1.

INTRODUCTION

Gold is a chemical element with the symbol Au and an atomic number of 79. It has been a highly sought-after precious metal for coinage, jewellery, and other arts since the beginning of recorded history. The metal occurs as nuggets or grains in rocks, in veins and in alluvial deposits. Gold is dense, soft, shiny and the most malleable and ductile pure metal known. Pure gold has a bright yellow colour and lustre traditionally considered attractive, which it maintains without oxidizing in air or water. Gold is one of the coinage metals and has served as a symbol of wealth and a store of value throughout history. Gold standards have provided a basis for monetary policies. It also has been linked to a variety of symbolisms and ideologies. A total of 161,000 tonnes of gold have been mined in human history, as of 2009. This is roughly equivalent to 5.175 billion troy ounces or, in terms of volume, about 8,333 cubic meters. Chemically, gold is a transition metal and can form trivalent and univalent cations in solutions. Compared with other metals, pure gold is chemically least reactive, but it is attacked by aqua regia (a mixture of acids), forming chloroauric acid, but not by the individual acids, and by alkaline solutions of cyanide. Gold dissolves in mercury, forming amalgam alloys, but does not react with it. Gold is insoluble in nitric acid, which dissolves silver and base metals. This property is exploited in the gold refining technique known as "inquartation and parting". Nitric acid has long been used to confirm the presence of gold in items, and this is the origin of the colloquial term "acid test", referring to a gold standard test for genuine value. Of all the precious metals, gold is the most popular as an investment. Investors generally buy gold as a hedge or safe haven against any economic, political, social or currency-based crises. These crises include investment market declines, burgeoning national debt, currency failure, inflation, war and social unrest. Speculators also buy gold early in a bull market and aim to sell it before a bear market begins, in an attempt to gain financially.
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Gold has been used throughout history as a form of payment and has been a relative standard for currency equivalents specific to economic regions or countries. Many European countries implemented gold standards in the later part of the 19th century until these were dismantled in the financial crises involving World War I. After World War II, the Bretton Woods system pegged the United States dollar to gold at a rate of US$35 per troy ounce. The system existed until the 1971 Nixon Shock, when the US unilaterally suspended the direct convertibility of the United States dollar to gold. Since 1919 the most common benchmark for the price of gold has been the London gold fixing, a twice-daily telephone meeting of representatives from five bulliontrading firms of the London bullion market. Furthermore, gold is traded continuously throughout the world based on the intra-day spot price, derived from over-the-counter gold-trading markets around the world. Today, like all investments and commodities, the price of gold is ultimately driven by supply and demand. Unlike most other commodities, the hoarding and disposal plays a much bigger role in affecting the price, because most of the gold ever mined still exists and is potentially able to come on to the market for the right price. At the end of 2006, it was estimated that all the gold ever mined totalled 158,000 tonnes This can be represented by a cube with an edge length of just 20.2 meters. At the end of 2004 central banks and official organizations held 19 percent of all above-ground gold as official gold reserves. Given the huge quantity of gold stored above-ground compared to the annual production, the price of gold is mainly affected by changes in sentiment, rather than changes in annual production. According to the World Gold Council, annual mine production of gold over the last few years has been close to 2,500 tonnes.[15] About 2,000 tonnes goes into jewellery or industrial/dental production, and around 500 tonnes goes to retail investors and exchange traded gold funds. This translates to an annual demand for gold to be 1,000 tonnes in excess over mine production which has come from central bank sales and other disposal. Central banks and the International Monetary Fund play an important role in the gold price. The Washington Agreement on Gold (WAG), which dates from September 1999, limits gold sales by its members (Europe, United States, Japan, Australia, Bank for International Settlements and the International Monetary Fund) to less than 400
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tonnes a year. European central banks, such as the Bank of England and Swiss National Bank, have been key sellers of gold over this period. Although central banks do not generally announce gold purchases in advance, some, such as Russia, have expressed interest in growing their gold reserves again as of late 2005. In early 2006, China, which only holds 1.3% of its reserves in gold, announced that it was looking for ways to improve the returns on its official reserves. Some bulls hope that this signals that China might reposition more of its holdings into gold in line with other Central Banks. India has recently purchased over 200 tons of gold which has led to a surge in prices. Bank failures When dollars were fully convertible into gold, both were regarded as money. However, most people preferred to carry around paper banknotes rather than the somewhat heavier and less divisible gold coins. If people feared their bank would fail, a bank run might have been the result. This is what happened in the USA during the Great Depression of the 1930s, leading President Roosevelt to impose a national emergency and to outlaw the ownership of gold by US citizens.

Low or negative real interest rates If the return on bonds, equities and real estate is not adequately compensating for risk and inflation then the demand for gold and other alternative investments such as commodities increases. An example of this is the period of Stagflation that occurred during the 1970s and which led to an economic bubble forming in precious metals. War, invasion, looting, crisis In times of national crisis, people fear that their assets may be seized and that the currency may become worthless. They see gold as a solid asset which will always buy food or transportation. Thus in times of great uncertainty, particularly when war is feared, the demand for gold rises.

2. ECONOMIC OVERVIEW
The Indian economy has continuously recorded high growth rates and has become an attractive destination for investments, according to Ms Pratibha Patil, the Indian President. "India's growth offers many opportunities for mutually beneficial cooperation," added Ms Patil. "Today India is among the most attractive destinations globally, for investments and business and FDI had increased over the last few years," said Ms Patil. The Indian economy is expected to grow at around 7.5 per cent, according to Dr Manmohan Singh, the Indian Prime Minister. The PM acknowledged Asia's emerging economies were "growing well" and were, "in fact, contributing to the recovery of the world economy". The overall growth of gross domestic product (GDP) at factor cost at constant prices, as per Revised Estimates, was 8.5 per cent in 2010-11 representing an increase from the revised growth of 8 per cent during 2009-10, according to the monthly economic report released for the month of September 2011 by the Ministry of Finance. Overall growth in the Index of Industrial Production (IIP) was 4.1 per cent during August 2011. The eight core Infrastructure industries grew by 3.5 per cent in August 2011 and during April-August 2011-12, these sectors increased by 5.3 per cent. In addition, exports and imports in terms of US dollar increased by 44.3 per cent 41.8 per cent respectively, during August 2011. Over the next two years India could attract foreign direct investment (FDI) worth US$ 80 billion, according to a research report by Morgan Stanley. India has received US$ 48 billion FDI in the last two years. Considering the pace of FDI growth in India, KPMG officials believe that FDI in 2011-12 might cross US$ 35 billion mark.

The Economic scenario India has been ranked at the second place in global foreign direct investments (FDI) in 2010 and is expected to remain among the top five attractive destinations for international investors during 2010-12, according to a report on world investment prospects titled, 'World Investment Prospects Survey 2009-2012' by the United Nations Conference on Trade and Development (UNCTAD). India's FDI gathered momentum with the inflows growing by 310 % in June 2011 to touch US$ 5.65 billion. It is the highest monthly inflow during the last 11 years. The total FDI stood at US$ 16.83 billion during January-June 2011, nearly 57 per cent higher than the US$ 10.74 billion received during the same period last year. Non-resident Indian (NRI) inflows in the first quarter of 2011-12 has witnessed a rise of 38 per cent as compared to the same period in 2010-11. NRIs invested US$ 1.54 billion in various NRI deposit schemes during April-June 2011. Private equity (PE) investments in India stood at US$ 6.14 billion in value terms, while the number of deals increased by 33 per cent to 195, during January-June 2011, according to data compiled by Chennai-based Venture Intelligence. The rise in the value of the deals so far (June 2011) recorded a growth of 52 per cent, as compared to US$ 4.04 billion raised during 2010. India's foreign exchange (Forex) reserves have increased by US$ 1.6 billion to register US$ 318 billion during the week ended August 19, 2011, according to data released by the Reserve Bank of India (RBI). The increase in Forex is largely attributed due to valuation changes. The Government has approved fund raising worth Rs 60,950 crore (US$ 13.24 billion) by companies through external commercial borrowings (ECB) or foreign currency convertible bonds (FCCB) for infrastructure projects in the financial years 2009-2011. India's merchandise exports have registered an increase of nearly 82 per cent during July 2011 from a year ago to touch US$ 29.3 billion, according to a release by the Ministry of Commerce and Industry. Exports during April-July 2011 reached US$ 108.3 billion, up 54 per cent over the same period a year ago, according to Mr Rahul Khullar, Commerce Secretary. Exports in the referred period increased on back of demand for engineering and petroleum products, gems and jewellery and readymade garments.
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3. RESEARCH DESIGN
3.1. Title of the study The impact of gold on the Indian economy and its evolution as an investment option A Study

3.2. Need for Study

This study aims at looking into the rise of gold throughout the history and it evolution to its current status in the Indian economy. This study will also help in establishing the relation ship between gold prices and the various economic indicators that are relevant in the current economic scenario. It gives an overview on the investment scenario concerning gold in its various forms. This report also throws a light on the gold standard, it rise in the international economy and its eventual fall.

