correlation between gold and stock markets

TABLE OF CONTENTS

Chapter 1 : Introduction…………………………………………………….……………..1

1.1 Objective of the study …………………………………….…………......................... 4

1.2 Research Methodology .……………………………………………………...…….....4

1.3 Limitations …………….……………………………………………….………..……4

Chapter 2 : Literature Review…………………………………………………….……....5

2.1 Capital Markets .………………….………………………………………..………....6

2.1.1 Scenario of Indian Capital Markets (2010-2011) ……………………………....8

2.1.2 BSE Sensex………………………………………………………………….....10

2.1.3 Dow Jones Industrial Average …………………………………………….......11

2.1.4 FTSE 100 Index..................................................................................................12

2.1.5 NIKKEI 225........................................................................................................13

2.2 Gold ............................................................................................................................16

2.2.1 Gold as an investment ........................................................................................16

2.2.2 Evolution of Gold in Global Economy ..............................................................18

2.2.3 Gold in India ......................................................................................................22

2.3 Gold Prices and Stock Market Indices ........................................................................26

Chapter 3 : Research Methods and Procedure…………………………….……………..30

Chapter 4 : Findings and Data Analysis ………………………………………………...34

4.1 Stock Indices and Gold Price……………………………………………………35

4.2 Correlation between Indices and Gold price…………………………………….40

4.3 Monthly Returns in Stock Indices and Gold price……………………………....45

4.4 Correlation between monthly returns of Indices and Gold price ……………….49

4.5 Annual returns on Stock and Gold………………………………………………54

4.6 Annualized volatility of Stock and Gold ……………………………………….55

Chapter 5 : Conclusion ………………………………………………………………….56

BIBLIOGRAPHY.............................................................................................................58

LIST OF TABLES

S. No. Table Name Page No.

1. Data selection criteria 33

2. Descriptive Statistics of Indices 35

3. Stock Indices Movement 37

4. Descriptive Statistics of Gold 38

5. Gold Price Movement 39

6. Stock Index and Gold 40

7. Descriptive statistics of Stock Index Monthly Returns 45

8. Stock Monthly Returns 46

9. Descriptive statistics Gold Price Monthly Returns 47

10. Gold Monthly Returns 48

11. Stock Returns and Gold Returns 49

12. Annual Returns on Stock and Gold 54

13. Annualized Volatility of Stock and Gold 55

LIST OF FIGURES

S. No. Figure Name Page No.

1 BSE Index chart 14

2 DJIA Index chart 14

3 FTSE 100 Index chart 15

4 NIKKEI 225 Index chart 15

5 Gold Price (INR) 24

6 Gold Price (USD) 24

7 Gold Price (GBP) 25

8 Gold Price (JPY) 25

9 Market timings 32

10 Stock Indices Box Plot 36

11 Gold Price Box Plot 38

12 DJIA Trend Lines 41

13 Gold (USD) Trend Lines 41

14 BSE Trend Lines 42

15 Gold (INR) Trend Lines 42

16 FTSE 100 Trend Lines 43

17 Gold (GBP) Trend Lines 43

18 NIKKEI Trend Lines 44

19 Gold (JPY) Trend Lines 44

20 Stock volatility box plot 45

21 Gold price volatility box plot 47

22 DJIA Volatility Trend Line 50

23 Gold (USD) Volatility Trend 50

24 BSE Volatility Trend Line 51

25 Gold (INR) Volatility Trend 51

26 FTSE 100 Volatility Trend Line 52

27 Gold (GBP) Volatility Trend 52

28 NIKKEI Volatility Trend Line 53

29 Gold (JPY) Volatility Trend 53

1

Chapter 1:

INTRODUCTION

2

INTRODUCTION

The study of the stock market of a country in terms of a wide range of macro-

economic and financial variables has been the subject matter of many researches since

last few decades. Empirical studies reveal that once financial deregulation takes place, the

stock markets of a country become more sensitive to both domestic and external factors

and one such factor is the gold. From 1900 to 1971, with the global systems of gold

standard and USD standard, gold price was regulated. But, since 1972, gold has been

disconnected from the USD. Particularly in 1976 when the International Monetary Fund

(IMF) passed Jamaica Agreement, did gold begin to evolve from currency to ordinary

merchandise and since then gold price has been determined by market supply and

demand. The volatility of the market is influenced by many factors. Gold is one of them.

Similarly the volatility of the stock market has a significant impact on the gold market. A

higher volatility in the stock market results higher investment in the gold market, as gold

is considered as a secure investment. This is because, gold is not affected by the

fluctuation in market fundamentals and it is used as a hedging instrument for risk

minimization.

In India, the government started the process of globalization and liberalization

since 1991 which allowed prices to be determined by the market forces. Since then, the

government has been taking a number of steps to reform the gold sector and ensure that

India benefits from the demand-influence that it has on the gold business internationally.

The liberalization of the gold sector has been made in stages; first allowing a number of

banks to import gold – braking the monopoly of the State Trading Corporations; then

considerably reducing the import duty – destroying a lucrative parallel smuggling

channel and now, allowing traders, manufacturers as well as investors to trade in gold

futures in India itself. Thus the gold market after deregulation exhibited more volatility

and there is subsequent increase in the price and investment pattern of gold market.

Though the volatility of gold market increased, but still it is considered as one of the

safest venture of investment. In India it is the second most preferred investment venture

after stock market. For this reason, investors prefer to invest in gold market, when the

3

stock market is very volatile. The globalization policy of government has opened up the

economy and deregulated the markets. But these market deregulations, structural reforms

in global trade and technological development has revolutionized the financial market. A

by- product of this revolution is increased volatility of the market.

Gold prices have been on an uptick since 2000, while the stock market declined

from 2000 to 2003 and then again in 2008. Through the recovery phase that commenced

in 2003, gold prices kept rising. However in 2008 when the market was suffering from

bearish phase worldwide, gold prices spiked as panic spread across global markets. Since

May 2009 when signs of recovery in the stock markets globally started emerging, gold

continued to forge ahead, albeit at a slower pace. In terms of returns there is clearly a

concrete case for including gold in one’s portfolio. The returns over the long term have

been high unlike the other safe debt instruments which are low yielding (compared with

equity). Over 10 years, gold has clearly done better than Sensex. While over the much

shorter one-year period the equation changes drastically. Over the one-year period after

2008 recession, the Sensex had delivered an impressive return of 25.5%, as against 16%

returned by gold. The characteristic difference between equity and gold is that the pace at

which one gains and loses money in case of equity is extremely high. The movement

from an average value in case of gold is not as drastic as in the case of Sensex.

In this concern the study of the relationship between the volatility of stock market

with that of the investment in gold market is of prime importance. A comprehensive

study of the gold market and its volatility pattern and its comparison with the stock

market will depict the relationship between these two markets. From which the investors

can better assess the risk and return of the markets and can take investment decisions

accordingly.

In our study, four different global stock markets indices viz. BSE Sensex (India),

Dow Jones Industrial average Index (USA), FTSE 100 Index (U.K.) and Nikkei Index

(Japan) are considered. The correlation of movement of Gold prices with respect to stock

markets fluctuation is studied over a period of last three years. The daily spot rates of

gold and daily closing prices of indices form the basis of secondary data. Though the very

4

short term trend may not be accurately determined, but in the long term, the study can

definitely help when the right time to invest in Gold or stock markets is.

Objective of the study

The objectives of the study are mentioned as below:

1) To study the relationship between the volatility of four different global stock

markets with that of the spot Gold market.

2) To find the correlation between US, India, UK and Japan Gold prices.

3) To find the correlation between US, India, UK and Japan Stock market indices.

