HOW DOES GOLDS VALUE CHANGE WITH THE STOCK MARKET?

Much has been written and said about the relative level of the stock market and the value of an ounce of gold. It is not possible to state that golds value changes as a result of activity within the stock market and it is also not possible to state that the level of the stock market changes as a result of activity in the gold market. It is more accurate to say that gold reacts differently to factors that impact the stock market. In short, the events and conditions which tend to result in a rising gold price also tend to result in a falling stock market. Whereas high inflation, credit and debt crises, bank failures, currency crises, commodity price shocks and international tensions tend to negatively impact the stock market, gold has historically held its value, or even risen, during such conditions. It is important to point out that gold and stocks are not perfect counterweights to each other. There are plenty of trading days in which both the price of gold and the stock market have gone up. This can even turn into a trend that can last weeks, or even for a few months. But the historical evidence is overwhelming. Over the long-term, gold and stocks tend to move in opposite directions. This has been born out in research done by the World Gold Council for decades which shows that there is indeed a negative long-term correlation between gold and stocks, as measured by all of the major stock indices, namely the Dow Jones Industrial Average, the Standard & Poors 500, and the Wilshire 5000. Whether the stocks being compared to gold are large blue chips or small, aggressive growth companies, the correlation to gold is still negative over the long-term. For that reason, gold is an excellent portfolio diversifier for a portfolio consisting of stocks, whether the portfolio contains just a few blue chips or a broad array of a cross section of the entire stock market. This alone is a compelling reason to buy and own gold and history provides us with important examples of this phenomenon.

In 1973-74, the Dow Jones Industrial Average fell by some 45%, the worst bear market in US stocks since the great depression. This bear market was caused partially by the onset of stagflation. During this same period, the price of gold as measured by the London Fix rose from $65 per ounce to $195 per ounce, an increase of more than 200%.

In October of 1987, a bear market in stocks culminated in a crash and decrease of more than 30% in the US stock market. During that same month, the price of gold exceeded $500 per ounce, at the time its highest level since 1983. In the 4th quarter of 2008, the US stock market was wracked by the shock waves of the subprime mortgage crisis, bank and other financial institution failures and fears of a credit/debt crisis as the US monetary and financial systems were shaken to their very foundations. Thousands of points disappeared off of the Dow. At the same time, the price of gold exceeded $1,000 per ounce for the first time ever.

It is impossible to accurately and repeatedly forecast the twists and turns of the stock market or the gold market. Because these two markets are negatively correlated with one another over the long-term, it makes sense to include gold in a properly diversified financial plan in order to be constantly vigilant against the possibility of a bear market in stocks. Posted in Uncategorized | Tagged Archive, factors, falling stock market, Gold Prices, gold values, rising gold prices, Stock Market Comments are closed.

The Stock Market/Gold Relationship

Im constantly asked about the effect the stock market has on the price of metals and my answer has always been, Very little, if any. Gold is a global market and the buying power behind gold is strong and steady. The NYSE and are other exchanges in the United States have very little, if any, impact on the price of gold and silver. Their nexus is not linked in a way that if the stock market goes up, gold goes down. It simply doesnt work that way. Sure, the stock market could rise and so can the price of gold. Conversely, the market could dip and so can gold. It could happen that way for a brief period of time, but I strongly believe that, when the market starts going down, people start pulling out and putting their Dollars somewhere else. And they, more often than not, put their money into gold. However, you want to view the relationship between gold and the stock market, I think gold is going to continue its ascent. We are seeing people right now taking money out of the stock market and putting it into gold so they can be in that asset class that is moving up. I cant envision gold going down versus the stock market, but the Dollar is another matter. As a rule of thumb, you could follow the price and value of one ounce of gold as compared to the Dow Jones Industrial Average. This is a very important relationship to follow. It will tell you when to be in metals and when to be in the stock market. The change in this relationship always occurs most dramatically in times of economic crisis, and we as a country have certainly been experiencing that for well over the last decade. In late 1999 it took 44 ounces of gold to equal the Dow Jones Industrial Average. Starting in 2000, and for the last 10 solid years, the relationship has continued going down, and the