3.3. Objectives

To study the emergence of the gold standards and its decline. The study the evolution of gold as an investment option. To study the role of gold in the Indian economy. To study the relationship between that exists between gold prices and the various economic indicators.

3.4. Research Methodology

This is partly a descriptive and partly a causal research study. The research tries to discover and get an insight into the important and defining characteristics of gold and its relationships with the various economic parameters. This research will be conducted mostly with the help of secondary data. This is data collected from literature review. White papers, news papers, magazines company websites are the key source of information. Further the so collected data will be processed with the help statistical tools.

3.5. Literature Review

3.5.1. Mosley, Layna. "Golden Straightjacket or Golden Opportunity? Sovereign Borrowing in the 19th and Early 20th Centuries"

Paper presented at the annual meeting of the American Political Science Association, Boston Marriott Copley Place, Sheraton Boston & Hynes Convention Centre, Boston, Massachusetts, Aug 28, 2002 Abstract What incentives did the classical gold standard provide for its maintenance? How did the benefits of the gold standard help it to be come a central piece of macroeconomic policy in the pre-World War I era? While the gold standard provided a variety of benefits to governments and societies, such as monetary restraint and the facilitation of trade flows, this paper focuses on the impact of the gold standard on sovereign borrowing. I argue that the classical gold standard regime served as both a constraint and an opportunity for governments, in a way similar to present-day currency boards, or to Economic and Monetary Union. Because it required automatic adjustment in response to balance of payments imbalances, as well as the free flow of capital and goods, the gold standard privileged external commitments (the maintenance of par values) over nations? Internal conditions. Governments? monetary policy autonomy was surrendered in service to the gold standard regime. At the same time, however, commitment to the gold standard allowed governments to access international capital
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markets at lower rates of interest; gold convertibility appeared to signal sound government finances, as well as future debt servicing capacity.

3.5.2. Gold exploration and mining scenario in India Raju k. K. The Hutti Gold Mines Co. Ltd, Hutti, INDE Abstract Gold, the oldest metal known to man, still dominates the world scene. India was renowned for its gold from time immemorial. Extensive and intensive ancient gold mining activity, as evidenced by numerous ancient workings, throughout the country testify the flourishing nature of the gold mining industry in India. Modern gold mining dates from the year 1870. Gold production in India was not significant when compared to world standards. At present, Bharat Gold Mines Ltd., and Hutti Gold Mines Co. Ltd., are the two primary gold producing units in India, and produced together about 2.5 tonnes of gold during 1995 as against the world's total of 2,272 tonnes. While production has fallen to very low levels in recent years, demand for the precious metal in domestic market has abnormally increased from 150 tonnes in 1986 to 506 tonnes in 1995 which was mainly met by imports. Indian mine production has been insignificant and remained static between 1.6 and 2.5 tonnes per annum during the last 10 years. This was mainly due to the fact that no new gold deposits of significant size were discovered in the country as the gold exploration and mining programmes were not aggressive due to the meagre budgetary allocations to these sectors as they were controlled by the Government. Considering the big gap in ever increasing demand for gold and the insignificant indigenous supply from the mines, and the vast geological potential, which was not thoroughly explored and mined, Government of India liberalised the mineral policy. The repeal of the Gold Control Order and economic liberalisation have thrown open new vistas for growth of gold mining in the country. There is ample market potential available in the country for indigenously produced gold as India is highly deficient in gold production. From the past history of gold mining and striking similarities in geological environment with the leading gold producing countries of the world. India offers a good potential for
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gold. The Archaean greenstone belts and the other favourable geological horizons have to be thoroughly explored systematically by the latest state-of-art technology. 3.5.3. Gold and Gold Stocks as Investments for Institutional Portfolios Jeffrey F. Jaffe 1989 CFA Institute. Abstract While gold is quite risky as an individual asset, its returns are generally independent of those on other assets. This suggests that gold can play an important role in a diversified portfolio. Tests of four hypothetical portfolios of varying risk show that the addition of gold in each case increases average return while reducing standard deviation. Gold stocks might be expected to be better investment vehicles than gold itself, because they do not share gold's high liquidity, consumption and convenience values. A portfolio of gold stocks on the Toronto Stock Exchange and a mutual fund of South African gold-mining stocks mirror the returns on gold. Adding a combination of these gold proxies to the hypothetical diversified portfolios raises their mean returns but also increases their standard deviations. The increase in returns, however, more than compensates for the increased risk. 3.5.4. Inflation, Tax Rules, And The Prices Of Land And Gold M. Feldstein Harvard University and the National Bureau of Economic Research, Cambridge, MA 02138, USA Abstract Traditional theory implies that the relative price of consumer goods and of such real assets as land and gold should not be permanently affected by the rate of inflation. A change in the general rate of inflation should, in equilibrium, cause an equal change in the rate of inflation for each asset price. The experience of the past decade has been very different from the predictions of this theory: the prices of land, gold, and other
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such stores of value have increased by substantially more than the general price level. The present paper presents a simple theoretical model that explains the positive relation between the rate of inflation and the relative price of such real assets. More specifically, in an economy with an income tax, an increase in the expected rate of inflation causes an immediate increase in the relative price of such store of value real assets. The behavior of real asset prices discussed in this paper is thus a further example of the non-neutral response of capital markets to inflation in an economy with income taxes.

3.5.5. Market Anticipations of Government Policies and the Price of Gold Stephen W. Salant and Dale W. Henderson The Journal of Political Economy, Vol. 86, No. 4 (Aug., 1978), pp. 627-648 Abstract This paper is an analysis of the effects of anticipations of government sales policies on the real price of gold. Although the risk of a future government gold auction depresses the price, it also causes the price to rise in percentage terms faster than the real rate of interest and at an increasing rate. Even risk-neutral investors require this rate of return as inducement to hold gold in the face of the asymmetric risk of a price collapse. Announcements making a government auction more probable cause a sudden drop in the price. Government attempts to peg the price or to defend a price ceiling with sales from its stockpile must result eventually in a sudden attack by speculators.

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4. DATA ANALYSIS
4.1. GOLD STANDARD
The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. When several nations are using such a fixed unit of account, the rates of exchange among national currencies effectively become fixed. The gold standard can also be viewed as a monetary system in which changes in the supply and demand of gold determine the value of goods and services in relation to their supply and demand. Why gold? Because of its rarity and durability, gold has long been used as a means of payment. The exact nature of the evolution of money varies significantly across time and place, though it is believed by historians that gold's high value for its utility, density, resistance to corrosion, uniformity, and easy divisibility made it useful both as a store of value and as a unit of account for stored value of other kinds in Babylon a bushel of wheat was the unit of account, with a weight in gold used as the token to transport value. Early monetary systems based on grain used gold to represent the stored value. Banking began when gold deposited in a bank could be transferred from one bank account to another by a giro system, or lent at interest. When used as part of a hard-money system, the function of paper currency is to reduce the danger of transporting gold, reduce the possibility of debasement of coins, and avoid the reduction in circulating medium to hoarding and losses. The early development of paper money was spurred originally by the unreliability of transportation and the dangers of long voyages, as well as by the desire of governments to control or regulate the flow of commerce within their dominion. Money backed by specie is sometimes called representative money, and the notes issued are often called certificates, to differentiate them from other forms of paper money.
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Through most of human history, however, silver was the primary circulating medium and major monetary metal. Gold was the metal which was used as an ultimate store of value and as means of payment when portability was at a premium, particularly for payment of armies. Gold would supplant silver as the basic unit of international trade at various times, including the Islamic golden age, the peak of the Italian trading states during the Renaissance, and most prominently during the 19th century. Gold would remain the metal of monetary reserve accounting until the collapse of the Bretton-Woods agreement in 1972, and remains an important hedge against the actions of central banks and governments, a means of maintaining general liquidity, and as a store of value.

