreign exchange reserves away from the US dollar into gold and non-US dollar currencies. Central banks portray a macro picture of the things to come. If they are increasing their gold reserves, why should retail investors be left behind? It¶s for you to decide wisely. Excess liquidity created by central banks to ensure higher retail spending and higher growth: The Federal Reserve Bank of Japan, Bank of England and other central banks are 38


continuously cutting interest rates consumption and growth. Interest rate cut adds to money supply created implies too much chasing too few investment and a rise in value of hard assets including gold. The Dollar Linkage: Financial markets are responding to the US dollar decline and near recession situation in the US economy by switching their investment away from the US dollar. Exporters of different currencies have started billing their exporters in currencies other than the US stocks and bonds, and are increasing investments in commodities including precious metals and soft commodities as a hedge against the decline in the US dollar. Even retail investors in the US are reducing their US dollar-based investments. More and more countries are resorting to liberal trade instead of multi-lateral trade, which is not billed in the US dollars. India has various free trade agreements wherein one need not bill their exports or imports in US dollar. We have the Indo-Thailand free trade agreements. Other countries are increasing bilateral trade which is beneficial to both the countries involved. If financial markets all of a sudden switch to the gold standards then 39


there will be global turmoil. Gold along with the basket of currencies including Chinese renminbi may replace the US dollar over the coming years. However, the Federal Reserve will not sit and see the decline of the US dollar. It will take steps to stimulate the US dollar¶s decline. Whether such steps are successful or not is something only time can decide. Deflation-Inflation-Stagflation-Recession: This is the cycle global economy follow. Globally, we are in stagflation cycle. Higher commodity and energy prices, including prices of food grains have resulted in higher inflation and lower growth in developed nations. Stagflation implies high inflation and low growth. Gold performs best under conditions of stagflation. Commodity prices inflation is here to stay, as demand pressure remains high. Dollar v/s Gold: Changing equations- There is a direct relationship between gold and a weaker US dollar. Most of the metals and soft commodities are quoted in US dollar. If the US dollar declines, the net receivables of the commodity producing nations also fall (assuming commodity prices remain the same). As the US dollar declines, commodity prices rise as they are mostly quoted in US dollars. Higher commodity prices lead to 40


higher inflation. This cycle will continue as long as the US dollar continues to depreciate and the world switches away from quoting commodities in US dollar. Gold is the best commodity against inflation.

GOLD: W ILL ILL IT R EPLACE EPLACE HE US DOLLAR ? T HE 41


y

GOLD AND US DOLLAR.

Gold prices rose to $846 an ounce in November 2007 from $254 in 2001, which is a 23%rise in nearly seven years. This is a great return considering the risk involved. Average annual price of gold has also been rising. Gold has gained maximum against the US dollar, which indicates US dollar¶s plight in the first decade of the 21st century. It is also an indication that the ³US ³US dollar is starting to lose its World Reserve Currency Peg´ Peg´ which will be completed by 2010. US have been the key driver behind global growth and consumption since 1960. And, the dependence on the US dollar and US economy also increased the value of US dollar. Crude oil, billed in US dollar, further added to the clout of greenback. All this is about to change. Crude oil may not be billed in US dollar after 2010. There are crack appearing in OPEC and the Middle East coalition of nations over the billing of crude oil in US dollar. How long can US and its allies attack nations which bill crude oil in a currency other than US dollar? Iran, Nigeria, Venezuela is all on the radar of the US government as they try to bill crude oil 42


in other currencies. More wars imply more US dollar bashing and greater value for gold. Investing can be broadly classified into: hard asset and paper assets. assets . Gold is a hard asset, while paper assets include equities, bonds, etc. Technology has also created more paper assets, as investments can be made even through the internet. Gold is also in the form of paper asset when investment in gold is done through the futures markets, Exchange Traded Funds (ETF), gold stocks and gold bonds. Exchange traded funds are backed by physical gold. y

CENTRAL BANK AND GOLD.

Most of the central banks, including India¶s, are holding gold reserves as a hedge against any fiscal crisis. In India, in 1991, the Narasimha Rao government had taken a loan against gold to tide over Indian fiscal crisis, which ultimately led to the opening up of the Indian economy. According to the International Monetary Fund, official gold reserves (including those of the IMF and the BIS) amounted to around 35580 tons at the end of 1990. At end of 2006, this had reduced to around 30380 tons, a 15% fall. A major portion of the 5200 tons reduction was due to sales by European 43


central banks, notably by the signatories to the Central Bank Gold Agreements (CNGA 1 AND CBGA 2) whose reported holdings were collectively reduced by around 4870 tons (although this figure may be distorted by gold swaps and by the institutional changes consequent on the introduction of the euro). Over the period, a majority of other central banks kept their gold reserves more or less stable. Some reduced their reported reserves and others increased them. Some of the central banks (for example, that of China, Russia and a few oil-producing nations) have started to increase their share of gold reserves and reduce their US dollar reserves. China had 700 tons of gold reserves. China had 700 tons of gold reserves at the end of September 2007 or just 0.90% of total reserves (up from 105 tons at the end of 2001). Russia had 407.50 tons of gold at the end of September 2007 or just 2.10% of reserves up from 317 tons at the end of 1993. A few other central banks have been steadily increasing their huge foreign exchange reserves in gold and in currencies other than US dollar. Central banks portray a macro picture of the things to come. If they are increasing their gold reserves, why should 44


retail investors be left behind? It¶s for you to decide wisely. y

GOLD : DEMAND AND SUPPLY.