relationship has moved in favor of gold and not the stock market. We have witnessed the relationship go from 44 to 1 to 43 to 1, 42 to 1, 41 to 1, 40 to 1 to where it is now, temporarily settling at 8 to 1. That relationship, in my opinion, will continue to go down, and I wont be surprised if it is soon 2 to 1. I also believe it could soon get close to 1 to 1, and one ounce of gold could be equal to more than the Dow Jones Industrial Average. There are some analysts who believe one ounce of gold could soon be more that the Dow Jones but the bottom line is that metals are a very strong buy! Gold is linked to the Dollar for a few reasons, but chiefly because gold is quoted in Dollars in our country. They are more brother and sister than gold and the exchanges. If the Dollar drops, it takes more money to purchase gold. So is gold going up or is the Dollar going down? You can look at it either way, but the truth is that it doesnt really matter how you view this conundrum. The Dollar versus gold scenario is one where if the Dollar goes down it takes more money to buy it. The next question you have to be asking yourself is will the Dollar continue to drop. I am not bashful when I tell you, unequivocally, that the Dollar is going to continue to decline in the long term. Yes, it will bounce back a little on a short-term basis, and a lot of that rebound is because the government will do anything not to let it bottom out. We as a country are going to continue to print gobs and gobs of fresh new money and our Dollar will continue to spiral downwards. I really do believe that, as much as I believe that gold is going to continue to go up side by side the Dollar. And let me add, gold is going to go up versus other currencies as well, primarily because the metal is being hoarded by central banks, investors, hedge funds and mutual funds. Im even seeing insurance companies, alumni associations and universities, groups who have never bought gold before, buying it now in lots as big as a half billion Dollars at a time. Obviously, I am unconcerned about the buying power behind gold easing up and the price of metal going down. I happen to believe that we just hit the bottom of the correction that is going on right now, and the next phase is the one where gold goes up to that $1,450 an ounce range. Then there will be some correcting more than likely, and in the next phase gold will leap up to the $1,600 - $1,700 an ounce price range, a price neighborhood where the analysts at Goldman Sachs predicts it is going. And I think that is a conservative prediction for the yellow metal. Keep in mind I am not talking about paper gold here. It has been estimated that the rate that paper gold is being sold, versus real gold trading hands, is at the rate of a 100 to 1, and that is analogous to an airline being allowed to sell a 100 tickets for one seat. Imagine how that scenario plays out. Ive said it before and I am going to say it again, paper gold is dangerous and the guy who had a million Dollars in gold ETFs (Electronically Traded Funds) is not in great position. If you read the prospectus of an ETF of any precious metal it states very clearly that it may follow the price of the metal but does not promise that it will.

The bottom line is that if you buy an EFT, you are in essence lending that ETF your money, and they are giving you a piece of paper that says you just bought into this fund. It is an unsecured debt, and you would be the last in line to get paid if something happened. That is why I dont recommend them.
Journal of Exclusive Management Science - March 2012-Vol 1 Issue 2 ISSN 2277 5684

ASSOCIATION BETWEEN GOLD PRICES AND STOCK MARKET RETURNS: EMPIRICAL EVIDENCE FROM NSE
*Dr. Amalendu Bhunia

**Mr. Amit Das

*Reader, Department of Commerce, Fakir Chand College, West Bengal, India

**Assistant Professor, Department of Commerce, Fakir Chand, West Bengal, India ABSTRACT The stock markets of a country become more sensitive to both domestic and external factors, and one such factor is the price of gold. In recent times gold price volatility has attracted the attention of many researchers, academicians and analysts. This study examines the gold price volatility and the causal relationship between gold prices and stock market returns in India. Taking into consideration the domestic gold prices and stock market returns based on NSE, the study investigates the Granger causality in the Vector Error Correction Model for the period from April 2001 to March 2011. Empirical results provide the support of feedback causality between the selected variables and indicate that the Gold prices Granger-causes stock market returns and stock market returns also Granger-causes the gold prices in India during the study period. The results indicate that the co-movement of gold prices and stock prices even during the period global financial crisis and thereafter. Indians have started considering gold not only as jewellery but also an important mode of investment like investment in bonds and equities. I. INTRODUCTION The study of the capital market of a country in terms of a wide range of macro-economic and financial variables has been the subject matter of many researches since last few years. Empirical studies reveal that once financial deregulation takes place, the stock markets of a country become more sensitive to both domestic and external factors, and one such factor is the price of gold. Historical experiences show that the trend of gold prices is always higher during period of stock market slump. However, in India stocks do not seem to be perceived as an alternative to gold. The reason for holding gold is, to a large extent, guided by the individual sentiments. The gold investing habits of Indians strongly ingrained in the Indian Social Psyche. In India gold has been held by individuals for years and have passed hands of many generations. This tendencies offer positive returns during a crisis of such a magnitude has renewed the interest in gold. It has also reactivated the old common knowledge of gold being a safe haven, inherited from its monetary role throughout history. Nevertheless, apart from the studies by Baur and Lucey (2010) and Baur and McDermott (2010), there have been few papers analysing the role of gold during economic and financial crises. Again, Baur and Lucey (2010) state that risky assets such as gold can qualify as safe havens for an initial portfolio of stocks if they have negative (or at least zero) correlations with stocks during crises. www.exclusivemba.com/jems
Journal of Exclusive Management Science - March 2012-Vol 1 Issue 2 ISSN 2277 5684