Early coinage
The first metal used as a currency was silver, before 2000 BC, when silver ingots were used in trade, and it was not until 1500 years later that the first coinage of pure gold was introduced. However, long before this time gold had been the basis of trade contracts in Akkadia, and later in Egypt. Silver remained the most common monetary metal used in ordinary transactions through the 19th century. The Persian Empire collected taxes in gold and, when conquered by Alexander the Great, this gold became the basis for the gold coinage of his empire. The paying of mercenaries and armies in gold solidified its importance: gold became synonymous with paying for military operations, as mentioned by Niccol Machiavelli in The Prince two thousand years later. The Roman Empire minted two important gold coins: aureus, which was approximately 7 grams of gold alloyed with silver, and the smaller solidus, which weighed 4.4 grams, of which 4.2 was gold. The Roman mints were fantastically active the Romans minted, and circulated, millions of coins during the course of the Republic and the Empire. After the collapse of the Western Roman Empire and the exhaustion of the gold mines in Europe, the Byzantine empire continued to mint successor coins to the solidus called the nomisma or bezant. They were forced to mix more and more base metal with the gold until, by the turn of the millennium, the coinage in circulation was only 25% gold by weight. This represented a tremendous drop in real value from the old

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95% pure Roman coins. Thus, trade was increasingly conducted via the coinage in use in the Arabic world, produced from African gold: the dinar. The dinar and dirham were gold and silver coins, respectively, originally minted by the Persians. The Caliphates in the Islamic world adopted these coins, but it is with Caliph Abd al-Malik (685705) who reformed the currency that the history of the dinar is usually thought to begin. He removed depictions from coins, established standard references to Allah on the coins, and fixed ratios of silver to gold. The growth of Islamic power and trade made the dinar the dominant coin from the Western coast of Africa to northern India until the late 1200s, and it continued to be one of the predominant coins for hundreds of years afterwards. In 1284, the Republic of Venice coined their first solid gold coin, the ducat, which was to become the standard of European coinage for the next 600 years. Other coins, the florin, noble, grosh, zloty, and guinea, were also introduced at this time by other European states to facilitate growing trade. The ducat, because of Venice's preeminent role in trade with the Islamic world and its ability to secure fresh stocks of gold, would remain the standard against which other coins were measured. Beginning with the conquest of the Aztec Empire and Inca Empire, Spain had access to stocks of new gold for coinage in addition to silver. The primary Spanish gold unit of account was the escudo, and the basic coin the 8 escudos piece, or "doubloon", which was originally set at 27.4680 grams of 22 carat gold, using current measures, and was valued at 16 times the equivalent weight of silver. The wide availability of milled and cob gold coins made it possible for the West Indies to make gold the only legal tender in 1704. The circulation of Spanish coins would create the unit of account for the United States, the "dollar" based on the Spanish silver real, and Philadelphia's currency market would trade in Spanish colonial coins.

Theory
The essential features of the gold standard in theory rest on the idea that inflation is caused by an increase in the quantity of money, an idea advocated by David Hume, and that uncertainty over the future purchasing power of money depresses business confidence and leads to reduced trade and capital investment. The central thesis of the
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gold standard is that removing uncertainty, friction between kinds of currency, and possible limitations in future trading partners will dramatically benefit an economy, by expanding both the market for its own goods, the solidity of its credit, and the markets from which its consumers may purchase goods. In much of gold standard theory, the benefits of enforcing monetary and fiscal discipline on the government are central to the benefits obtained, advocates of the gold standard often believe that governments are almost entirely destructive of economic activity, and that a gold standard, by reducing their ability to intervene in markets, will increase personal liberty and economic vitality.

Differing definitions of "gold standard"

If the monetary authority holds sufficient gold to convert all circulating money, then this is known as a 100% reserve gold standard, or a full gold standard. Some believe there is no other form of gold standard, since on any "partial" gold standard the value of circulating representative paper in a free economy will always reflect the faith that the market has in that note being redeemable for gold. Others, such as some modern advocates of supply-side economics contest that so long as gold is the accepted unit of account then it is a true gold standard. In an internal gold-standard system, gold coins circulate as legal tender or paper money is freely convertible into gold at a fixed price. In an international gold-standard system, which may exist in the absence of any internal gold standard, gold or a currency that is convertible into gold at a fixed price is used as a means of making international payments. Under such a system, when exchange rates rise above or fall below the fixed mint rate by more than the cost of shipping gold from one country to another, large inflows or outflows occur until the rates return to the official level. International gold standards often limit which entities have the right to redeem currency for gold. Under the Bretton Woods system, these were called "SDRs" for Special Drawing Rights.

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4.2. GOLD AS A RESERVE ASSET

Central banks, and official international institutions, have been major holders of gold for more than 100 years and are expected to retain large stocks in future. They currently account for about 20% of above-ground stocks. The process of rebalancing reserve portfolios to adjust to changing conditions has led to a reduction in the amount of gold held by some central banks recently and this process may continue for some years to come. But the central banks have affirmed that gold will remain an important reserve asset for the foreseeable future and it retains an important role in reserve management. Central banks started building up their stocks of gold from the 1880s, during the period of the classical gold standard. Under that system, for countries on the gold standard, the amount of money in circulation was linked to the country's gold stock, and paper money was convertible into gold at a fixed price. The development of banking and credit meant that the amount of money in circulation was greater than the gold stock itself, but everybody had sufficient confidence in convertibility that there was no danger of this option actually being exercised. That at least was the case during the height of the gold standard for the UK, the then dominant economic, political and financial power. As other countries decided to join the gold standard, they also started to accumulate gold so as to be able to maintain convertibility at a fixed price. The Bank of England, as the central bank at the centre of the system, commanded such universal confidence that it actually needed very little gold. In 1870, its reserves were 161 tonnes and by 1913 this had risen to a still moderate figure of 248 tonnes. Some other countries had by then accumulated much larger stocks: the United States had 2,293 tonnes, Russia 1,233 tonnes, France 1,030 tonnes, Argentina 440 tonnes, Germany 439 tonnes, Austria 378 tonnes and Italy 356 tonnes. Even Australia had more than the UK, at 310 tonnes. The world's total of official gold reserves is estimated to have been about 8,100 tonnes in 1913, compared with only 700 tonnes in 1870.

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The rise in official gold stocks

The period of economic nationalism between the two world wars saw a rapid concentration of gold in official hands - up to that point, most gold had always been held privately, circulating as currency among citizens and across borders in commercial trade transactions. Gold, which had been the foundation of the first genuinely international monetary system during the period before World War 1, came to be used as a weapon in economic competition and national rivalries. In 1933-34, the United States under President Roosevelt devalued the dollar in terms of gold, raising the price from $20.67 an ounce to $35 an ounce. This new higher price caused holders of gold around the world to sell their holdings to the United States. US official holdings rose from 6,000 tonnes in 1925 to 18,000 tonnes at the end of World War II, when it had about 60%of all the official stocks of gold. At their peak in the 1960s, official gold stocks reached about 38,000 tonnes and probably accounted for about 50% - or perhaps slightly more - of all above ground stocks. Central banks kept gold because, through the fixed official dollar price of gold, and dollar convertibility, it was still the foundation of the international monetary system. Although there was no direct link between gold holdings and national money supplies (as there had been under the classic gold standard), gold was still the primary "reserve asset". Central banks could convert dollar balances into gold at the official price. So gold provided the "anchor" to which all currencies of member countries were linked, directly or indirectly. But gradually, as central banks created more money than was consistent with stable prices, and after several years of moderate but persistent inflation, the fixed official gold price again became unrealistic, and the United States, as the pivot of the system, was faced with the choice of deflating, devaluing or abandoning the system. In August 1971, it abandoned the system, with President Nixon "closing the gold window".

Mobilising gold
As the ultimate form of payment, gold has sometimes proved the only asset, when used either as cash or as collateral, acceptable to counterparties. Gold can indeed play a crucial and strategic role in central bank reserve mobilisation in case of need.

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Some examples of where gold has been used in political or economic emergencies are as follows:

For example, in the 1981 Iranian hostage crisis, Iran refused to accept U.S. dollars in return for releasing the American hostages it held. So the U.S. transferred 50 tonnes of gold instead. As then Treasury Assistant Secretary Manuel Johnson went on to say in Congressional testimony in 1983 - and in the light of this recent experience - "The Treasury, of course, regards the US gold stock as part of our national patrimony and of value as a precautionary asset." The US government simultaneously took ownership of an equivalent quantity of Iranian gold that had been frozen at the New York Fed, so there was no net cost to US reserves.

In 1974 Italy secured a $2 billion loan from the Bundesbank with gold as part of a package (including the then largest ever IMF loan) to shore up its balance of payments after the 1973 oil price rise.

Hit by a short-run foreign exchange crisis in 1991, India had to rely on its bullion holdings to survive. First the government swapped 20 tonnes on the Swiss market and, later, shipped a further 46 tonnes to London as collateral for a loan from the Bank of Japan. An IMF official at the time noted: "There were discussions over the weekend about a pool of central banks coming to the rescue and the first question that was asked by those sponsor banks was whether they were prepared to give their gold as collateral."

Finally, gold in the private sector can provide a vital support for public sector purposes. In the aftermath of the 1997 Asian currency crisis several countries in the region announced plans to mobilise residents' gold holdings - Malaysia, South Korea and Thailand among them. Only South Korea raised significant amounts (approximately 270 tonnes) but the avowed intent of all three was to rely on local citizens' patriotism to surrender gold in return for government bonds or local currency. The gold collected was either placed directly in reserves, thereby adding to credibility, or sold for dollars which could be used to repay external debt or in intervention to support their ailing currencies.

