Gold (Hedge)

 

 

Introduction
 
Gold is the most desired precious metal in the history of the world. The value assigned to gold by everyone primarily stems from the fact that it is almost always in demand compared to its relative scarcity; despite this, it is the most highly distributed precious metal. It is widely sought after and possessed by most countries and it is found in most nations – from equatorial regions to freezing Siberia; and is produced across nations in notable quantities. Historically, gold was mined vigorously from Africa; however, it is now found and processed in my countries including South America, Transylvania in Europe, Siberia in Asia, California in North America, and Australia. In nature, gold occurs as nuggets or grains in rocks, veins and alluvial deposits. It is the most malleable and ductile metal ever known. It maintains its bright yellow luster without oxidizing in air or water. Around 174,100 tonnes of gold have been mined till 2012 according to GFMS gold survey report 2013. It is also widely used across the globe as an alternative medium for monetary exchange. Besides its widespread monetary and symbolic functions, gold has many practical uses in dentistry, electronics, and other fields. Its high malleability, ductility, resistance to corrosion and most other chemical reactions, and conductivity of electricity has led to many uses, including electric wiring, colored-glass production, and gold leafing. However, the amount of gold in the world is finite and production has not grown in relation to the world's economies. Today, gold mining output is declining. With the sharp growth of economies in the 20th century, and increasing foreign exchange, the world's gold reserves and their trading market have become a small fraction of all markets and fixed exchange rates of currencies to gold became unsustainable.
 
Futures trading – benefits to the economy
 
  • India, being a major consumer, needs to be integrated with international markets. Developed economies provide avenues for efficient price discovery and risk management. Having a futures platform in India will allow Indian value chain members to participate in the above process, and also offset their price risk.
  • India already has a huge spot market in gold. A futures exchange will only complement the existing system by providing a forward curve for prices. Going forward, the futures platform will integrate fully with the spot market creating a symbiotic relationship wherein mutual benefits will flow seamlessly.
The futures market will allow investment gold to freely flow into the market, which will further strengthen the price discovery process.
 
Need for Futures Trading in Gold
 
Gold is the most liquid asset in the world. The standard gold bar of 995 or 999 purity is accepted across the world and returns its full asset value which makes it the least risky. More importantly, India being the largest consumer, it has always been linked to the international bullion market. All developed economies allow for “derivatives” trading in gold comprising of futures, options, swaps, etc. These derivative instruments have immense benefits to different strata of the market. Some are listed below:
 
  • Producers of gold are always exposed to downside risk of their gold decreasing in value by the time it is mined, refined and taken to market. For them, futures trading allows for advance sale of their gold at prices suitable to them, so that their margins are secured.
  • Jewelry makers buy gold to be designed as per their customers’ specifications. For them a lag in procurement of gold as raw material and sale of finished Jewelry would expose them to price risk, thus, affecting their profit margins. Futures trading will allow them to book gold as per their design schedule. Moreover, in case of uncertainties, they can always hedge their risk on futures so that the loss arising in their business is offset by equivalent profits on gold futures.
  • Supply concerns are one of the most important reasons for futures trading to exist. In the last few years, supply increase has been from scrap recovery, sales from central banks and loans from official gold reserves. Owing to these supply pushes, price of gold fluctuates causing volatility.
 
Since gold is priced in US Dollars, any economic activity that affects this currency, indirectly affects the gold price. Additionally, conditions like inflation, deflation, bankruptcies, etc. affect the economy at a larger level. Gold, being an inflationary hedge, automatically attracts investors’ attention for diversifying their risk and neutralizing their portfolio.