Research Methodology

A descriptive research methodology is adopted to find the relation between the stock

market movement and gold price movement and al the relation between their returns. The

data has been collected from the secondary source only. The secondary data are collected

from various books and journals, Securities and Exchange Board of India circulars, world

gold council publications, Securities and Exchange Board of India, Commodity Year

Book of Multi Commodity Exchange Limited and websites having historical data like

yahoo finance. The data so collected were classified and tabulated for analysis and

interpretation. To find out the relationship between the gold market and the stock market,

regression models are built. For this purpose SPSS Statistical Package is used.

Limitations

Some of the limitations that are faced during the study are:

1) The information collected is limited by authenticity and accuracy.

2) The time period which is studied is not sufficient to precisely support the hypothesis

with stronger evidence.

5

Chapter 2:

LITERATURE REVIEW

6

CAPITAL MARKETS

Introduction to capital market

Essentially, capital is wealth, usually in the form of money or property. Capital markets

exist when two groups interact: those who are seeking capital and those who have capital

to provide. The capital seekers are the businesses and governments who want to finance

their projects and enterprises by borrowing or selling equity stakes. The capital providers

are the people and institutions who are willing to lend or buy, expecting to realize a

profit. Investment capital is wealth that is put to work by investors. By participating in

the stock and bond markets, which are the pillars of the capital markets, the investors

commit their capital by investing in the equity or debt of issuers that they believe have a

viable plan for using that capital. Because so many investors participate in the capital

markets, they make it possible for enterprises to raise substantial capital, which is enough

to carry out much larger projects than might be possible otherwise. The amounts they

raise allow businesses to innovate and expand, create new products, reach new

customers, improve processes, and explore new ideas. They allow governments to carry

out projects that serve the public through building roads and firehouses, training armies,

or feeding the poor etc. All of these things could be more difficult, perhaps even

impossible to achieve without the financing provided by the capital market place. The

capital market can be categorized into two parts, i.e. primary market and the secondary

market. The primary market deals with the raising of capital by the government and the

corporate entities, whereas the secondary market deals with the trading of the shares of

the companies.

Primary Market

There are actually two levels of the capital markets in which investors participate: the

primary markets and the secondary markets. Businesses and governments raise capital in

primary markets, selling stocks and bonds to investors and collecting the cash. Essentially

7

primary market is one of the mechanisms from where the government or the corporate

entities raise capital for the first time through initial public offerings (IPO). FPO (Follow

on Placement Offer) is another way of raising capital from the market in which the entity

raises capital from the market for the second time. The primary market also includes the

rights issue and private placement. When new shares are issued in favor of the existing

shareholders or the owners, it is known as rights issue. Similarly, when the shares are

privately issued to the institutional investors or high net-worth individuals, it is known as

private placement.

Secondary Market: The Stock Market

In secondary markets, investors buy and sell the stocks and bonds among themselves or

more precisely, through intermediaries. While the money raised in secondary sales

doesn’t go to the stock or bond issuers, it does create an incentive for investors to commit

capital to investments in the first place. The stock markets are essentially the secondary

market, where buying and selling of the shares take place. The price at which each

buying and selling transaction takes is determined by the market forces i.e. demand and

supply for a particular stock. Suppose ABC Co. Ltd. enjoys high investor confidence and

there is an anticipation of an upward movement in its stock price. More and more people

would want to buy this stock (i.e. high demand) and very few people will want to sell this

stock at current market price (i.e. less supply). Therefore, buyers will have to bid a higher

price for this stock to match the ask price from the seller which will increase the stock

price of ABC Co. Ltd. On the contrary, if there are more sellers than buyers (i.e. high

supply and low demand) for the stock of ABC Co. Ltd. in the market, its price will fall

down. In earlier times, buyers and sellers used to assemble at stock exchanges to make a

transaction but now with the dawn of IT, most of the operations are done electronically

and the stock markets have become almost paperless. Now investors don’t have to gather

at the Exchanges, and can trade freely from their home or office over the phone or

through Internet.

8

Scenario of Indian Capital Markets (2010-2011)

Equity market in India witnessed a significant uptrend during 2010-11 till October

2010. This was primarily on account of significant FII inflows into India and number of

IPOs/FPOs of companies like Coal India Ltd, Power Grid Corporation of India Ltd etc.

coming to primary market which attracted number of investors to capital market.

However, post Diwali in November 2010 when market touched its peak, Indian securities

market took downward trend from December 2010 to February 2011 on account of

significant FII outflows and concerns raised on domestic and international issues.

However, the markets got revived in March 2011 as compared to February 2011 on

account of easing of concerns on domestic and international issues and FIIs being net

investor in Indian markets in March, 2011 which helped the market sentiments.

Primary market

• Indian primary market witnessed renewed activity in terms of resource mobilisation

and number of issues during 2010-11, continuing its momentum from 2009-10. In

view of the recovery witnessed in equity markets post global financial crisis,

companies, largely public sector entered the primary market during 2010-11.

• Capital was raised to the tune of Rs. 67,609 crores through 91 issues (81 equity and

10 debt issues) during 2010-11, higher than Rs. 57,555 crores mobilized through 76

issues during 2009-10.

• There were 53 IPOs during 2010-11 as against 39 during 2009-10. The amount raised

through IPOs during 2010-11 was at Rs. 35,559 crores as compared to Rs. 24,696

crores during 2009-10.

• The biggest IPO in 2010-11 was of Coal India with issue size of Rs. 15,199.4 crores

in October 2010.

• Sector-wise classification reveals that 77 private sector and 14 public sector issues

mobilized resources through primary market during 2010-11 as compared to 70

private sector and six public sectors issues in 2009-10.

9

• The share of private sector in total resource mobilisation stood at 43.5 % in 2010-11

as compared to 45.9 % in 2009-10, consequently, the share of public sector in total

resource mobilisation increased to 56.5 % from 54.1 % during the same period.

• There were 36 mega issues in 2010-11 as compared to 30 mega issues in 2009-10.

(An issue of Rs. 300 crores and above is referred to as Mega Issue).

• These 36 mega issues mobilized Rs. 59,547.4 crores which amounts to 88.1 % of total

resource mobilisation during the year.

Secondary Market

• Secondary market segment showed signs of recovery of Indian Corporates from

global financial crises witnessed in 2008.

• During 2010-11, Foreign Institutional Investors (FIIs) made record investments of Rs.

1,46,438 crores in the Indian market (equities and debt combined) surpassing the

previous high of 2009-10 net investments of Rs. 1,42,658 crores.

• Mobilisation of resources by mutual funds was less than redemptions which resulted

into substantial net outflow of funds from mutual funds.

• During 2010-11, Sensex reached its maximum level at 21005 on November 5, 2010

and touched its bottom at 16022.5 on May 25, 2010.

• On analyzing performance of sectoral indices at BSE, though there was an uptrend in

majority of sectoral indices till November 2010, however at the end of year only three

sectoral indices i.e. Consumer Durable, Bankex and Auto index witnessed significant

increase in their levels.

• During 2010-11, turnover of all stock exchanges in India in the cash segment

decreased by 15.1 percent to Rs. 46,85,034 crores from Rs. 55,18,469 crores in 2009-

10

• The market capitalization of all listed companies at BSE increased by 10.9 % to Rs.

68, 39,084 crores in 2010-11 from Rs. 61, 65,619 crores in 2009-10.

10

BSE SENSEX

The Bombay Stock Exchange SENSEX also referred to as BSE 30 is a free-float market

capitalization-weighted stock market index of 30 well-established and financially sound

companies listed on Bombay Stock Exchange. The 30 component companies are

representative of various industrial sectors of the Indian economy. The base value of the

SENSEX is taken as 100 on April 1, 1979, and its base year as 1978-79. India has the

highest number of companies listed in the stock market. Out of this, about 75 % of the

companies are listed with the Bombay Stock Exchange.