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Tracking central bank gold holdings

Most central banks place data on their reserve assets, including gold, in the public domain and report them regularly to the IMF, including reports made under the Standard Data Dissemination Standards. Official holdings are therefore generally more transparent and easier to track than those of other large holders such as most major private investors. However, some central banks also hold stocks of gold that are not considered or reported as formal reserves while some official or quasi-official institutions have gold holdings that are not reported. In addition holdings may not always be reported in a way that facilitates analysis. The World Gold Council compiles a number of statistical tables based on official data in the public domain and drawn from a variety of sources.

Why central banks hold gold

Monetary authorities have long held gold in their reserves. Today their stocks amount to some 30,000 tonnes - similar to their holdings 60 years ago. It is sometimes suggested that maintaining such holdings is inefficient in comparison to foreign exchange. However, there are good reasons for countries continuing to hold gold as part of their reserves. These are recognised by central banks themselves although different central banks would emphasise different factors.

Diversification
In any asset portfolio, it rarely makes sense to have all your eggs in one basket. Obviously the price of gold can fluctuate - but so too do the exchange and interest rates of currencies held in reserves. A strategy of reserve diversification will normally provide a less volatile return than one based on a single asset. Gold has good diversification properties in a currency portfolio. These stem from the fact that its value is determined by supply and demand in the world gold markets, whereas currencies and government securities depend on government promises and the variations in central banks monetary policies. The price of gold therefore behaves in a completely different way from the prices of currencies or the exchange rates between currencies.
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Economic Security
Gold is a unique asset in that it is no one else's liability. Its status cannot therefore be undermined by inflation in a reserve currency country. Nor is there any risk of the liability being repudiated. Gold has maintained its value in terms of real purchasing power in the long run and is thus particularly suited to form part of central banks' reserves. In contrast, paper currencies always lose value in the long run and often in the short term as well.

Physical Security
Countries have in the past imposed exchange controls or, at the worst, total asset freezes. Reserves held in the form of foreign securities are vulnerable to such measures. Where appropriately located, gold is much less vulnerable. Reserves are for using when you need to. Total and incontrovertible liquidity is therefore essential. Gold provides this.

Unexpected needs
If there is one thing of which we can be certain, it is that todays status quo will not last for ever. Economic developments both at home and in the rest of the world can upset countries plans, while global shocks can affect the whole international monetary system. Owning gold is thus an option against an unknown future. It provides a form of insurance against some improbable but, if it occurs, highly damaging event. Such events might include war, an unexpected surge in inflation, a generalised crisis leading to repudiation of foreign debts by major sovereign borrowers, a regression to a world of currency or trading blocs or the international isolation of a country. In emergencies countries may need liquid resources. Gold is liquid and is universally acceptable as a means of payment. It can also serve as collateral for borrowing.

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Confidence
The public takes confidence from knowing that its Government holds gold - an indestructible asset and one not prone to the inflationary worries overhanging paper money. Some countries give explicit recognition to its support for the domestic currency. And rating agencies will take comfort from the presence of gold in a country's reserves. The IMF's Executive Board, representing the world's governments, has recognised that the Fund's own holdings of gold give a "fundamental strength" to its balance sheet. The same applies to gold held on the balance sheet of a central bank.

Income
Gold is sometimes described as a non income-earning asset. This is untrue. There is a gold lending market and gold can also be traded to generate profits. There may be an "opportunity cost" of holding gold but, in a world of low interest rates, this is less than is often thought. The other advantages of gold may well offset any such costs.

Insurance
The opportunity cost of holding gold may be viewed as comparable to an insurance premium. It is the price deliberately paid to provide protection against a highly improbable but highly damaging event. Such an event might be war, an unexpected surge of inflation, a generalised debt crisis involving the repudiation of foreign debts by major sovereign borrowers, a regression to a world of currency and trading blocs, or the international isolation of a country.

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4.3. THE RESERVE BANK OF INDIA

The Reserve Bank is required to hold a fixed amount of gold under the Reserve Bank of India Act. The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin, gold bullion and foreign securities, with not less than Rs. 400 million in value held in gold. The system was later amended, under the Reserve Bank of India Amendment Act 1956, to the minimum reserve system, that required the bank to hold at least Rs.1150 million of its assets in gold (this did not imply the need to acquire additional gold, as the value of existing gold reserves were revised up at the time). Rs.1150 million equates o just $24.7 million at todays exchange rate and is tiny in comparison to Indias total foreign exchange reserves of 151.6 billion. India mobilised its gold reserves during the 1991 balance of payments crisis. Between May and July, India shipped a total of 47 tonnes of the countrys gold reserves (the RBI is allowed to hold up to15% of its total old reserves outside the country) to the Bank of England as collateral against a $400 million loan and leased a further 20 tonnes of confiscated gold (not included in the reserve figures)to Union Bank of Switzerland with a six month buyback option to raise a $200million loan. The funds were used to help India meet its short-term debt obligations and import bill. The RBI bought back all 67 tonnes of gold later that year. It also revalued its gold reserves from Rs.28 billion to Rs.72 billion, as it moved from using an outdated gold price4 to valuing its reserves at close to he international market price. The move vastly improved Indias reported import coverage ratio. The RBI currently olds 357.7 tonnes of gold, which though small in comparison to total reserves (4.4% as at September2006), is still he fifteenth highest of central banks in tonnage terms in the world.

RBI and Its Gold Policy Measures

The Reserve Bank of India (RBI) holds 357.75 tons of gold forming about 6 per cent of the current value of its total foreign exchange reserves. The evolution of the gold related policy since independence was centred around some major objectives, viz., weaning away people from gold, regulating the supply of gold, reducing the domestic demand and prices and curbing smuggling.

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In the wake of the Chinese war, it was felt in some circles that it would be feasible to make a frontal attack on demand for gold in India. Accordingly, the Gold Control Order 1962 was issued, banning the making and selling of jewellery above 14 carats, making it compulsory for gold smiths to be licensed and submit accounts of all gold received and utilized by them etc., The measures met with lot of resistance and criticism. This coupled with complexities resulted in the failure of the Gold Control order. Bullion imports and exports were also banned but restrictions on import of gold into the country resulted in the flourishing of smuggling and unofficial transactions in foreign exchange. Official imports to discourage smuggling was first mooted in 1977 but viewed against the forex reserves available then, it was thought as an impossible proposition. The Government decided to sell confiscated gold in small quantities through the RBI. However, it did not have any major impact on smuggling.

4.4. ROLE OF GOLD IN INDIAN ECONOMY

India is the worlds largest gold market in volume terms, one that has expanded considerably during its period of liberalisation. This part of the report provides a broad overview of the gold market within the context of Indias new super charged economy. It looks at all the major aspects of demand and supply, including how the jewellery sector is being affected by the current social and economic changes, new ways to invest in gold, the role of the Reserve Bank of India and on the supply-side, mine production and the scrap market.

The origins of gold demand

Indian gold demand is firmly embedded in cultural and religious traditions. The country has one of the most deeply religious societies in the world, the most widespread faith being Hinduism, which is practiced by around 80% of the population. Gold is seen as a symbol of wealth and prosperity in the Hindu religion. The goddess Lakshmi, who symbolises fertility, productiveness and prosperity, is said
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to have been bathed by elephants who carried pure water in golden vessels. She is depicted as a beautiful woman of golden complexion, dressed in gold-embroidered red clothes, with gold coins flowing from her hands. Since it is suggested that those who worship her gain wealth, Hindus consider gold an auspicious metal, which they like to buy or gift during religious festivals. The most important of these is Diwali, which marks the beginning of the Hindu New Year and usually takes place in October or November. Akshaya Thrithiya, falling in April or May, has also become an important day to buy gold. Purchases on this day are considered auspicious (it is the third most auspicious day in the Hindu calendar). The association between gold and auspiciousness has been used in recent years to promote the idea of buying gold. Over the past five years, Akshaya Thrithiya has become a major gold-buying occasion in the South of India, especially in the State of Tamil Nadu, where sales have reached record levels. Since 2005, the idea has been promoted across the North and West of the country, which has also resulted in a significant rise in gold sales in these regions. Gold also plays an important role in the marriage ceremony, where brides are often adorned from head to toe in gold jewellery. Most of this will be a gift from her parents as a way of giving her some inheritance, as Hindu tradition dictates that the familys assets are only passed down to sons. The gold (and other gifts) the bride receives or her Streedhan (Stree meaning woman and dhan meaning wealth) mean her parents can make sure she is financially secure and enjoys at least the same standard of living to which she was accustomed in her childhood. Gold is especially important in this respect as it remains directly under her control, whereas she may not be privy to the familys other financial affairs. With an estimated 10 million marriages a year taking place in India, wedding-related demand is big business. Much of this demand takes place in the wedding season, which falls between October and January, and April and May, though a good many purchases will be made well in advance of the wedding. Indeed, it is customary for the parents of a baby girl to start accumulating gold for this purpose soon after the child is born. Not all gold demand is allied with cultural and religious beliefs. Gold is also viewed as a secure and easily accessible savings vehicle by the rural community, where around 70% of the population lives. Gold has the added virtue of being an inflation hedge.. This is because the Rupee is not yet fully convertible Indians are only allowed to hold financial assets in Rupees whereas they have been allowed to hold gold since 1990 when the Gold Control Act was repealed.
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Recent Economic Trends

The Indian economy has enjoyed rapid growth over the past decade, thanks to the progressive liberalisation of its economy and the consequent inflow of foreign direct investment, which has allowed the economy to start reaping the benefits of globalisation on a truly massive scale. India is now the fifth largest economy in the world (on a PPP basis) having posted average annual growth rate of 6%p.a for the past decade. The economy shows no signs of slowing either. A noticeable feature of Indias development has been the strength of its domestic economy relative to most emerging markets in Asia. This is particularly true of consumer spending, which has accounted for the lions share of growth over the past decade. The countrys $200 billion retail industry is changing, with the mergence of new large-scale retailing. Shopping centres are starting to spring up across urban India, something which is changing theface of retailing and will affect traditional gold retailers. KPMG and the Federation of Indian Chambers of Commerce and Industry estimate that the amount of shopping centre space will have risen to90 million square feet by the end of 2007,more than four times the 22 million square feet estimated in 2005.

