2.1 Gold and Gold-Standard

Adibe and Fei (2009) in their research work have discussed the gold’s importance and its

relevance to the macro economy. According to Adibe and Fei, in order to fully

understand the gold-rates fluctuations and its current status, one cannot totally disregard

its history associated with the world economy. A widely used ornamental metal used in

rituals, jewelries and decorations. Its unique chemical characteristics - highly dense,

superior malleability and lasting shine - and its rarity all contribute towards Gold being

the most sought after commodity in almost all cultures (p 3). Adibe and Fei further

explain how gold achieved a center stage status of global economy. They revealed in

their research paper that when gold was set as a standard for backing the monetary

policies and paper currency in the late nineteenth century, its importance increased many

folds in view of the global economy. Adibe and Fie concluded that as opposed to the

widespread belief about the gold’s mysterious behavior during economic and inflationary

trends - and gold widely regarded as a negative beta asset, having inverse price

fluctuation as compared to the economic trends – their study revealed that gold is a zero-

beta asset. Their study also disproved gold’s use as an inflation hedge in the short-term.

Adibe and Fei further revealed that there is a significant relationship between the price

movement of gold and the value of US Dollar (p 30).

In another related study, Gulati and Mody (1982) mention that in 1960’s the US found its

monetary gold stock depleting. So in its attempt to maintain the gold value of dollar (@

1/35th of an ounce), in 1971, therefore, the US stopped dollar conversion in gold and also

depreciated the dollar. In 1973, the 'fixed' exchange rate system was discarded in favor of

the 'floating' exchange rate system (under which market forces are allowed to ascertain

the exchange rates, subject to intervention by central banks) (p 1865).

Blose (1996) compared gold fund returns with returns on gold bullion. He found that all

the mutual funds have a greater standard deviation than gold Bullion, indicating that the

total risk for the funds is greater than for gold. Gold Bullion has a significantly negative

beta, but the R2 value was low. (0.014). He concluded that the market has a very little, if

any, impact on both gold bullion and gold mutual funds. If an investor (for the purpose

of diversification) is looking for an asset which is largely uncorrelated with the market,

gold or any of the mutual funds will serve that purpose; however gold may be marginally

better in this regard than the mutual funds.

2.2 International Gold Price Movements

Gulati and Mody (1982), on international gold price movements, discussed the impact of

inflationary expectations, exchange rate fluctuations and changes in interest rates on gold

prices. Gulati and Mody studied the gold price movements during the ’72-’82 decade. In

their work, they noted that the gold prices and petroleum prices moved in the same

direction (p 1864). While studying the effect of exchange rate behavior on gold prices,

Gulati and Mody noted real gold price increased and decreased with the rise and fall of

exchange rate fluctuations. Their study concluded (p 1869) that interest rates did not have

a significant weakening effect on gold price, and that gold prices rise only if there

develops some international economic crisis that would violently disturb the global

exchange rates, but this rise in prices would only be temporary. This conclusion was

strongly affirmed when the world was hit by the Global Financial Crisis of 2008-2009

onwards, during which the gold price had raised to an all-time high of US$1,215 per

ounce on 15th December, 2009.

2.3 Oil

Barsky and Kilian (2004) have revealed some significant findings on the effects of oil

prices’ fluctuations and the resulting effects on the macro economy. Barsky and Kilian,

while commenting on Hamilton’s (1988) sectoral shifts model – that explained how and

oil price shock would lower real GDP – mentioned that an increase in oil price will result

in reduced purchases of fuel-goods such as automobiles. Such purchases may have large

dollar value relative to the gasoline-cost. This demand shift results in sectoral reallocation

of labor (p 120).

Barsky and Kilian also mention that conventional wisdom may suggest that exogenous

political events in the Middle East region drive the major rises in oil prices (p 125). Ii

their conclusion, Barsky and Kilian said that exogenous political events are just one of

the several factors that may affect the driving of oil prices. They also concluded that oil

price shocks may not necessarily be pivotal, although the timing of increased oil prices

and recessionary trends in the economy coincide with one another (p 132).

2.4 Crude Oil

Crude Oil, as defined by the U.S. Energy Information Administration, is a mixture of

hydrocarbons that exists in liquid phase in natural underground reservoirs and remains

liquid at atmospheric pressure after passing through surface separating facilities. Liquids

produced at natural gas processing plants are excluded. Crude oil is refined to produce a

wide array of petroleum products, including heating oils; gasoline, diesel and jet fuels;

lubricants; asphalt; ethane, propane, and butane; and many other products used for their

energy or chemical content.

The term “Landed Cost of Crude Oil” refers to the dollar-per-barrel price of crude oil at

the port of discharge. Included are the charges associated with the purchase, transporting,

and insuring of a cargo from the purchase point to the port of discharge. Not included are

charges incurred at the discharge port (e.g. import tariffs or fees).