The Bombay Stock Exchange (BSE) regularly reviews and modifies its composition to be

sure it reflects current market conditions. Initially, the index was calculated based on the

‘full market capitalization’ method. However this was shifted to the free float method

with effect from September 1, 2003. Instead of using a company's outstanding shares; it

uses its float, or shares that are readily available for trading. The free-float method,

therefore, does not include restricted stocks, such as those held by promoters, government

and strategic investors.

The index has increased by over ten times from June 1990 to the present. Using

information from April 1979 onwards, the long-run rate of return on the BSE SENSEX

works out to be 18.6% per annum, which translates to roughly 9% per annum after

compensating for inflation.

11

DOW JONES INDUSTRIAL AVERAGE INDEX

The Dow Jones Industrial Average also called the Industrial Average, the Dow Jones, the

Dow 30, or simply the Dow, is a stock market index, and one of several indices created

by Charles Dow. It was founded on May 26, 1896, and is now owned by Dow Jones

Indexes, which is majority owned by the CME Group. It is an index that shows how 30

large, publicly owned companies based in the United States have traded during a standard

trading session in the stock. Roughly two-thirds of the DJIA's 30 component companies

are manufacturers of industrial and consumer goods. The others represent industries as

diverse as financial services, entertainment and information technology. Unlike many

other indices, the DJIA is not a weighted index i.e. the Index does not take market

capitalization into account. The value of the Dow is not the actual average of the prices of

its component stocks, but rather the sum of the component prices divided by a divisor,

which changes whenever one of the component stocks has a stock split or stock dividend,

so as to generate a consistent value for the index.

The Dow 30 is among the most closely watched U.S. benchmark indices tracking

targeted stock market activity. Although Dow compiled the index to gauge the

performance of the industrial sector within the American economy, the index's

performance continues to be influenced by not only corporate and economic reports, but

also by domestic and foreign political events such as war and terrorism, as well as by

natural disasters that could potentially lead to economic harm. Components of the Dow

trade on both the NASDAQ OMX and the NYSE Euronext, two of the largest stock

exchanges.

12

FTSE 100 INDEX

The FTSE 100 Index, also called FTSE 100 is a share index of the 100 most highly

capitalized UK companies listed on the London Stock Exchange. The index is maintained

by the FTSE Group, an independent company jointly owned by the Financial Times and

the London Stock Exchange. The index began on 3 January 1984 with a base level of

1000; the highest value reached to date is 6950.6, on 30 December 1999. FTSE 100

companies represent about 81% of the market capitalization of the whole London Stock

Exchange. The constituents of the index are determined quarterly; the largest companies

in the FTSE 250 Index are promoted if their market capitalization would place them in

the top ninety firms of the FTSE 100 Index. It is the most widely used of the FTSE

Group's indices, and is frequently reported as a measure of business prosperity.

In the FTSE, share prices are weighted by market capitalization, so that the larger

companies make more of a difference to the index than smaller companies. The Free float

Adjustment factor represents the percentage of all issued shares that are readily available

for trading. The factor is then rounded up to the nearest multiple of 5% for calculation

purposes. To find the free-float capitalization of a company, first find its market cap

(number of shares x share price) then multiply by its free-float factor. Free-float

capitalization, therefore, does not include restricted stocks, such as those held by

company insiders.

Index level = Σ (Price of stock x Number of shares) x Free float Adjustment factor

Index Divisor

13

NIKKEI 225

The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese

companies listed in the Tokyo Stock Exchange. The Nikkei Stock Average was first

published on May 16, 1949, where the average price was ¥176.21 with a divisor of 225.

It is a price-weighted average (the unit is yen), and the components are reviewed once a

year.

The Nikkei average has deviated sharply from the textbook model of stock averages

which grow at a steady exponential rate. The average hit its all-time high on December

29, 1989, during the peak of the Japanese asset price bubble, when it reached an intra-day

high of 38,957.44 before closing at 38,915.87, having grown six fold during the decade.

Stocks are weighted on the Nikkei 225 by giving an equal weighting based on a par value

of 50 yen per share. Events such as stock splits, removals and additions of constituents

impact upon the effective weighting of individual stocks and the divisor. The Nikkei 225

is designed to reflect the overall market, so there is no specific weighting of industries.

Stocks are reviewed annually and announcements of review results are made in

September. Changes, if required, are made at the beginning of October. Changes may

also take place at any time if a stock is found to be ineligible (e.g., delisting). After a

stock has been replaced, the divisor is reviewed and modified to ensure a smooth

transition of the stock index.

14

INDEX CHARTS

Fig.1 BSE Index chart

Fig.2 DJIA Index chart

15

Fig.4 NIKKEI 225 Index chart

Fig.3 FTSE 100 Index chart

16

GOLD

Gold has been synonymous to wealth and prosperity through the ages. In the

modern history, Gold became the international currency as the Gold standard came into

existence. Even after dismantling of Gold standard, Gold existed as the backbone of

international trade and economics as all the countries tried to accumulate tones of it. Till

today, Gold has retained its basic use as a commodity without losing its sheen as a

currency.

The following characteristics of Gold have enabled it play this role:

• It is durable, homogenous and divisible

• Gold’s rarity gives it intrinsic value and that value is high per unit of volume.

• Its value is recognized across the globe and is traded in a continuous market.

• It occurs in a virtually pure and workable state, whereas most other metals tend to

be found in ore-bodies that pose some difficulty in smelting.

Gold as an investment

Gold is a foundation asset within any long term savings or investment portfolio. For

centuries, particularly during times of financial stress and the resulting 'flight to quality',

investors have sought to protect their capital in assets that offer safer stores of value. A

potent wealth preserver, gold’s stability remains as compelling as ever for today’s

investor. A number of reasons portraying gold as a worthy investment are:

1) Portfolio diversification

Most investment portfolios primarily hold traditional financial assets such as stocks and

bonds. Diversifying the portfolio can offer added protection against fluctuations in the

value of any single asset or group of assets. Risk factors that may affect the gold price are

quite different in nature from those that affect other assets. Statistically, portfolios

containing gold are generally more robust and less volatile than those that do not.

17

2) Inflation hedge

Market cycles come and go, but over the long term, gold retains its purchasing power.

Gold’s value, in terms of the real goods and services that it can buy, has remained

remarkably stable for centuries. In contrast, the purchasing power of many currencies has

generally declined, due for the most part to the rising price of goods and services. Hence

investors often rely on gold to counter the effects of inflation and currency fluctuations.

3) Currency hedge

Gold is employed as a hedge against fluctuations in currencies, particularly the US dollar.

If the world’s main trading currency appreciates, the dollar gold price generally falls. On

the other hand, a fall in the dollar relative to the other main currencies produces a rise in

the gold price. For this reason, gold has consistently proved to be one of the most

effective assets in protecting against dollar weakness.

4) Risk management

Gold is significantly less volatile than most commodities and many equity indices. It

tends to behave more like a currency. Assets with low volatility will help to reduce

overall risk in our portfolio, adding a beneficial effect on expected returns. Gold also

helps to manage risk more effectively by protecting against infrequent or unlikely but

consequential negative events, often referred to as “tail risks”.

5) Demand and supply

The price of gold tracks the shifting balance of supply and demand. Long lead times in

gold mining mean production of gold is relatively inelastic, regardless of increases in

demand. That’s why the rally in the gold price since 2001 has not given rise to a

meaningful increase in gold production levels.

Demand for gold has shown sustained growth recently, due at least in part to rising

income levels in key markets. These supply and demand factors have laid foundations for

gold’s most positive outlook in over a quarter of a century

18

Evolution of gold in global economy

1944 - Establishment of the IMF puts gold at the centre of the new international

monetary system (Bretton Woods System)

• All member countries should establish “par values” for their currencies in terms of

gold, or in terms of the US dollar which itself was defined in terms of gold ( 1USD =

$35 an ounce ).

• To enable lending by IMF, its members were also required to pay 25% of their

subscription to the Fund in gold. Members had to buy and sell gold at the fixed price.