Gold Demand Trends and Outlook

The past decade can be split into two distinct periods as far as the value of gold sales is concerned: 1996-2001, when sales were broadly stable in value terms, and 20022005, when sales accelerated strongly. During the first period, spending averaged Rs.284 billion per annum and fluctuated in a relatively narrow range of Rs.224-316 billion a year. Spending was especially strong in 1998 thanks to the release of pent up demand following the removal of import controls in November 1997. Gold sales were broadly stable in the three years that followed, held back by relatively weak income growth. Sales in tonnage were more volatile over the period, averaging 709 tonnes and fluctuating between 506-810 tonnes. The higher variability of volume as oppose to value spending is a function of both the retail price setting mechanism in Indian, as well as the origins of demand.

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The price of jewellery changes in line with changes in the international market price in India, with each item weighed then priced according to the prevailing daily market rate. The retail mark up is also normally relatively small in relation to the value of the piece. Still, the value of gold sales is often quite price inelastic, especially where gold is being used as a long-term savings vehicle. A prime example would be the parents of a baby girl saving for a future Streedhan, who will usually purchase acertain monetary value of gold each month, although the volume of gold they can afford each year will rise and fall with the price.

That Indian demand is not necessarily adversely impacted by rising prices is clear from the experience of the past few years (2002-2005), when gold demand rose steadily from Rs.276 billion to Rs.473 billion (or 571 tonnes to 750 tonnes)despite a coincident rise in the gold price from Rs.15,026 to Rs.19,599. Indeed, a rising price can often stimulate investment demand for gold, as was the case in Q1 2006, when retail investment spending surged by 32% year-on-year despite an 11% rise in the gold price in rupee terms. What does seem to adversely impact on demand is a pick up in the pace of daily price fluctuations or volatility. Consumers are wary about purchasing when the price is volatile for fear that they buy and then find the price falls. This shows the relationship between the average annual 22-day rolling annualised volatility rate of the rupee denominated gold price and the change in the value of gold sales: the two show a clear inverse relationship over the sample period from 1993 to 2005. The same message would seem to come from H1 2006s experience, when the value of spending fell by 7%, as gold price volatility spiked upwards.

The main theme of the past few years has been a solid upswing in gold sales, with spending increasing from Rs. 276billion in 2002 to Rs. 473 billion in 2005.This has been underpinned by social and economic changes in the Indian economy trends that look set to persist alongside new and better marketing campaigns from 2004 and a growing perception that higher gold prices are here to stay. Indians are enjoying a rapid acceleration in income growth, which is supporting discretionary spending on consumer goods, including gold. More workers are moving from low income to middle and high income quartiles, as India continues to attract large volumes of foreign direct investment, especially into the outsourcing and IT sectors. Last year,
25

estimated 110million households were earning between $10-30K, 16 million between$30-80K and just short of a 1 million earning over $80K. Global Insight, an economic forecasting agency, expects the number of people earning between $1330K, $30-80K and $80K+to increase by 52%, 87% and 200% in real terms to 167 million, 30 million and 3 million respectively by 2015.Social trends are also changing. More women are seeking their independence by entering the workforce, which means there are increasingly two bread winners in the family and there is more disposable income available for discretionary purchases than in the past. Equally importantly, young middle class Indians are more willing to spend than their parents generation was, while tastes are becoming more international, with households increasingly demanding all the conveniences of the modern world, such as mobile phones and home computers.

A recent WGC study, conducted across six key gold markets, including India, found that the increasing independence of woman in developing countries and shifts in attitudes and behaviours, combined with a significant increase in their personal wealth, has meant that gold has become a more relevant and desirable product to a greater number of women. This has increased the number of women falling into golds core target group in India from 25 million in 2002 to 32 million in 2005 and contributing to the rise in gold purchases over the past few years. Of course, gold must compete with a growing desire for other luxury goods too. However, as there is a much bigger pool of money available, it seems likely that the net impact of these socio- economic changes will be positive for gold sales, especially with the relevant marketing initiatives targeted at Indias new affluent young middle class. Recent experience supports this premise, with the rise in gold sales outstripping the rise in general retail spending indices. These socio-economic changes have led to enormous growth in the potential market for gold jewellery.

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Factors Influencing Demand for Gold

Following are the factors influencing the demand for gold. The increase in the irrigation, technological change in agriculture (through mechanization and high yielding varieties), have generated large marketable surplus and a highly skewed rural income distribution is another factors contributing to additional demand for gold.

Black money originating in the services sector, like real estate and public sector, has contributed to gold as store of value. Hence income generated in these service sectors can be treated as a determining variable

Since bank deposits, Mutual funds, small savings, etc are alternative avenues for investing savings, the weighted return on these alternative assets can be considered as another influencing factors.

Inflation redistributes incomes in favour of non-wage income earners, leading to more skewed income distribution. With incremental income of non-wage earners, the demand for gold as a store of value can be expected to rise.

Ways to buy gold

Traditionally most investment has taken the form of physical gold. In 2005, Indians bought 102 tonnes of gold coins and bars. But there are new ways toinvest in gold. Since October 003 the government has allowed futures trading and there are now three futures exchanges, the two largest being he Multi Commodity Exchange of India Ltd(MCX) and the National Commodity and Derivatives Exchange Ltd NCDEX). The next major development is likely to be the arrival of Exchange Traded Funds(ETFs), expected before he end of 2006.UTI Asset Management Company Ltd and Benchmark Asset Management Ltd are currently seeking regulatory approval to sell a gold ETF. These instruments give investors a relatively cost efficient and secure way to access the gold market. They are listed securities that are backed by allocated gold held in a vault on behalf of investors and are intended to offer investors a means of participating in the gold bullion market without the necessity of taking physical delivery of gold, and to buy and sell that interest through the trading of a security on regulated stock exchange.

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Major Markets in India Mumbai

Mumbai is the major wholesale trading centre in India, price quoting in Mumbai market is taken as reference price in most other parts of the country. Mumbai was losing its shine due to high sales tax of 2% prior to April 2002, but the rationalization of the local taxes in Maharashtra in April 2002 which brought sales tax level to 0.5% has it helped the gold trade to move back to Mumbai and it would not be a surprise to see Mumbai to re-emerge as one of the largest gold trading centres in India and maybe the world. Mumbai and Ahmedabad together account for about 45% Indian gold trade.

Ahmedabad
The bullion market of Ahmedabad, became the largest landed destination in the country for the yellow metal after the Gold Control Act was scrapped in 1991-92.The Gujarat bullion market, which at 280 tonnes accounted for a high 40 per cent of the entire country's 700-tonne market in 2000-01, had hit a trough in the 2001 fiscal with volumes crashing by over 50 per cent to less than 140 tonnes. In rupee terms, the Ahmedabad bullion juggernaut has slowed down perceptibly to Rs6000 crore worth of business in the last fiscal, a slump from Rs 12,000 crore worth of transaction in the previous year. However, after the VAT implication in Rajasthan and Gujarat there should not be major difference in the tax structure. Still Ahmedabad is considered one of the important bullion markets in the country. The physical delivery in bullion for the both NCDEX and MCX also generally takes place in Ahmedabad.

Delhi
Delhi is another major gold market in the country. Delhi prices command some prominence in some parts of the country. Delhi was gaining prominence when Mumbai was loosing its shine. Delhi Gold market constitutes about 15% of total Indian gold trade.