In addition, the equity culture in India is not as developed as in some other parts of the world. Gold has not yet lost its prime importance as a hedge against loss of wealth in times of crises. In this backdrop, the paper proceeds to investigate the direction of causality between domestic gold prices and stock market returns in India. The rest of the paper is organized as follows: Section II explains the data and methodology, Section III includes the analysis, and Section IV concludes. II. BRIEF REVIEW OF LITERATURE Prior to the introduction of economic liberalization in July 1991, gold prices in India showed an increasing trend. In the post liberalization period, the average annual prices of gold also showed an increasing trend from the year 1991 to 1996. But, it showed a decreasing trend in 1997 and 1998 and again showed an increasing trend since 2000 till date. The domestic gold price in India is continuously increasing due to its heavy domestic demand. The most important reasons for high demand of gold in India are:(i) Security ( gold offers full security as long as it is retained by central banks and there is no credit risk attached to gold), (ii) Liquidity ( gold is able to maintain its liquidity even at times of crisis like high global inflation or political turbulence), and (iii) Diversified Portfolio

(many prefer holding gold is to build a diversified portfolio) . Gold also plays the role of an asset of last resort. World Economic History shows that countries have repeatedly used gold as security against loans when they have had difficulties with their balance of payments. The domestic gold prices in India are associated strongly with the import parity prices which are determined by the global spot prices, Dollar-Rupee rate and local taxes and levies. Any change in the global prices gets transmitted very quickly and gets reflected in domestic prices, particularly for countries like India who are price takers in gold with a major part of the demand met by imports. The twin factors, namely, (i) increase in global spot gold prices (as the commodity becomes dearer to those looking for safe haven during times of economic crisis), and (ii) appreciation of USD against INR, led to sharp rise in gold prices in India in the recent past. Since the gold prices are influenced by international factors, its volatility is very important. Volatility involves short term (monthly, weekly or even hourly) fluctuations in gold prices as measured by their absolute percentage changes during a particular period. If we look at the rolling standard deviation of monthly gold prices since 2000, the prices are more volatile after July 2007 which is almost the same time when the slow down started in USA as a result of the sub-prime crisis. A number of studies have examined the relationship between gold prices and gold mining company returns, including
Twite, G. (2002) and

Faff and Hillier (2004). Based on regression analysis, gold mining company stocks were found to have a greater exposure to gold price returns than to stock market returns (gold betas were higher than market betas). But little attention has been devoted to investigating the time series characteristics and possibilities of a long-term co-integrating relationship between these variables. In fact, we are aware of only one study that tests for non-stationarity in any of these variables (Smith, 2001). Smith examined the short-term and long-term relationships between four gold price series and six different US stock price indices over the 1991www.exclusivemba.com/jems
Journal of Exclusive Management Science - March 2012-Vol 1 Issue 2 ISSN 2277 5684