• It resulted in IMF holdings of gold rising to 153 million ounces by 1975, at the time

worth $21 billion.

Early 1960s – Central banks try to stabilize the price of gold

• An agreement among central banks called ‘The Gold Pool’ was established to hold

the price of gold close to the then official price of $35 an ounce.

• It followed a speculative attack on dollar that brought the price up to $40 an ounce.

• To tackle it, bank and U.S. authorities sold gold on a substantial scale to bring the

price down.

• The Cuba missile crisis of July 1962 triggered record demands for gold on the

London market, which was again met by official selling. The objective was to avoid

fluctuations in gold prices.

• The central banks abolished The Gold Pool in 1968, agreeing that they would no

longer supply gold to the market but transact only among themselves.

• This established a two-tier system – price based on supply and demand in market and

the other for official transactions at the official price.

• This agreement lasted until November 1973, when the price of gold was allowed to

move freely, following the suspension of dollar convertibility into gold in August

1971.

19

1978 - The IMF attempts to write gold out of the system

• The Second Amendment of the Articles barred members from fixing their exchange

rates to gold and removed the obligation on members to conduct transactions in gold

at the official gold price.

• The IMF was instructed to dispose of 50 million ounces of its gold stock of 153

million ounces. It achieved this partly by sales to the market and partly by giving

some gold to members in relation to their quotas.

• Few countries showed any inclination to sell the gold handed to them, and in the vast

majority of cases it continues to sit on their books.

The European Central Bank (ECB) and Gold

• The ECB decided that the national central banks participating in the euro area should

include gold in the initial transfer of foreign reserve assets to ECB by Jan 1, 1999.

• The collective initial transfer of foreign reserves to ECB was approximately EUR

39.46 billion. It asked its members that 15% of this initial transfer should be in gold

and remaining 85% in foreign currency assets.

• There was no implication by ECB to maintain a constant ratio of 15% of its reserves

in gold in the future. ECB’s total reserves have grown considerably since then due to

the sharp increase in the gold price.

• As at September 2010, the ECB had 26% of its reserves in gold.

The first Central Bank Gold Agreement (CBGA1)

• At that time, Central banks held nearly a quarter of all world gold so their actions

were of key interest to the gold market. Gold remained an important element of

global monetary reserves.

20

• Many central banks of Western Europe having large stocks of had then sold gold or

announced plans to do so causing further falls in the price of gold and instability in

market.

• The market falls caused considerable pain for gold producing countries. Among these

were a number of developing countries, including a HIPCs (Heavily Indebted Poor

Countries).

• In response, 15 European central banks drew up the first Central Bank Gold

Agreement. They agreed to limit their collective sales to 2,000 tonnes over next 5

years.

• In addition a number of other major holders like US, Japan etc. informally associated

themselves with the Agreement.

• It prompted a sharp spike in the price over the following days and the major element

of instability had been effectively removed with the introduction of greater

transparency.

The second Central Bank Gold Agreement (CBGA2)

• On March 8th 2004, the signatory banks announced the second Central Bank Gold

Agreement. Like the first Agreement, CBGA2 covered a five-year period, from

September 27th 2004 to September 26th 2009.

• While the rest of the Agreement covered similar ground to the first, there were some

important differences.

• The maximum amount of gold that the signatories could sell over the five years was

2,500 tonnes, compared to 2,000 tonnes in the first Agreement.

• It happened as the signatories had sold significantly less than the permitted ceiling

they had set themselves.

The third Central Bank Gold Agreement (CBGA3)

• CBGA3 covers a five-year period, in this case from 27 September 2009 to 26

September 2014.This Agreement also included two important departures from the

prior Agreements.

21

• First, the collective ceiling was reduced so that total sales over this period will not

exceed 2,000 tonnes, 500 tonnes lower than the 2,500 tonnes in second agreement.

• As signatories to CBGA2 had significantly undersold the permitted annual ceiling in

the final two years of that Agreement, the new lower ceiling did not create any impact

on the gold price.

• In both the previous Agreements, signatories undertook not to increase their activities

in the derivatives and lending markets above the levels of September 1999, when the

first CBGA was signed which followed in third agreement too.

Market moving factors for gold prices

• The global prices are driven by a host of factors with macro-economic factors like

strength of the economy, rising importance of emerging markets, currency

movements, interest rates etc.

• Supply-demand is a major influencer, amid rising global investor demand and

sometimes interrupted productions.

• Shifts in official gold reserves, reports of sales/purchases by central banks act as

major price influencing factors, whenever such reports surface.

• The investment in gold is influenced by comparative returns from other markets

like stock markets, real estate other commodities like crude oil.

• Indian gold prices are highly correlated with international prices. However, the

fluctuations in the US Dollar impact domestic gold prices to major extent.

• Domestically, demand and consequently prices to large extent are influenced by

seasonal factors like marriages.

22

Gold in India

India’s centuries old gold industry is the world’s biggest market for the metal,

with imports meeting almost all the country’s requirements for jewellery and investment.

India is the world's largest consumer of gold. India's gold demand is firmly embedded in

cultural and religious traditions. It is also valued in India as a savings and investment

vehicle and is the second preferred investment after bank deposits.

The gold market has benefited significantly from India’s economic liberalization

which has served to accelerate the country’s growth. In the period from 1996-2001,

Indian gold sales were broadly stable in value terms, averaging Rs284 bn per annum.

Spending was especially strong in 1998 due to the release of pent up demand following

the removal of import controls in the previous year. But then, in the period from 2002-

2010, gold sales accelerated strongly – with the exception of 2009 when record rupee

prices and a major deterioration in the domestic economy impacted demand. In 2010, the

Indian economy rebounded from the global financial crisis and so did the demand for

gold.

Demand for Gold in India

Indians hold the largest stock of gold in the world, 18,000 tonnes of which is held by

households. It is estimated that 7% of India’s $256 billion in total household savings is

currently held in gold. This stock is likely to grow over the next decade. As India's

domestic primary production of gold is very less, at around 2-3tonnes a year, the country

imports most of its domestic requirement. While Indian gold demand accounted for 32%

of global consumer demand in 2010 at 963 tonnes, the psychology of Indian demand is

unlike that of any other market. Despite a 400% rise in the Rupee gold price in the last

ten years, gold demand from Indian consumers has shown no signs of dwindling. History

shows that during periods of major price increases, demand can stall. However, as wealth

increases, Indians will continue to buy gold as the price gradually rises.

23

Cultural beliefs

Cultural ideas about gold have influenced all communities of India for generations.

Gold’s mythology is sewn into the fabric of Indian society. Gold’s narrative is a

permanent thread in the symbols and rituals of the most widespread faith. In India,

Hinduism, this is practiced by around 80% of the population. For most Indians gold is

sacred; an embodiment of divinity and a symbol of purity, prosperity and good fortune

that can adorn the body and celebrate life.

Jewellery

In the last decade, 75% of gold demand in India has taken the form of jewellery. The

motivation for a jewellery purchase is inextricably linked to value, wealth preservation

and growth rather than pure adornment. The rural agricultural sector, approximately 70%

of the Indian population, has been the source of more than two thirds of gold demand.

This is partly because in practical terms one’s wealth must be easily worn on one’s

person, easily liquidated and relatively stable as a value store. Indian jewellery demand

witnessed a remarkable surge to 745.7 tonnes in 2010, 13% above the previous peak in

1998. In local currency terms, Indian jewellery demand more than doubled in 2010; to

Rs. 1,342 bn. This compares with 2009 demand equal to Rs669 bn.

Forex reserves

Gold has also long formed an important part of India’s currency reserves. Although, even

with a substantial stock of gold reserves, gold’s share in total reserves had declined over

the past decade due to the vast growth in dollar-denominated assets. This led the Reserve

Bank of India (RBI) to rebalance its reserves through the purchase of 200 tonnes of gold

in late November 2009, taking the RBI’s stock of gold to 558 tonnes or 8.5% of total

reserves and making it the eleventh largest official sector holder of gold in the world.

