An Empirical Study on Gold as a Commodity Derivative

Topics: Gold, Gold as an investment, Precious metal Pages: 22 (6629 words) Published: January 4, 2011

* Associate Professor, IBS, Hyderabad, A.P India. , ** MBA Class of 2011, IBS, Hyderabad, A.P India. ,

ABSTRACT India is among the top 5 producer of the most of the commodities in addition to being a major consumer of bullion and energy products. Agriculture contributes more than 23% to be GDP of Indian economy. It employees around 57% of the labor force on a total of 185 million hectares of land. Agriculture sector is an important factor to achieving a GDP growth of 8.10. All this indicates that India can be promoted as a major center for trading of commodity derivatives. It is important to understand why commodity derivatives are required and the role they can play in risk management. It is common knowledge that prices of commodities, metals, shares and currencies fluctuate over time. The possibilities of adverse price change in future create risk for business. Derivatives are used to reduce or eliminate price risk arising from unforeseen price change. A derivative is a financial contract whose price depends on, or is derived from the price of other assets. The present study focuses primarily on how gold can be used as a commodity tool for hedging portfolio, medium of exchange, savings and investment. It first explains what is commodity, the structure of commodity market, the various types of derivative market. The study also explains the functioning of the derivative market. The various exchange for commodity market like NCDEX, MCX etc. are described. Keywords: Gold, Commodity Derivative, Hedging, Relative Strength Index, Open Interest. INTRODUCTION The high volatility in equity market with high risk and the arrival of low interest rates have increased the investor presence in alternative investments such as gold. In India, gold has traditionally played a multi-faceted role. Apart from being used for ornament purpose, it has also served as an asset of the last resort and a hedge against inflation and currency depreciation. But most importantly, it has most often been treated as an investment due to the below reasons: l

Gold supply primarily comes from mine production, official sector sales of global central banks, old gold scrap and net disinvestments of invested gold. Out of the total supply of 3385.8 tons last year, 59% was from mine production, 40% from old gold scrap and 1% from official sector sales1. Demand globally generate from fabrication (jewellery and other fabrication), bar hoarding, net producer hedging and implied investment. Gold continues to occupy a prominent part in rural India economy and a significant part of the rural credit market revolves around bullion as security. India is the largest consumer of gold in the world accounting for more than 26.25% of the total world demand annually due to the sustained rural buying and heavy demand from retail investors. According to unofficial estimates, India has more than 15000 tonnes of hoarded gold, which translates to around $200 billion. Inspite of its predominant position, especially in the gold market where India is the 1 d.pdf

The first reason is security, gold offers full security as

long as it is retained by central banks. There is no credit risk attached to gold. l

Secondly, gold is able to maintain its liquidity even at

times of crisis situations like high global inflation or political turbulence. l

The third reason for holding gold is to build a diversified


i-manager’s Journal on Management, Vol. 5 l1 l - August 2010 No. June


largest importer, India has traditionally been a price. seeker in the global bullion market. As considering the Indian growth scenario in GDP and increase importance in world economy near future, at present position India might guide the world gold economy prices....
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