Gold Price and Effect on Stock Exchange

Topics: Gold exchange-traded fund, Gold as an investment, Econometrics Pages: 14 (4626 words) Published: January 9, 2012
Gold Price Volatility and Stock Market Returns in India
P K Mishra Faculty in Economics, Siksha O Anusandhan University, Orissa, India E-mail: pkmishra1974@gmail.com J R Das Faculty in Management, Siksha O Anusandhan University, Orissa, India E-mail: j.35979@yahoo.co.in S K Mishra Faculty in Economics, TITE, Orissa, India E-mail: sk_mishra@yahoo.co.in Abstract The study of the capital market of a country in terms of a wide range of macroeconomic and financial variables has been the subject matter of many researches since last few decades. Recently one such variable, that is, gold price volatility has attracted the attention of many researchers, academicians and analysts. Thus, this paper is an attempt to analyse the causality relation that may run between domestic gold prices and stock market returns in India. The study by taking into consideration the domestic gold prices and stock market returns based on BSE 100 index, investigates the Granger causality in the Vector Error Correction Model for the period January 1991 to December 2009. The analysis provides the evidence of feedback causality between the variables. It infers that the Gold prices Granger-causes stock market returns and stock market returns also Granger-causes the gold prices in India during the sample period. Thus, both the variables contain some significant information for the prediction of one in terms of another.

Keywords: Gold Price, Stock Market Return, BSE 100 Index, India, Volatility, Causality JEL Classification Codes: C22, C32, E44

1. Introduction
The study of the capital 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 price of 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. And, in India, the government started the process of globalization and liberalization since 1991 which allowed prices to be determined by the market forces.

Gold Price Volatility and Stock Market Returns in India

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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 liberalisation 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. Figure 1: Annual Price Movement of Gold in Indian Market

Prior to the introduction of liberalization and globalization policies, gold prices in India showed an increasing trend (Fig.1). In the post liberalization period, the average annual prices of gold also showed an increasing trend from the year 1991 to 1996. But, it showed a decreasing trend in 1997 and 1998 and again showed an increasing trend in the year 2000. From 2000 to 2009, gold prices are continuously increasing. The domestic gold price in India is continuously increasing due to its heavy demand in the country. There are several reasons gold has high demand in India. The first reason is security; gold offers full security as long as it is retained by central banks. There is no credit risk attached to gold. Secondly, gold is able to maintain its liquidity even at times of crisis situations like...

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