24

GOLD CHARTS

Fig.5 Gold Price (INR)

Fig.6 Gold Price (USD)

25

Fig.7 Gold Price (GBP)

Fig.8 Gold Price (JPY)

26

Gold Prices and Stock Market Indices

Gold price volatility and Stock market returns in India

The twin factors namely increase in global spot gold prices and appreciation of USD

against INR, led to sharp rise in gold prices in India in the recent past. Since the gold

prices in India are influenced by international factors, its volatility is very important.

Volatility involves short term - monthly, weekly or even hourly fluctuations in gold

prices as measured by their absolute percentage changes during a particular period. If we

look at the rolling standard deviation of monthly gold prices since 2000, the prices are

more volatile after July 2007 which is almost the same time when the slow down started

in USA as a result of the sub-prime crisis. A look at the historic data brings out that when

the stock market crashes or when the dollar weakens, gold continues to be a safe haven

investment because gold prices rise in such circumstances. It is no surprise that many

investors, big and small have chosen to hedge their investments through gold at the time

of crises. Gold prices have been on an uptick since 2000, while the stock market declined

from 2000 to 2003 and then again in 2008. In 2008 when the market was suffering from

bearish phase worldwide, gold prices spiked as panic spread across global markets. So far

since March 2009 in India signs of recovery in the stock markets have emerged. At the

same time gold continues to forge ahead, albeit at a slower pace. In 2008, the two assets

prices – equity and gold, were moving in opposite directions, displaying the ability of the

yellow metal to protect one's portfolios at the time of a dip. In fact, during each of the

two prolonged bear phases (lasting at least a year) over the past decade, gold has

provided an effective hedge. Gold has not yet lost its prime importance as a hedge against

loss of wealth in times of crises.

The relationship among oil prices, gold prices and individual industrial sub-indices in

Taiwan.

The fact that oil and gold prices keep rising to record levels influences financial markets

deeply and attracts attention from both academic and practical perspectives. It is believed

27

that commodity prices should have different degrees of influences to individual industries

instead of the whole market. As the oil prices and gold prices make the Volatility

Spillover Effects, the fluctuations in the gold prices will be effected by the severe

fluctuations in the oil prices. The fluctuations in oil prices will influence both the

Electronic Industrial Sub-Indices and the Rubber Industrial Sub-Indices. The correlations

among oil prices and the Electronic Industrial Sub-Indices and the Rubber Industrial Sub-

Indices are positive. The Chemical Industrial Sub-Indices, Cement Industrial Sub-Indices,

Automobile Industrial Sub-Indices, Food Industrial Sub-Indices, and Textiles Industrial

Sub-Indices will be influenced by fluctuations in gold prices.

London gold prices and stock price indices in Europe and Japan

For the period beginning in January 1991 and ending in October 2001 empirical evidence

is examined on the relationship between the price of gold and stock price indices for

markets in Europe and Japan. Three gold prices set in London and 23 stock price indices

for 18 countries are used. The short-run correlation between returns on gold and returns

on US stock price indices is small and negative and for some series and time periods

insignificantly different from zero. Occasionally it is small and positive—but typically

only one-tenth of the magnitude of the sample correlation coefficient between returns on

the FTSE All Share and DAX 100 indices. Over the period examined, there is no co-

integration involving a gold price and a stock price index. That is, there is no long-run

equilibrium and the series do not share a common stochastic trend. Only weak short-run

relationships are evident.

The price of gold and stock price indices for the United States For the period beginning in January 1991 and ending in October 2001 empirical evidence

is examined on the relationship between the price of gold and stock price indices for the

United States. Three gold prices set in London and one set in New York are used,

together with six stock price indices of varying coverage. The short run correlation

between returns on gold and returns on US stock price indices is small and negative and

for some series and time periods insignificantly different from zero. Over the period

examined, there is no co-integration involving a gold price and US stock price index.

28

That is, there is no long-run equilibrium and the series do not share a common stochastic

trend. Only short-run relationships are evident. Granger causality tests find evidence of

unidirectional causality from US stock returns to returns on the gold price set in the

London morning fixing and the closing price. For the price set in the afternoon fixing,

there is clear evidence of feedback between the markets for gold and US stocks.

Gold: Hedging against tail risk

The research found that gold effectively helps manage risk in a portfolio, not only by

means of increasing risk-adjusted returns, but also by reducing expected losses incurred

in extreme circumstances. Such tail-risk events, while unlikely can be seen to have a

damaging effect on an investor’s capital. The analysis suggests that even relatively small

allocations to gold, ranging from 2.5% to 9.0%, can have a positive impact on the

structure of a portfolio. It is found that, on average such allocations can reduce the Value

at Risk (VaR) of a portfolio, while maintaining a similar return profile to equivalent

portfolios which do not include gold. For the eight portfolios analyzed using data from

January 1987 to July 2010, adding gold reduced the 1% and 2.5% VaR by between 0.1%

and 18.5%. Moreover, that portfolios which included gold outperformed those which did

not in 18 out of 24 occasions (75%) when doing an in-sample analysis, and in seven out

of ten (70%) in out-of-sample tests. Finally, gold also has other unique characteristics

that make it very useful in periods of financial distress. For example, the gold market is

highly liquid and many gold bullion investments have neither credit nor counterparty

risk.

Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold. The paper analyzes whether gold works as a safe haven asset in financial markets. A safe

haven asset is distinguished from a hedge and a diversifier asset, which provide

diversification benefits on average but not necessarily when they are needed most, that is,

in times of market turmoil. The empirical results show that gold is a safe haven for

stocks. However, gold is generally not a safe haven for bonds in any market. Gold only

29

functions as a safe haven for a limited time, around 15 trading days. In the longer run,

gold is not a safe haven, that is, investors that hold gold more than 15 trading days after

an extreme negative shock lose money with their gold investment. This finding suggests

that investors buy gold on days of extreme negative returns and sell it when market

participants regain confidence and volatility is lower. The constant and time-varying

relations between U.S., U.K. and German stock and bond returns and gold returns are

studied to investigate gold as a hedge and a safe haven. It is found that gold is a hedge

against stocks on average and a safe haven in extreme stock market conditions. A

portfolio analysis further showed that the safe haven property is short-lived.

Relationships among Oil Price, Gold Price, Exchange Rate and International Stock Markets When talking about macro economy including economic prosperity and recession, the

stock market up and down, and consumer price index higher or lower, one cannot help

but think of the investment “Gold” which maintains its value well and can also hedge

against inflation. Historical experience shows that in countries during period of stock

market slump, the gold always trends higher. Therefore this article would like to explore

the impact of gold price fluctuations on stock indices in various countries. The paper uses

daily data and time series method to explore the impacts of fluctuations in crude oil price,

gold price, and exchange rates of the US dollar vs. various currencies on the stock price

indices of the United States, Germany, Japan, Taiwan, and China respectively, as well as

the long and short-term correlations among these variables. Empirical results show that

there exist co-integrations among fluctuations in oil price, gold price and exchange rates

of the dollar vs. various currencies, and the stock markets in Germany, Japan, Taiwan and

China. This indicates that there exist long-term stable relationships among these

variables. Whereas there is no co-integration relationship among these variables and the

U.S. stock market indices which indicates that there is no long-term stable relationship

among the oil price, gold price and exchange rate and the US stock market index. In

addition, empirical results of the causal relation show that in Taiwan, for example, oil

price, stock price and gold price have two-way feedback relations.