2001 time periods. Smith reported that gold prices and US stock index levels were nonstationary, but were stationary in first differences. He found no bilateral long-term relationship, or co-integration, between a gold price series and a stock market index. There was, however, some evidences of a negative short-term Granger causality running from US stock index returns to gold returns, but not the reverse. A look at the historic data brings out that when the stock market crashes or when the dollar weakens, gold continues to be a safe haven investment because gold prices rise in such circumstances (Gaur and Bansal, 2010). It is no surprise that many investors, big and small have chosen to hedge their investments through gold at the time of crises. Gold prices have been on an up tick since 2000, while the stock market declined from 2000 to 2003 and then again in 2008. In 2008 when the market was suffering from bearish phase worldwide, gold prices spiked as panic spread across global markets. However, signs of recovery in the Indian stock markets have emerged since March 2009.. At the same time gold continues to forge ahead, albeit at a slower pace. In 2008, the prices of two assets equity and gold, were moving in opposite directions, displaying the ability of the yellow metal to protect one's portfolios at the time of a dip. In fact, during each of the two prolonged bear phases over the past decade, gold has provided an effective hedge. Wang et al (2010) explored the impacts of fluctuations in crude oil price, gold price, and exchange rates of the US dollar vs. various currencies on the stock price indices of the United States, Germany, Japan, Taiwan, and China respectively, as well as the long and short-term correlations among these variables. Empirical results show that there exist cointegrations among fluctuations in oil price, gold price and exchange rates of the dollar vs. various currencies, and the stock markets in Germany, Japan, Taiwan and China. This indicates that there exist long-term stable relationships among these variables. Whereas there is no co-integration relationship among these variables and the U.S. stock market indices which indicates that there is no long-term stable relationship among the oil price, gold price and exchange rate and the US stock market index. III. DATA AND METHODOLOGY The present study is based on secondary data obtained from various data sources of the Ministry of Finance, Government of India, NSE database and the Bloomberg database. We have considered monthly data comprising the stock return of National Stock Exchange (NIFTY) and the gold prices. The sample period spans from April 2001 to March 2011. After matching monthly stock return with the corresponding gold price, there are 120 observations. Eviews 6.0 package program has been used for arranging the data and conducting econometric analyses using Augmented Dickey-Fuller (ADF) Unit Root (1981) Test, Johansens (1995) Co-integration Test and Granger (1969) Causality Test. For the purpose of analysis, linear deterministic trend and lags interval in first differences have been used. The Augmented Dickey-Fuller unit root test has been used to examine the stationarity of

the time series data used for the study and to find the order of integration between them. The ADF unit root test has been performed by estimating the regression: y
t

=a
0

+ y
t-1

+ b
i

y
t-1

+e
t

The ADF unit root test is based on the null hypothesis (H

0

): Y
t

is not I (0). If the calculated ADF statistic is less than the critical value, then the null hypothesis is rejected; www.exclusivemba.com/jems
Journal of Exclusive Management Science - March 2012-Vol 1 Issue 2 ISSN 2277 5684

otherwise accepted. If the variable is stationary at level, the variable is said to be integrated of order zero, I(0). If the variable is non-stationary at level, the ADF test can be conducted and the first difference of the variable can be used for testing a unit root. In this case, the variable is said to be co-integrated of order one, I(1). In the second step, the Johansens co-integration test has been applied to check whether the long run equilibrium relation exists between the variables. The Johansen approach to co-integration test is based on two test statistics, viz., the trace test statistic, and the maximum eigenvalue test statistic. The trace test statistic can be specified as:
trace

(r) = -Tlog(1 -
i

) where
i

is the i
th

largest eigenvalue of matrix , and T is the number of observations. In the trace test, the null hypothesis (H
0

) is that the number of distinct co-integrating vector(s) is less than or equal to the number of co-integration relations (r ) . The maximum eigenvalue test examines the null hypothesis of exactly r co-integrating relations against the alternative of r + 1 cointegrating relations with the test statistic:
max

= -T log (1 -
r+1

) where
r+1

is the ( r + 1)
th

largest squared eigenvalue. In the trace test, the null hypothesis of r = 0 is tested against the alternative of

r + 1 co-integrating vectors. At the end, the Granger Causality test has been used to determine whether one time series is useful in forecasting another thereby finding out the direction of relationship between the variables of the study. In the Granger Causality test, the vector of endogenous variables is divided in two subvectors, Y
1t

and Y
2t,

with dimensions K
1

and K
2

respectively, so that K = K
1

+ K
2

. The sub-vector Y
1t

is said to be Granger-causal for Y

2t

if it contains useful information for predicting the latter set of variables. For testing this property, the levels VAR following form without exogenous variables of the model is considered. A
0

Y
t

=A
1

Y
t-1

+ ........+A
p+1

Y
t-p-1

+B
0

X
t

+.....+B
q

X
t-q

+C*D*
t

+u
t

If that model contains p + 1 lags of the endogenous variables as in the above model, the test is based on a model with p + 2 lags of the endogenous variables proposed by Dolado and Ltkepohl (1996). The null hypothesis that 1t Y is not Granger-causal for 2t Y is tested by checking the null hypothesis i = 0, i = 1, 2... p + 1 A Wald test statistic, divided by the number of restrictions pK
1