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Above ground stocks

Supply from above ground stocks is much more important in India, with the main source of domestic supply coming from recycled jewellery. Over the past five years, Indians have recycled an average of 105 tonnes of gold per annum. Scrap supply is sensitive to general economic conditions, the price of gold and price expectations. The harp increase inscrap5 in 2002 and 2003 (Figure 10) was driven by a combination of distress selling in rural areas because of the poor2002 monsoon and subsequent hit to agricultural incomes, as well as a higher high gold price the gold price averaged$309.68 in 2002 and $363.32 in 2003,compared with $271-$279 in the previous three ears). Price expectations also matter. For instance, the decline in scrap supply in 2005, in the face of high prices and generally good economic conditions, is attributed to expectations of still higher prices6.In summary, India looks poised to remain the worlds foremost gold consumer in tonnage terms for many years to come. Its dynamic population growth and strong cultural and religious affinity to gold will continue to underpin structural demand. Mean while, rapid income growth, thanks to the influx of foreign capital, should, in tandem with new successful marketing campaigns, continue to boost discretionary spending on gold, notwithstanding temporary fluctuations associated with spikes in price volatility. Indias demand will continue to be satisfied almost entirely from imports, as aside from the scrap market, very little supply comes from domestic sources.

Economic Implications of Gold Imports

Gold by it self does not add much to production or productive capacity. However the foreign exchange used for importing it in effect reduces the availability of this resource for other imports (including raw materials, intermediates and capital equipment) needed for current production and to expand productive capacity. In the Indian context, the magnitude of FOREX expended on gold imports has been large and growing in 1970, Indias imports at the prices prevailing in the world market at that time, would have cost $ 2.2 billion, equivalent to about one eighth of merchandise exports and 8 percent of merchandise imports and the corresponding figures for 1997 was $ 7.5 billion. (Equivalent to about one fifth of exports and one sixth of imports).

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Prior to 1992, gold imports being illegal were financed by the proceeds of under invoicing of the exports, over invoicing of imports, earning of migrant workers remitted through hawala channels and smuggling of silver and contra brand drugs. These transactions did not figure at all in the countrys trade or payment statistics. After 1992, the value of legal gold imports cleared through the customs are included as part of merchandise imports in the balance of payments data (but not in the trade statistics) an equivalent amount being recorded as transfer receipts under invisible. The nature and sources of the latter are not indicated for lack of information. Clearly they, as well as the resources needed for the still substantial smuggled gold, must have been derived from one or the other of the extra legal sources cited earlier. Possibly their relative importance has changed in effect the hawala market continues to operate but with indirect legal sanction given by the gold import policy. The magnitudes involved are large in relation to the size of the countrys foreign trade and payments: The gold stock of the country at the end of 2000 was close to 14,000 tons valued at current price at $ 165 billion. Their continued rapid growth can have significant consequences in the terms of scale and functioning of the hawala market, the availability of FOREX for other purposes and the health of the balance of payment. The other characteristics of gold are that it is a highly liquid store of value. It represents command over both at home and at abroad which can in principle be invoked whenever necessary. Its physical depreciation is negligible and it can be readily converted in to cash by sale in the world market by acquiring other resources both at domestic and international market. Though it does not earn any interest and though it is no longer used as the standard for fixing currency values, the fact that there is a very well developed world market for metal and that its prices have until recently increased much faster than the general price level makes it a attractive asset. So far Gold is treated as ornament, it can be treated as durable consumer good. But this function does not in any way dilute its advantage as liquid, risk free asset. In any case, not all gold is held in the form of ornaments; a large part of it is held in the form of bars. Altogether from countrys point of view, golds holding whether in the form of bars or ornaments, are no different from FOREX holdings. That the bulk of it is in the hands of private individuals who may or may not be willing to convert it into other
30

assets is another matter, and does not detract from this feature. Of course, it is important to such a context, to understand why people prefer to hold gold and the conditions under which they will add or reduce the stock of it in their hands. If accumulating gold, in principle, is no different from accumulation of FOREX reserves or investment in foreign financial assets, then they must be properly counted as part of the economys savings. The more so because investment in gold, in real sense, a substitute for investment in other assets. It is significant that during the last five years, the value of additions to gold stock accounts for over 20% of private noncorporate sectors investment in financial instruments. Exclusion of gold from the estimates of domestic savings thus understates the household and overall domestic savings rate, and this bias has been increasing from the last two decades.

Tariff Structure
The import duty on Gold was Rs.220 per ten grams upto January 1999,after which it was increased to Rs400 per ten grams, this led to increased gold smuggling. As a result, India lost an estimated Rs6000 crores (Rs 60 billion) of foreign exchange. Smuggling gradually came down when the duty was reduced to Rs250 per ten grams on April 2001 and subsequently to Rs100 per ten grams. The amount of duty released from gold imports indicates an annual figure varying from Rs.1000 to Rs.2,000 crore per annum since 1997.

4.5. GOLD AS AN INVESTMENT INSTRUMENT

Of all the precious metals, gold is the most popular as an investment. Investment demand can be split broadly into two, private and public-sector holdings. Private sector holdings come in the form of bars and coins. Unlike jewellery, which is held at least in part for decorative purposes, these holdings are purely a store of value, although in the Middle East coins and small bars are often incorporated into jewellery. Private investment holdings amount to just under 25,000 tonnes, a figure that has been growing slowly over time. More interestingly the location of the bulk of these holdings is believed to have shifted. Whereas thirty years ago, a substantial portion of
31

this was held by Western investors, the overwhelming majority is now thought to be held in other parts of the world. Reasons for holding physical gold vary widely. In markets with poorly developed financial systems, inaccessible or insecure banks, or where trust in the government is low, gold is attractive as a store of value which is portable, anonymous and readily marketable anywhere. In countries with a stable political and financial system, the prime attraction of gold is as an investment which has very low or negative, correlation with other assets, and which may hold or increase its value if for some reason investors flee from purely financial assets like bonds and equities. If gold is held primarily as an investment asset, it does not need to be held in physical form. The investor could hold gold-linked paper assets or could lend out the physical gold on the market. While proper discussion of the gold lending market is reserved to the second chapter of the report, suffice to observe here that an investor who wants exposure to gold, particularly if his position is more than, say, 10,000 ounces, will normally be able to achieve an increase in return of perhaps 1% by lending out his gold over the return he would gain by holding physical gold. In addition he will save on the storage costs. Current holdings by different countries are quite diverse both in terms of absolute quantity and as a proportion of their total external reserves. Gold holdings twenty years ago are a good predictor of a central banks holding today. The stability has been particularly marked among the larger holders - including the United States, Germany, the International Monetary Fund and France. There have been substantial sales, most notably by Argentina, Australia, Belgium, Canada, the Netherlands, Switzerland and the UK. There have also been confirmed buyers, the largest being Taiwan and Poland. These differences can partly be explained by the way in which reserves are viewed nationally, and the way in which decisions on reserve policy are taken, and also by the very large size of reserves relative to the underlying flow of production and consumption. Given the size of official reserves relative to consumption levels, the possibility of changes in policy has had a substantial impact on the gold price.

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Investment vehicles Retail Gold Investment

The definition excludes so-called investment jewellery. It is decided to only count physical bullion coins and bars, with these in turn defined by the standard adopted by the European Union. In counting such bullion, however, private investor metal account holdings are included. Theoretically in the latter case, there could be a problem with unallocated as opposed to allocated gold holdings, as the part of the former would be lent out. Making an allowance for this is, however, impractical. Finally, the definition of retail investment demand excludes all institutional investment.

The broadest definition of retail investment would incorporate any private sector demand for gold that was not related purely to adornment or industrial purposes. This would include so-called investment jewellery (generally high carat, low mark-up jewellery purchased with an investment motive). The problem with such a definition is that it is highly subjective as well as excessively elastic. It is subjective because purchase-motive is extremely difficult to measure on a scientific basis. For example, wedding-related demand for high-carat jewellery in India has an important investment motive but it is also purchased for adornment.. In addition, to complicate matters still further, one is dealing with a dynamic situation. For example, changing tastes in jewellery and the shift to lower-carat articles in some parts of the world, where highcarat was formerly predominant, makes it impossible on a systematic and regular basis to measure investment jewellery demand worldwide.