30

Chapter 3:

RESEARCH METHODS AND

PROCEDURE

31

Research Design

A Research Design is a frame work or blue print for conducting any research project. It

details the procedures necessary for obtaining the information needed to structure or

solve any research problem. Although a broad approach to the problem is initially

developed by researcher, the research design specifies the details– the nuts and bolts– of

implementing the approach. It lays the foundation for conducting the project. A good

research design will ensure that the study is conducted effectively and efficiently. There

are three types of research designs viz.

a) Exploratory: This type of research is done when objective is not known and it helps in

providing insight and understandings to define a problem.

b) Descriptive: After defining a problem from exploratory research, we should define

questions, hypothesis, method of analysis, data collection and data analysis of problem.

c) Causal: It helps in determining the cause and effect relationships. Manipulation of one

or more independent variables is done to match with the objective of our problem.

� In this project, Descriptive Research Design had been used to determine the degree

to which different variables are associated.

Research Objectives

The objectives of the study are mentioned as below:

1) To study the relationship between the movement and volatility of four different

global stock markets with that of the Gold spot market.

2) To find the correlation between US, India, UK and Japan Gold prices.

3) To find the correlation between US, India, UK and Japan Stock market indices.

32

Fig.9 Market Timings

Population, Sample and Sampling design

The four stock market indices are chosen in such a manner that they broadly cover the

different time zones of the world. Thus on a particular date, markets start firstly on Tokyo

stock exchange followed by Bombay Stock exchange. Then comes London stock

exchange and finally New York stock exchange. Same is the case in spot market for gold.

When market in one country is about to close, the market in next region starts for the day,

thus making an overlap pattern.

For stock indices, the closing point for the particular day is taken. The gold spot rates as

published by world gold council are used. The duration for which the data is collected is

of 3 years starting from January 2009 till February 2012. As we know that in January

2009, the world was in the initial stages of economic downturn and it was during that

time, that investors were very careful while building their portfolios. Hence this period

will give a fairer view about the relation between market indices and gold prices.

Data Collection

In this project, only Secondary data has been considered to quantitatively prove the

hypothesis.

There were some instances in data when the working and non working days at different

regions were not same on a particular date. To remove this error, only the dates common

to all four indices i.e. when all exchanges opened on a particular date are chosen.

33

Date TSE BSE LSE NYSE

6/7/2010 Open Open Close Open Not selected

7/7/2010 Close Open Close Close Not selected

8/7/2010 Open Open Open Open Date Selected

Since the stock market indices use home currency to decide their points, the price of gold

is considered in home currency rates i.e. in JPY for Tokyo, INR for Mumbai, GBP for

London and USD for New York. This eliminates the variation arising out of

convertibility issues.

Data Analysis

Statistical packages like SPSS and MS Excel will be used to analyze the numerical data.

Different analyses to be performed are:

• Formulating Regression equations

• Correlation between data sets

• Descriptive Statistics

• Line charts

Table 1. Data Selection Criteria

34

Chapter 4:

FINDINGS AND DATA

ANALYSIS

35

1. STOCK INDICES AND GOLD PRICE

a) Stock Indices

N Minimum Maximum Mean Std. Deviation Coef. of Variation

DJIA 705 6547.05 12949.87 10595.6539 1469.35245 0.1386

BSE 705 8160.40 21004.96 16593.7909 2799.57334 0.1687

FTSE_100 705 3512.10 6091.30 5263.3152 608.22201 0.1155

NIKKEI 705 7086.03 11292.83 9565.6476 826.00704 0.0863

Valid N (listwise) 705

Interpretation:

The above data table reflects the four stock indices in past three years. Since all the

four data sets have varied mean and standard deviation values, we use coefficient of

variation to describe consistency. Coefficient of variation is least for NIKKEI index

with 8.63% thereby depicting uniformity and consistency in value relative to others.

For BSE, value is 16.87% which states that variability in value is almost double than

that of NIKKEI. The above data is displayed graphically in form of a Box Plot on

next page.

Table 2. Descriptive Statistics of Indices

36

BOX PLOT

Fig.10 Stock Indices Box Plot

37

b) Correlation between Stock Indices

Table 3. INDEX MOVEMENT (Correlations)

DJIA BSE FTSE_100 NIKKEI

DJIA Pearson Correlation 1 .789** .945

** .258

**

Coef. Of Determination .622 .893 .066

N 705 705 705 705

BSE Pearson Correlation .789** 1 .888

** .555

**


N 705 705 705 705

FTSE_100 Pearson Correlation .945** .888

** 1 .465

**


N 705 705 705 705

NIKKEI Pearson Correlation .258** .555

** .465

** 1


N 705 705 705 705

**. Correlation is significant at the 0.01 level (2-tailed).

Interpretation

On a particular date, the Markets open at NIKKEI, then at BSE, followed by FTSE 100

and finally DJIA. Thus every index has relatively maximum correlation with succeeding

market than other two. For e.g. NIKKEI has relatively maximum correlation with BSE

with Pearson coefficient 0.555, followed by FTSE (.465) and least with DJIA (.258).

Similarly BSE has maximum correlation with FTSE (.888) followed by DJIA (.789) on a

particular date.

DJIA and FTSE are highly correlated (.945) and 89.3% changes in DJIA is explained by

FTSE. 78.8% changes in FTSE is due to BSE with correlation coefficient .888. However

the least correlation is showed by NIKKEI Index with DJIA (.258) where only 6.6%

changes in NIKKEI is explained by DJIA.

38

c) Gold Price ( per Troy oz. or 31.103gm)

Table 4. Descriptive Statistics of Gold

N Minimum Maximum Mean Std. Deviation Coef. Of Variation

USD 705 810.00 1895.00 1275.5152 276.85346 0.2175

JPY 705 72661.04 146132.91 108670.0717 15707.73476 0.1445

GBP 705 556.11 1184.19 810.3806 168.78183 0.2082

INR 705 39714.30 91149.91 59969.2787 13431.64581 0.2239


Interpretation

The above data table shows the descriptive statistics of Gold prices in four countries

depicted in their home currency. The most consistent price of gold is seen in Japan with

variation coefficient of 14.45 %. In US and UK the variation is approximately same,

however in India, it is comparatively high. Also, the range of Gold rates is very broad in

India showing high variability in price.

Fig.11 Gold Price Box Plot

39

d) Correlation between Gold Prices

Table 5. GOLD Price Movement (Correlations)

USD JPY GBP INR

USD Pearson Correlation 1 .984** .985

** .972

**


N 705 705 705 705

JPY Pearson Correlation .984** 1 .974

** .947

**


N 705 705 705 705

GBP Pearson Correlation .985** .974

** 1 .973

**


N 705 705 705 705

INR Pearson Correlation .972** .947

** .973

** 1


N 705 705 705 705


Interpretation

The Gold Price movement in all four countries shows high degree of correlation. Since

Gold is a precious universal commodity, its prices are determined due to demand and

supply in economies. Thus very less chances of arbitration exist.

In the above table, Gold rates movements in US and UK have the highest Pearson

correlation (.985) and coefficient of determination value explains 97% changes in US

gold price explained by UK prices. Almost all the correlations are significant with 95%

or more changes explained by gold prices in other countries. Gold rate correlation in

India and Japan are relatively less (.947) with 89.6% changes in Indian gold prices

explained by Japan prices.

40

2. CORRELATION BETWEEN INDICES AND GOLD PRICES

Table 6. STOCK INDEX AND GOLD (Correlation)

Country No. of

Days

Stock

Index

Gold (in

Currency)

Pearson

Correlation

Coef. Of

Determination

USA 705

DJIA USD 0.846 0.715

India 705

BSE INR 0.411 0.169

UK 705 FTSE

100 GBP 0.633

0.401

Japan 705

NIKKEI JPY -0.096 0.009

Interpretation

The Pearson coefficient is high for movements in DJIA and Gold prices in dollar with

value of 0.846 stating that movement in gold prices is significantly correlated with

movement in DJIA index and 71.5% changes in Gold USD is explained by changes in

DJIA. The correlation between BSE / Gold price in rupees and FTSE 100 with Gold price

in GBP is positive but is moderate. But 16.9% changes in Gold INR are explained by

changes in BSE Sensex while 83.1% is due to other factors. However NIKKEI and gold

price in Japan show a very weak negative correlation. The coefficient of determination is

insignificant with value of 0.9% but the movement trends in opposite direction.

