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).