Bars
The most traditional way of investing in gold is by buying bullion gold bars. In some countries, like Argentina, Austria, Liechtenstein and Switzerland, these can easily be bought or sold "over the counter" of the major banks. Alternatively, there are bullion dealers that provide the same service. Bars are available in various sizes, for example in Europe these would typically be in 12.5kg or 1kg bars (1kg = 32.15072 Troy ounces), although many other weights exist, such as the Tael, 10oz, 1oz bar, 10g, or 1

33

Tola. Gold bars can be held either directly (i.e. held directly by you or in your own safe) or indirectly (held in a safe deposit box or bank vault on your behalf). Because of the many difficulties of transporting, storing and verifying pure gold bars, an increasingly popular method of investing in gold bars for the small investor is via allocated holdings using a gold account - see 'Accounts' below. Bars are increasing in popularity as investment vehicles, as they carry lower premiums than gold bullions. It is estimated that the premiums on kilo gold bars can be at least $50 per ounce less than the premiums on bars such as the American Gold Eagles. Gold bars for sale include 1-oz gold bars, 10-oz gold bars, kilo gold bars, and 100gram gold bars. All these gold bars are .9999 fine (99.99 pure.).
[26]

It seems that the

gold bars are primarily sold as kilo bars rather than 1-oz gold bars, due to the fact that they are much easier to store. Kilo gold bars are .9999 fine (99.99% pure) and contain 32.15 troy ounces each. The most commonly available kilo gold bars are the PAMP and the Royal Canadian Mint (RCM) gold bars. PAMP kilo gold bars usually come with certificates. RCM bars do not come with either protective cases or certificates. actually consists of the PAMP hallmark on the gold bars.
[27]

The PAMP certificate

Coins
Buying gold coins is a popular way of holding gold. Typically bullion coins are priced according to their weight, plus a premium above the gold spot price. Again, the large Swiss and Liechtenstein banks buy and sell these coins over the counter. One of the most popular gold coins is the American Eagle bullion coin, which is guaranteed by the United States Government and has been in circulation for over 300 years. The American Eagle coins contain a stated amount of pure gold and are made in four denominations, by the Department of Treasury.

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The standard gold eagle coins have a fineness of 0.916 and have a face value of $50. The actual gold content of these coins is 1.0 troy ounce (31.103 grs). These US gold eagle coins are also minted in , and 1/10 ounce sizes. [28]

Exchange-traded funds
Gold exchange-traded funds (or GETFs) are traded like shares on the major stock exchanges including London, New York and Sydney. The first gold ETF, Gold Bullion Securities (ticker symbol "GOLD"), was launched in March 2003 on the Australian Stock Exchange, and originally represented exactly one-tenth of an ounce of gold. Gold ETFs represent an easy way to gain exposure to the gold price, without the inconvenience of storing physical bars. Typically a small commission is charged for trading in gold ETFs and a small annual storage fee is charged. The annual expenses of the fund such as storage, insurance, and management fees are charged by selling a small amount of gold represented by each certificate, so the amount of gold in each certificate will gradually decline over time. Exchange-traded funds, or ETFs, are investment companies that are legally classified as open-end companies or Unit Investment Trusts (UITs), but that differ from traditional open-end companies and UITs. The main differences are that ETFs do not sell directly to investors and they issue their shares in what are called "Creation Units" (large blocks such as blocks of 50,000 shares). Also, the Creation Units may not be purchased with cash but a basket of securities that mirrors the ETF's portfolio. Usually, the Creation Units are split up and re-sold on a secondary market.

Certificates
A certificate of ownership can be held by gold investors, instead of storing the actual gold bullion. Gold certificates allow investors to buy and sell the security without the inconvenience associated with the transfer of actual physical gold. Gold certificates may be described as the first paper bank notes. They were first issued in the 17th century when they were used by goldsmiths in England and The

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Netherlands for customers who kept deposits of gold bullion into their safe-keeping. Two centuries later, the gold certificates began being issued in the United States when the US Treasury issued such certificates that could be exchanged for gold. The United States Government first authorized the use of the gold certificates in 1863. In the early 1930s the US Government restricted the private gold ownership in the United States and therefore, the gold certificates stopped circulating as money. Nowadays, gold certificates are still issued by gold pool programs in Australia and the United States, as well as by banks in Germany and Switzerland.

Accounts
Most Swiss banks offer gold accounts where gold can be instantly bought or sold just like any foreign currency. Digital gold currency accounts and the BullionVault gold exchange work on a similar principle. Gold accounts are typically backed through unallocated (fungible or pooled) or allocated (also known as non-fungible) gold storage. Different accounts impose varying levels of intermediation between the client and their gold, for example through bailment or within a trust. Bailment is the legal action of a client entrusting their physical property to another party for safekeeping, and paying for the service.

Derivatives, CFDs and spread betting

Derivatives, such as gold forwards, futures and options, currently trade on various exchanges around the world and over-the-counter (OTC) directly in the private market. In the U.S., gold futures are primarily traded on the New York Commodities Exchange (COMEX), a division of the New York Mercantile Exchange (NYMEX), and NYSE Liffe US. In India, gold futures are traded on the National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX). Firms such as Cantor Index, CMC Markets, IG Index and City Index, all from the UK, provide contract for difference (CFD) or spread bets on the price of gold.

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Gold derivatives: basic principles

In its most simplified form, the transaction can be described as follows: 1.Gold is leased by central banks and other holders to commercial/bullion banks and thus earns for the lender a return in line with the gold lease rate. It is this liquidity which then allows for the execution of all further derivative transactions. 2. With respect to producer hedging, the bullion banks contract to buy gold forward from mining companies. To fund the purchase, the bullion banks sell an equivalent amount of gold borrowed from central banks. The proceeds of this sale are invested and earn interest at money market rates. Thus under these conditions, the borrowed gold is sold, which effectively adds to supply in the very short term. In the absence of compensating factors, this can place pressure on the gold price. This is why hedging of this nature is sometimes termed accelerated supply. In essence it mobilises metal inventories by bringing this metal into the active market. 3. When the forward sale comes to delivery, the producer delivers either newly-mined gold or gold purchased in the market to the bullion bank at the contract price. In theory, the bullion bank then repays its borrowed gold to the central bank and the transaction is unwound in its entirety. However, more commonly, the central bank rolls over the loan, thus maintaining the liquidity to fund further derivative transactions. 4. The transaction in respect to speculative short-selling has an identical effect on the gold market to that of mining companies (except possibly that mining transactions typically involve a longer time horizon). In this case the bullion bank, instead of contracting to buy gold forward from a mining company, contracts to buy gold forward from a speculator (eg a hedge fund or a banks proprietary trading desk). To fund the transaction it once again sells the gold borrowed from the central bank and invests the proceeds on the money market.

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What is special about investing in gold?

Gold is in many ways more like a financial asset than a commodity. Unlike most other commodities, but like financial assets, gold is bought to be stored or kept rather than to be consumed. Most of the gold that has ever been produced is still available and could come back to the market under appropriate conditions. The lending market for gold is also far more developed than for a typical commodity. The existence of an active lending market with rather stable and low interest rates is quite typical of financial assets. In many markets equities can be borrowed at a rate which is only a small margin above the dividend yield. Liquid bonds can be borrowed at a rate only a small premium to their running yield. From this perspective it is not surprising that gold, which pays no dividends or coupons, can be borrowed at a rate close to zero. If gold were like any other financial asset the evidence in the preceding section suggests little reason to believe that the derivative market is likely to distort the cash market. In classic portfolio theory, demand depends not on the price of the asset but on its expected return. Investors buy an asset if its risk adjusted return is higher than the market. Demand for individual financial assets tends to be highly elastic. There are very many different financial assets, most of which are very close substitutes for each other. Demand for financial assets tends to be measured as a stock so many billion dollars rather than as a flow so many dollars per year because investors who currently hold the asset can and will sell their holdings in their entirety if the expected return is too low. All these features of financial assets help ensure that the growth of a derivatives market is unlikely to have a destabilising effect on prices. Even if the derivatives market causes investors to rebalance their portfolios, and buy or sell the underlying asset, large changes in holdings can be accommodated with very little shift in prices. If gold behaves like a typical financial asset one would expect it too to have a very elastic price schedule. If a derivatives market does make it easier for producers and speculators to sell gold short, then a small price reduction would suffice to attract new investors into the market to take the opposite side of the transaction. But there are reasons for doubting that the elasticity of demand for gold is so high, or that a moderate reduction in expected returns on gold would cause most holders to liquidate their portfolios. The pattern of investors who hold gold is not like that for other financial assets. Most private and institutional investors hold little or no gold.
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Investors who hold gold do so at least in part because gold has certain properties which make it peculiarly attractive in the event of acute political or financial instability. For these investors, gold is not readily substitutable by other assets. Their response to changes in expected returns may be relatively small. For example, someone who holds all their financial wealth in the form of gold will have a cash demand for gold which may be largely independent of either the price of gold or of the expected rate of return on holding gold. This means that the price elasticity of demand is close to unity, since a 10% increase in the gold price will reduce the volume of gold bought by 10%.Gold is also unlike a financial asset in that there is substantial consumption demand for gold. While it is hard to separate consumption and investment motives for purchasing jewellery, it is likely that both the price level of gold (for consumption) and the expected return on gold (for investment) play a part in determining demand.

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4.6. GOLD IN CORRELATION WITH THE ECONOMIC INDICATORS 4.6.1. GOLD V/S INFLATION (CPI)
Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also erosion in the purchasing power of money a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time. Inflation's effects on an economy are manifold and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time; uncertainty about future inflation may discourage investment and saving, or may lead to reductions in investment of productive capital and increase savings in non-producing assets. e.g. selling stocks and buying gold. This can reduce overall economic productivity rates, as the capital required to retool companies becomes more elusive or expensive. High inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include a mitigation of economic recessions, and debt relief by reducing the real level of debt. Several leading indicators are monitored by central banks and other agents in the economy in order to forecast the inflation rate. Variables such as exchange rates, inventories and durable consumption, to name but a few, are closely monitoredand scrutinized in order to determine whether the economy is accelerating or decelerating in order to determine future movements in the rate of inflation. Financial asset prices have also been found to possess useful leading indicator properties since their rates of return should embed inflation expectations, but their predictive power has been found to hold only for some periods, and only for certain countries.