Regression lines: In the figures below, regression lines are drawn for indices and gold

prices. Along with it, moving average curve for 50 days is also drawn. The slope is

positive for all except for NIKKEI where it shows a negative trendline.

41

y = 6.534x + 8288.

0

2000

4000

6000

8000

10000

12000

14000

1

31

61

91

12

1

15

1

18

1

21

1

24

1

27

1

30

1

33

1

36

1

39

1

42

1

45

1

48

1

51

1

54

1

57

1

60

1

63

1

66

1

69

1

Series1

MA 50

Linear (Series1)

y = 1.301x + 813.5

0.00

200.00

400.00

600.00

800.00

1000.00

1200.00

1400.00

1600.00

1800.00

2000.00

13

16

19

11

21

15

11

81

21

12

41

27

13

01

33

13

61

39

14

21

45

14

81

51

15

41

57

16

01

63

16

61

69

1

Series1

Linear (Series1)

MA 50

Fig.12 DJIA Trend Lines

Fig.13 Gold (USD) Trend Lines

42

y = 8.694x + 13525

0

5000

10000

15000

20000

25000

13

16

19

11

21

15

11

81

21

12

41

27

13

01

33

13

61

39

14

21

45

14

81

51

15

41

57

16

01

63

16

61

69

1

Series1

Linear (Series1)

MA 50

y = 61.31x + 38209

0.00

10000.00

20000.00

30000.00

40000.00

50000.00

60000.00

70000.00

80000.00

90000.00

100000.00

13

16

19

11

21

15

11

81

21

12

41

27

13

01

33

13

61

39

14

21

45

14

81

51

15

41

57

16

01

63

16

61

69

1

Series1

MA 50

Linear (Series1)

Fig.14 BSE Trend Lines

Fig.15 Gold (INR) Trend Lines

43

y = 2.273x + 4460.

0

1000

2000

3000

4000

5000

6000

7000

1

31

61

91

12

1

15

1

18

1

21

1

24

1

27

1

30

1

33

1

36

1

39

1

42

1

45

1

48

1

51

1

54

1

57

1

60

1

63

1

66

1

69

1

Series1

Linear (Series1)

MA 50

y = 0.781x + 533.0

0.00

200.00

400.00

600.00

800.00

1000.00

1200.00

1400.00

13

16

19

11

21

15

11

81

21

12

41

27

13

01

33

13

61

39

14

21

45

14

81

51

15

41

57

16

01

63

16

61

69

1

Series1

Linear (Series1)

MA 50

Fig.16 FTSE 100 Trend Lines

Fig.17 Gold (GBP) Trend Lines

44

y = -0.322x + 9679.

0

2000

4000

6000

8000

10000

12000

13

16

19

11

21

15

11

81

21

12

41

27

13

01

33

13

61

39

14

21

45

14

81

51

15

41

57

16

01

63

16

61

69

1

Series1

Linear (Series1)

MA 50

y = 72.03x + 83050

0.00

20000.00

40000.00

60000.00

80000.00

100000.00

120000.00

140000.00

160000.00

13

16

19

11

21

15

11

81

21

12

41

27

13

01

33

13

61

39

14

21

45

14

81

51

15

41

57

16

01

63

16

61

69

1

Series1

Linear

(Series1)

MA 50

Fig.18 NIKKEI Trend Lines

Fig.19 Gold (JPY) Trend Lines

45

3. MONTHLY RETURNS OF STOCK INDICES AND GOLD PRICES

a) Stock Indices Monthly Returns

Table 7. Stock Index Monthly Returns

N Minimum Maximum Mean Std. Deviation

DJIA 36 -16.00 13.77 0.9089 6.03712

BSE 36 -12.88 20.30 1.2096 8.05289

FTSE_100 36 -11.75 11.60 0.5925 5.71521

NIKKEI 36 -13.84 13.73 -0.1525 6.50438


Interpretation

From the above data table, the variability in monthly return is expressed through standard

deviation where FTSE index is relatively consistent in monthly returns. The maximum

variability in monthly returns is seen in BSE Index with S.D. value of 8.05 though the

highest monthly return noted is also in BSE index with 20.3% value.

Fig.20 Stock return box plot

46

b) Correlation between Stock Indices Monthly Return

Table 8. Stock Return (Correlations)

DJIA BSE FTSE_100 NIKKEI

DJIA Pearson Correlation 1 .619** .916

** .692

**


N 36 36 36 36

BSE Pearson Correlation .619** 1 .663

** .536

**


N 36 36 36 36

FTSE_100 Pearson Correlation .916** .663

** 1 .665

**


N 36 36 36 36

NIKKEI Pearson Correlation .692** .536

** .665

** 1


N 36 36 36 36


Interpretation

The Monthly returns of stock indices shows a moderate to high degree of correlation

indicating that the returns in one market have a substantial impact on other market

returns. The highest correlation is between monthly returns of DJIA and FTSE (.916).

About 83.9% monthly returns in DJIA are explained by FTSE return. DJIA also has good

correlation with BSE and NIKKEI with 38.3% and 47.8% changes in DJIA explained by

the two respectively.

FTSE serves as a crucial index as it is closely correlated to all the markets. NIKKEI has

relatively less correlation with others and least with BSE where only 28.7% changes in

BSE monthly returns are explained by NIKKEI returns.

47

c) Gold Price Monthly Returns

Table 9. Gold Price Monthly Returns

N Minimum Maximum Mean Std. Deviation Coef. Of Variation

USD 36 -12.46 14.45 1.7681 5.53260 3.14

JPY 36 -12.62 14.65 1.2316 5.40014 4.39

GBP 36 -8.80 14.78 1.5760 5.83156 3.71

INR 36 -6.18 18.24 2.0096 5.38159 2.67


Interpretation

The average monthly returns are positive for all the markets but it is highest for Indian

gold prices. It also shows the maximum count of return and least variability with

coefficient of variation 2.67. Thus it served as the best market for investing in gold. The

Japanese market showed relatively higher variability with coefficient value of 4.39

Fig.21 Gold price return box plot

48

d) Correlation between Gold Price Monthly Return

Table 10. Gold Return (Correlations)

GOLD_USD GOLD_JPY GOLD_GBP GOLD_INR

GOLD_USD Pearson Correlation 1 .845** .849

** .877

**


N 36 36 36 36

GOLD_JPY Pearson Correlation .845** 1 .740

** .783

**


N 36 36 36 36

GOLD_GBP Pearson Correlation .849** .740

** 1 .880

**


N 36 36 36 36

GOLD_INR Pearson Correlation .877** .783

** .880

** 1


N 36 36 36 36


Interpretation

The monthly return of gold price in all four countries shows high degree of correlation. In

the above table, Gold rates return in UK and India have the highest Pearson correlation

(.880) depicting the similar nature of returns expected by investor. About 77.4% returns

in UK gold market can be explained by Indian gold market. The return in Japan, UK and

Indian gold markets is significantly correlated with US gold return. More than 70%

variations in US gold returns can be explained by each individual market. But the

correlation in return in Gold prices in Japan with respect to India and UK is moderately

significant with values .783 and .74 respectively which means 61.3% and 54.8% of

monthly returns in India and UK respectively is explained by returns of Japanese gold

market.