Unless new gold mines are found in the coming years or some of the major central banks (including Federal Reserve) sell gold, there will be a shortage of gold. Further, the cost of extracting gold is also rising. As far as supplies are concerned, in 2006, the mine output was more or less unchanged at 2473tons, while the total gold supplies in 2006 (including producer price hedging, central bank sale, and scrap sales) stood at 3557tons. In 2006, the total gold demand, including jewelry and ETF demand, was at 3386 tons. At the moment, there is still a marginal surplus. Gold ETF demand is expected to rise in the coming years. Jewelry demand from India and China is expected to rise over the next few years. There has also been a rise in the Chinese demand for gold. The overall consumer demand in China rose by 24% in tonnage terms, continuing the upward movements that started in 2003, paused when the price was volatile in the first half of 2006, and then resumed. Jewelry¶s performance was more 45


mixed: a further substantial increase in mainland China, a smaller but solid increase in Hong Kong, and a further fall in Taiwan. The rise in retail investment has been stronger. However, the demand has also been supported by the steady gains in gold prices, which has appealed to the investment motive that is present not just in the buying of bars and coins but also often in jewelry purchase, along with concern over rising inflation and continued promotional activity. Stock market performance will also play a role in determining consumer buying power and hence in the propensity to purchase gold. Gold demand from other regions across the globe is expected to rise as well, particularly from the Middle East, Eastern Europe and Russia (apart from Asia).

BOTTOM OF PYRAMID OPPURTUNITIES In efforts to sell more, the industry has to search for newer means and avenues, and one such untapped area is the bottom of the pyramid (BOP), which comprises consumers at 46


the lower end of the market, the largest but socially poorest economic group. India has a huge untapped BOP market, and one company that is providing access to the poorest section of society is precious metal is the Muthoot Pappachan Group. Thomas Muthoot from the Muthoot Pappachan Group shared his experiences and the idea of tapping this section of the market. The group introduced a scheme µSwarna Varsham¶, Varsham¶, in which the consumer can pay an equal daily investment which is similar to the equated monthly installment (EMI) system system.. ³It ³It is paid on a daily basis and begins at as low as Rs16. Through this system, the consumer can make the physical purchase of the products once their investments have reached the price of at least a gram of gold. gold.´ The group has increased its customer base from 10, when it began this scheme, to more than 500 people now.

CONCLUSION The US subprime financial crisis had a direct impact on the global gold market in the quarter of 2007, as safe haven investors spurred record inflows into gold exchange traded funds. 47


Financial markets are responding to the US dollar decline and near recession situation in the US economy by switching their investment away from the US dollar. Exporters of different currencies have started billing their exporters in currencies other than the US stocks and bonds, and are increasing investments in commodities including precious metals and soft commodities as a hedge against the decline in the US dollar. Even retail investors in the US are reducing their US dollar-based investments. i nvestments. Thus, if this trend continues, Gold along with the basket of currencies including Chinese renminbi may replace the US dollar over the coming years. However, the Federal Reserve will not sit and see the decline of the US dollar. It will take steps to stimulate the US dollar¶s decline. Whether such steps are successful or not is something only time can decide«. In the light of fall down of equity markets, investors realized that they need to have at least 10-15 per cent of their portfolio in gold. As a result, number of retail investors is growing. Besides, though gold has been volatile recently, the underlying trend is for it to rise. So, it may be recommended for investors whose portfolios include gold, to keep holding on to it. 48


Gold is a hedge against all kind of uncertainties. Over the past 2-3 years, global growth rates have averaged over 5.0% consistently. Gold demand by way of ETF increased sharply between August 2007 and November 2007 after the US subprime crisis. Gold is the best hedge not only against global slowdown and readjustment but also against geopolitical risk. Gold, despite an occasional fall, is bound to remain bullish due to the prevailing global political and financial uncertainty uncertainty..

BIBLIOGRAPHY The ICFAI University Press- The Analyst January 2009* March 2009* May 2009* y y y

http://en.wikipedia.org/wiki/Gold_market 49


finance.indiamart.com/markets/commodity/ gold.html www.kitco.com/market the-gold-market.com www.bullionvault.com/gold_market.do www.usagold.com/dailyquotes.html economictimes.indiatimes.com/Markets/ Bullion www.indiabullion.com/indiagoldmarket.php goldnews.bullionvault.com/gold*_india*_*ma rket*_price*_*demand_*...*

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impact of gold on economy

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