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A cursory glance at golds performance in the years since The Golden Constant was first published shows an intuitive relationship between changes in the gold price and changes in the US consumer price index, with peaks in the gold price tending to lead peaks in the CPI.

4.1.

FIGURE SHOWING THE RETURN ON GOLD AND THE CHANGE IN

INFLATION
40.00

30.00

20.00 Gold price

10.00

0.00

change in inflation

-10.00

-20.00

The above graph shows the movement of returns on gold and the differential inflation 1981 to 2009. We can visibly infer that the correlation between the gold returns and the inflation differential is negligible. To get the correlation between the gold and the inflation the percentage changes were considered compared to the previous year.

The Correlation between the returns on gold and the differential annualised inflation CPI (with the base year of the year 2000) is 0.106131. Further the calculation of the regression gave the Beta as 0.037945, indicating that with every one point of change in the gold price there is a very minimal change in the inflation (CPI) of 0.037945. Therefore we can safely assume that there is no prominent relationship that exists between gold and inflation.

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4.6.3. GOLD V/S IMPORTS

Indias imports, after declining since December 2008 for eleven months, exhibited reversal in trend in November 2009 with an increase of 2.6 per cent. The uptrend in imports continued through February 2010. Between December 2009 and February 2010, import growth averaged at 43.0 per cent. Cumulatively, during 2009-10 (AprilFebruary), imports recorded a decline of 13.5 per cent in contrast with a growth of 25.9 per cent a year ago, which resulted from lower international crude oil prices during the period and slowdown in domestic economic activity. Reflecting the increase in gold prices and the higher volume of gold imports on account of the economic recovery, oil imports have increased during the recent period. The commodity-wise imports during April-September 2009 indicated slowdown in non-POL imports, which was mainly due to sharp decline in imports of capital goods, gold and silver, pearls, precious and semi-precious stones, chemicals, iron and steel. Imports of edible oil and pulses, however, witnessed considerable growth, reflecting domestic supply constraints and higher prices

4.4. FIGURE SHOWING THE RETURN ON GOLD AND THE CHANGE IN THE
IMPORTS OF INDIA
140 120 100 80 60 40 20 0 1971-72 1973-74 1975-76 1977-78 1979-80 1981-82 1983-84 1985-86 1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04 2005-06 -20 -40 -60 2007-08 gold prices Imports

0.21502 is the correlation that exists between the returns on gold and the differential imports of India.
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4.6.4. GOLD V/S SENSEX

For the premier Stock Exchange that pioneered the stock broking activity in India, 128 years of experience seems to be a proud milestone. A lot has changed since 1875 when 318 persons became members of what today is called "The Stock Exchange, Mumbai" by paying a princely amount of Re1.Since then, the country's capital markets have passed through both good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no scale to measure the ups and downs in the Indian stock market.

The Stock Exchange, Mumbai (BSE) in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market. SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. First compiled in 1986, SENSEX is a basket of 30constituent stocks representing a sample of large, liquid and representative companies.

The base year of SENSEX is 1978-79 and the base value is 100. The index is widely reported in both domestic and international markets through print as well as electronic media. The Index was initially calculated based on the "Full Market Capitalization" methodology but was shifted to the free-float methodology with effect from September 1, 2003. The "Free-float Market Capitalization" methodology of index construction is regarded as an industry best practice globally. All major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the Free-float methodology.

The growth of equity markets in India has been phenomenal in the decade gone by. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. The SENSEX captured all these events in the most judicial manner. One can identify the booms and busts of the Indian stock market through SENSEX SENSEX is calculated using the "Free-float Market Capitalization" methodology. As per this methodology, the level of index at any point of time reflects the Free-float
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market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization. The base period of SENSEX is1978-79 and the base value is 100 index points. This is often indicated by the notation1978-79=100. The calculation of SENSEX involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate SENSEX every 15 seconds and disseminated in real time.

4.5. FIGURE SHOWING THE RETURN ON GOLD AND SENSEX RETURNS

100 80 60 40 20 0 -20 -40

gold prices annualized sensex

The return on gold correlates to the return on the BSE SENSEX to the extent of 0.178412, which is not a very strong relationship. The regration of the gold returns to that of the BSE comes up to 0.069205. Therefore it is apparent that the effect of gold prices in negligible when it comes to the BSE SENSEX.

1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08

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4.6.5. GOLD V/S SILVER

The prices of gold & silver are viewed differently in different market environments. During the period between 1990- 1998, the price of silver was rising consistently. This is because in a booming economy where silver has a number of industrial uses, the commodity was considered to be much more valuable to gold & hence preferred to gold. From 1998 through 2008, starting with the Hedge Fund and Asian crises, through the Y2K scare and the economic collapse of 2000, through the start of the Iraq war, Gold began to be accumulated more than Silver. Suddenly Gold as money was deemed an important crisis commodity. As fear replaced confidence, Gold relative to Silver increased in value, doubling from 40 times silver in 1998, to 80 times silver in 2003 & 60 times silver in 2005. From early 2004 to now, the Gold- Silver ratio varied between 50 and 70, stabilizing and narrowing towards a mean of 60, which is about where we are now.

4.6. FIGURE SHOWING THE RETURN ON GOLD AND

70 60 50 40 30 20 10 0 Silver Mumbai Rupees per kg. Gold Mumbai Rupees per 10gms.

1974-75

2002-03

1970-71

1972-73

1976-77

1978-79

1980-81

1982-83

1984-85

1986-87

1988-89

1990-91

1992-93

1994-95

1996-97

1998-99

2000-01

2004-05

-10 -20

The price relationship with silver is 0.740537. Here we can clearly see that the interrelationship between gold and silver is quite strong.
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2006-07

5. FINDINGS AND CONCLUSION

5.1. Findings Gold Standards
The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. The essential features of the gold standard in theory rest on the idea that inflation is caused by an increase in the quantity of money The gold standard, in theory, limits the power of governments to cause price inflation by excessive issue of paper currency

Gold as a Reserve Asset

Central banks, and official international institutions, have been major holders of gold for more than 100 years. Gold can play a crucial and strategic role in central bank reserve mobilisation in case of need. The original RBI Act (1934) obliged the Reserve Bank to hold 40% of its assets in gold coin, gold bullion and foreign securities, with not less than Rs. 400 million in value held in gold. The Reserve Bank of India (RBI) holds 357.75 tons of gold forming about 6 per cent of the current value of its total foreign exchange reserves.

Role of Gold in Indian Economy

India is the worlds largest gold market in volume terms, one that has expanded considerably during its period of liberalisation. Sales have averaged 676 tonnes per annum over the past decade Indian gold demand is firmly embedded in cultural and religious traditions. Traditionally most investment has taken the form of physical gold. The main producers of Gold are Hutti Gold Mines and Bharat Gold mines Ltd
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Gold as an Investment Instrument

Gold investment demand can be split broadly into two, private and publicsector holdings. Private sector holdings come in the form of bars and coins. Investment vehicles o Bars o Coins o Certificates o Exchange-traded funds o Accounts and o Derivatives, CFDs and spread betting

Gold V/S Inflation (Cpi)

The Correlation between the returns on gold and the differential annualised inflation CPI (with the base year of the year 2000) is 0.106131.

Gold V/S Imports

0.21502 is the correlation that exists between the returns on gold and the differential imports of India.\

Gold V/S Sensex

The return on gold correlates to the return on the BSE SENSEX to the extent of 0.178412, which is not a very strong relationship. The regration of the gold returns to that of the BSE comes up to 0.069205.

Gold V/S Silver

The price relationship with silver is 0.740537. Here we can clearly see that the interrelationship between gold and silver is quite strong.

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5.2. Conclusion
Throughout the report we can clearly make out the importance of gold in India. Not only economical but also culturally. We observed how gold affected the world economy during the prevalence of the gold standards, its rise to its eventual fall. By establishing the relationship between the return on gold over a period of years and the various economic indicators we can come to the conclusion that though gold is one of the most valuable metal and the most sought after commodity, the gold prices do not really indicate the course of the economy. The relationship that gold has with inflation is nothing but a perceptual link that exists only in the minds of the investors and buyers. The same thing holds true for the relationship between gold returns and the returns on SENSEX, as gold is perceived as an hedging instrument, investors turn towards gold when there is a bearish trend. Through the studies done in tis report we can conclude that the gold price is not the best of the indicators of the economy, as emotional sentiments play a major role where gold is considered.

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