K
2

, is used in conjunction with an F (pK

1

K
2

, KT n *) distribution for testing the restrictions. Here n* is the total number of parameters in the system (Ltkepohl, 1991), including the parameters of the deterministic term. Of course, the role of Y
1t

and Y
2t

can be reversed to test Grangercausality from Y

1t

to Y
2t

. www.exclusivemba.com/jems
Journal of Exclusive Management Science - March 2012-Vol 1 Issue 2 ISSN 2277 5684

IV. EMPIRICAL ANALYSIS & FINDINGS The Augmented Dickey-Fuller unit root test has been used for the purpose of verifying data series and the results of such test are reported in Table 1. Table 1: Results of Augmented Dickey-Fuller Unit Root Test Variables in their First Differences ADF Statistic Critical Values Decision Gold Prices -14.61 At 1%: -3.459 At 5%: -2.874 At 10%: -2.573 Reject Null hypothesis of no unit root Stock Market Returns -12.01 At 1%: -3.459 At 5%: -2.874 At 10%: -2.573 Reject Null hypothesis of no unit root It is clear from Table 1 that the null hypothesis of no unit roots for both the time series are rejected at their first differences as the ADF test statistic values are less than the critical values at 10%, 5% and 1% levels of significances. Thus, the variables are stationary and integrated of same order, i.e., I(1). In the next step, the co-integration between the stationary variables has been tested by the Johansens Trace and Maximum Eigenvalue tests. The results of these tests are shown in Table 2. The Trace test indicates the existence of two co-integrating equations at 5% level of significance. And, the maximum eigenvalue test makes the confirmation of this result. Thus, the two variables of the study have long-run or equilibrium relationship between them. Table 2: Results of Johansens Co-integration Test [Unrestricted Co-integration Rank Test] (Trace) Hypothesized No. of CE(s) Eigenvalue Trace Statistic 0.05 Critical Value Prob.** None * At most 1 * 0.264883 0.062248 83.69901 14.46069 15.49471 3.841466 0.0000 0.0001 * denotes rejection of the hypothesis at the 0.05 level ** MacKinnon-Haug-Michelis (1999) p-values www.exclusivemba.com/jems
Journal of Exclusive Management Science - March 2012-Vol 1 Issue 2 ISSN 2277 5684

Table 2:

Results of Johansens Co-integration Test [Unrestricted Co-integration Rank Test] (Maximum Eigenvalue) Hypothesized No. of CE(s) Eigenvalue Trace Statistic 0.05 Critical Value Prob.** None * At most 1 * 0.264883 0.062248 69.23832 14.46069 14.26460 3.841466 0.0000 0.0001 * denotes rejection of the hypothesis at the 0.05 level ** MacKinnon-Haug-Michelis (1999) p-values Table 3: Results of Granger Causality Test Null Hypothesis F-Statistic Probability Decision Gold Prices do not Granger Cause Stock Market Returns Stock Market Returns do not Granger Cause Gold Prices 11.678 32.997 0.000 0.000 Reject Reject Now, the Granger causality test can be performed to determine the direction of causation between these two variables in the Vector Error Correction Model. The results of the Granger causality test shown in Table 3 confirm rejection of the null hypothesis of Gold Prices do not Granger Cause Stock Market Returns and Stock Market Returns do not Granger Cause Gold Prices. Therefore, it may be inferred that both the variables contain some significant information such that they cause each other. The findings of the study on the gold price volatility and the causality between domestic gold prices and stock market returns in India over a period of 10 years (2001-02 to 201011) are summarized below. The Augmented Dickey-Fuller test shows that the time series data used for the study are stationary and all integrated of order one. The Johansens co-integration test reveals that there exists long run equilibrium relation between gold prices and stock market returns in India. The Granger causality test in the vector error correction model suggests the evidence of feedback causality running between the gold prices and Nifty based stock returns in India. Thus, each variable contains some significant information so that one can be used to predict the other. www.exclusivemba.com/jems

1 Month Gold Chart, US Dollar per Ounce of Gold

6 Month Gold Chart, US Dollar per Ounce of Gold

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5 Year Gold Chart, US Dollar per Ounce of Gold

10 Year Gold Chart, US Dollar per Ounce of Gold

30 Year Gold Chart, US Dollar per Ounce of Gold