49

4. CORRELATION BETWEEN MONTHLY RETURNS OF INDICES AND

GOLD PRICE

Table 11. Stock Return and Gold Return (Correlation)

Country No. of

Months Stock Index

Gold (in

Currency)

Pearson

Correlation

Coefficient of

Determination

USA 36 DJIA USD -0.126 0.016

India 36 BSE INR -0.286 0.082

UK 36 FTSE 100 GBP -0.376 0.141

Japan 36 NIKKEI JPY -0.095 0.009

Interpretation

The Pearson coefficient is negative for monthly returns of all indices and Gold prices in

their respective country. From the above table, DJIA/ Gold in dollars and NIKKEI/ Gold

in yen have a very weak negative correlation. For BSE/ Gold in dollars and FTSE/ Gold

in Pounds, there exists a moderate negative correlation. Still only 14.1% and 8.2%

changes in gold prices in UK and India can be explained by FTSE and Sensex

respectively.

Regression lines: In the figures below, regression lines are drawn for return of indices

and gold prices. Almost all the data points are distributed on both sides of the x axis. The

regression line in most of the charts show a negative slope.

50

y = 0.004x + 1.005

R² = 7E-05

-20

-15

-10

-5

0

5

10

15

20

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37

Series1

Linear (Series1)

y = -0.038x + 2.652

R² = 0.005

-15

-10

-5

0

5

10

15

20

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Series1

Linear (Series1)

Fig.22 DJIA Return Trend Line

Fig.23 Gold (USD) Return Trend

51

y = -0.247x + 6.126

R² = 0.097

-15

-10

-5

0

5

10

15

20

25

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37

Series1

Linear (Series1)

y = 0.033x + 1.551

R² = 0.004

-10

-5

0

5

10

15

20

25

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Series1

Linear (Series1)

Fig.24 BSE Return Trend Line

Fig.25 Gold(INR) Return Trend Line

52

y = -0.027x + 1.26

R² = 0.002

-15

-10

-5

0

5

10

15

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Series1

Linear (Series1)

y = -0.004x + 1.831

R² = 5E-05

-10

-5

0

5

10

15

20

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Series1

Linear (Series1)

Fig.26 FTSE 100 Return Trend Line

Fig.27 Gold(GBP) Return Trend Line

53

y = -0.086x + 1.650

R² = 0.019

-15

-10

-5

0

5

10

15

20

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Series1

Linear (Series1)

y = -0.063x + 2.555

R² = 0.015

-15

-10

-5

0

5

10

15

20

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

Series1

Linear (Series1)

Fig.28 NIKKEI Return Trend Line

Fig.29 Gold (JPY) Return Trend Line

54

5. ANNUAL RETURNS ON STOCK AND GOLD

Factors

Yearly Returns (%)

3 yr return (%)

2009 2010 2011 2009-11

DJIA 16.40 9.77 4.04 31.09

GOLD (USD) 24.23 22.57 9.77 58.43

BSE 52.34 14.94 -28.24 40.81

GOLD (INR) 20.45 19.64 26.36 67.41

FTSE 16.44 8.21 -7.62 19.62

GOLD (GBP) 14.77 27.19 10.12 51.95

NIKKEI 15.38 -4.08 -20.68 -6.72

GOLD (JPY) 23.78 10.37 3.37 39.38

Interpretation:

After the 2008 economic recession, 2009 proved to be a good year with all the markets

reviving up and BSE Sensex showed a staggering 52.34 % annual return. But in 2010, the

pace of annual returns slowed down with NIKKEI giving negative returns. 2011 was not

a good year for investors in stock markets as except for DJIA, rest three markets earned

negative returns where BSE was the biggest loser. But on a long term from 2009 to 2011,

BSE index showed maximum returns of 40.81% but NIKKEI was on a losing streak with

negative returns of 6.72%.

However Gold markets showed a positive return in all the years for above four countries.

The highest return for a three year period was in Indian market with 67.41%. On annual

basis, Gold in UK showed relatively maximum yearly return of 27.19% in 2010.

55

6. ANNUALIZED VOLATILITY OF STOCKS AND GOLD

Factors

Annualized Volatility

3 yr volatility

2009 2010 2011 2009-11

DJIA 24.27 16.04 21.15 36.01

GOLD (USD) 20.52 15.64 21.88 34.42

BSE 34.56 16.38 20.97 44.02

GOLD (INR) 19.54 15.73 20.48 32.84

FTSE 23.51 17.71 20.38 35.97

GOLD (GBP) 23.23 16.95 21.14 36.17

NIKKEI 26.93 20.52 23.45 41.41

GOLD (JPY) 21.51 17.74 22.59 36.19

Interpretation:

The annualized volatility is product of daily logarithmic returns in a year and sqrt of

number of trading days in year. Though returns were high in BSE Sensex in 2009, the

volatility or risk was also much high with value of 34.56. In 2010 and 2011, NIKKEI was

the most volatile market but gave negative returns in both the period. Over a period of 3

years, BSE Sensex proved to be the most volatile with 44.02 and the least volatile was the

FTSE market with value of 35.97

The annualized volatility of Gold market was similar in all the four countries with years

2009 and 2011 more fluctuating compared to 2010. For three year period, volatility of

Gold prices was most in UK and Japan while in India, it was relatively less.

56

Chapter 5:

Conclusion

57

Conclusion

The investors diversify their portfolio to minimize risks and maximize their return but it

is important to find the correlation of movement and volatility between different assets.

Stock markets and gold have been considered as important assets and from the above

study, we have come to following conclusions:

• Dow Jones Industrial average index, BSE Sensex and FTSE are significantly

correlated to each other. NIKKEI doesn’t have strong correlation with other

markets.

• Gold prices are significantly correlated in USA, UK , India and Japan

• DJIA and Gold Price in USA are significantly correlated; FTSE and Gold price in

UK; and BSE and Gold price in India are moderately correlated. In Japan,

NIKKEI and Gold prices are not correlated.

• The monthly stock indices returns are highly correlated for DJIA and FTSE; while

all the other indices monthly returns are moderately correlated to each other.

• The monthly gold returns are correlated significantly for all countries with respect

to other three countries.

• There exist a negative correlation between stock market monthly return and gold

monthly return. But the correlation is moderately significant for UK and India and

weekly significant for USA and Japan.

• The returns for three year period from 2009 – 2011 was highest in BSE Sensex

(40.81%) and Gold returns in India (67.41%). NIKKEI showed a negative return.

• The three year volatility was highest in BSE Sensex (44.02) and gold in Japan

(36.19) FTSE was relatively the least volatile market.

58

BIBLIOGRAPHY

59

Literary References

1) Mu-Lan Wang, Ching-Ping Wang and Tzu-Ying Huang (2010), Relationships among

Oil Price, Gold Price, Exchange Rate and International Stock Markets, International

Research Journal of Finance and Economics, Issue 47

2) Brian M. Lucey and Dirk G. Baur, (2010), Is Gold a Hedge or a Safe Haven? An

Analysis of Stocks, Bonds and Gold, The Financial Review, Issue 45

3) P K Mishra, J R Das and S K Mishra(2010), Gold Price Volatility and Stock Market

Returns in India ,American Journal of Scientific Research, Issue 9

4) S.J. Liao and J.T. ChenLiao (2008), The relationship among oil prices, gold prices,

and the individual industrial sub-indices in Taiwan, Working paper, presented at

International Conference on Business and Information (BAI2008), Seoul, South

Korea.

5) Graham Smith(2002), London gold prices and stock price indices in Europe and

Japan , World Gold Council publications

6) Graham Smith(2001), The price of gold and stock price indices for the United States ,

World Gold Council publications

7) Gold: Hedging against Tail Risk(2010), World Gold Council Publications

8) India: Heart of Gold (2011), World Gold Council Publications.

9) Annual Report 2010-2011 (2011), Securities and Exchange Board of India.

Website References

1) www.gold.org

2) www.sebi.gov.in

3) www.forexpros.com

4) www.rbi.org.in

5) www.in.finance.yahoo.com

6) www.ebscohost.com

correlation between gold and stock markets

Documents

bearish phase worldwide

common stochastic trend

data selection criteria

empirical results show

bombay stock exchange

return trend line

london stock exchange

tokyo stock exchange