Introduction

The performance of economy usually is reflected by its stock market. So stock markets are

representative of its economy as it provides one of the best measures of performance of

economy. Various researches depicts that stock market is highly dependent on macroeconomic

variables. Since the stock prices and returns change on daily basis so we can say that stock

markets keep on adjusting itself with reference to these macroeconomic variables. There are

various stock exchanges in Pakistan i.e. Lahore Karachi, Islamabad Stock exchanges etc. The

representative of the Pakistani economy among these stock markets is Karachi Stock Exchange-

100 index since it is the most liquid and the largest exchange of Pakistan and incorporates almost

all the companies. To conduct research on an Economy, the researchers usually take its

representative Stock Market, thus KSE-100 has been selected in this Study.

Financial sector of any country plays very vital role in the countrys economic growth. Stock

market is financial sectors key institution which provides a platform, where borrower and lender

can easily fulfill their financial needs. Stock market performance is factual reflection of

countrys economic performance. Many researchers like Demirguc-Kunt and Levine (1996a),

Singh (1997), and Levine and Zervos (1998) found in their research that stock market

development plays an important role in economic growth. The World Bank Economic Review

also contributes in its May 1996 issue to the role of the stock markets in economic growth. There

are numerous factors having impact on the performance of stock markets, such as, expansion in

the countrys economic activities, strength in the exchange rate, decrease in lending interest rates

and improvement in recovery of outstanding loans, rescheduling and payment of foreign debts,

large scale mergers and acquisitions, better relationship with the neighbor countries, investor

friendly policies and strong regulatory framework (Imran Ali, 2009). In Pakistan stock markets
performance is also affected by legal, economic and political factors. The Karachi Stock

Exchange (KSE) is Pakistans first and one of the oldest stock exchanges in emerging markets of

South Asia. KSE was established in 18th September, 1947, just two months after Pakistan

became an independent state. KSE is the Pakistans largest stock exchange. The other exchanges

in Pakistan, the Lahore Stock Exchange (LSE) and the Islamabad Stock Exchange (ISE), were

established in 1974 and 1997 respectively. Stock market performance, economical and political

condition of a country is interrelated and has been a significant debating issue. Many studies

directly or indirectly have been dealing with the macroeconomic and institutional factors and

their correlation with the stock market performance at both theoretical and empirical levels.

Among the determinants of economic growth, stock market development is increasingly

becoming an important factor to impact upon it. The importance of stock markets lies in the

contributions of it. First, at the initial stages of economic development, financial markets are

undeveloped and very small in their magnitude. During these stages, financial markets are

primarily dominated by banks and other similar types of financial intermediaries. There is almost

no role of stock markets or, even if they exist in any form, their size is negligible. Second, when

financial intermediaries expand with capital accumulation, the number of sophisticated and more

tailored financial instruments increases, as do the level of sophistication and complexity of

financial contracts and the flow of resources and funds accruing to the financial market. Stock

markets start developing both in terms of the number of listed firms and market capitalization.

Third, when the economy continues to grow, equity markets develop further as well as the

banking system. Similarly, other financial intermediaries also develop. Fourth, researchers

recognize the common view that the stock markets appear to develop in a non-monotonic ways.

In economies where stock markets are relatively small, capital accumulation seems to be
followed by a relative increase in banks share in the financial system and in economies where

the stock market has already reached a reasonable size, further development of the market causes

an increase in the equity markets share. In other words, evidence shows that the equity/debt

ratio first decreases and, only with further development of the stock market, this ratio increases.

Financial sector of every country is the provider of financial resources and real activities which
financial assets like money and bank credit, stocks and bonds are transacted and divided into two
sectors of monetary and capital markets. Supplying financial resources in long term period and
required flexibility in this matter is one of the key functions of capital market. Because of low
efficiency of the other kinds of investment, stock market become to a famous investment channel
in recent years (Wang &et al, 2012).

Some of the main functions of stock market are risk transferring and distribution
management, information transparency, price discovery, creating competitive markets and also
collecting small savings and capitals for financing economic activities and finally to contribute to
a more equitable price for bonds and to accelerate transactions. Because of the effects of hidden
factors in the stock price, stock market is volatile. These hidden factors are divided into two
sections of qualitative factors including political events, international incidents, economic policy
of firms, economic condition, commodity prices index, interest rate, exchange rate and
psychological factors and etc. and quantitative factors including open rate, close rate, up and
down rates of individual equities (Padhiary& Mishra, 2011).

Forecasting can control fear and greed plus paving the way for dialectic thinking. Moreover,
study tried to point out that valuation is about determining reasonable ranges of fair value. In
other words, fair value is perhaps more a metaphor than a precise or absolute calculation.
The real value in considering valuation is the determination as to whether the investment makes
economic sense and whether or not the risk taken is acceptable.
Stock markets data, particularly in recent years, became very important object of
academic research. Failures of big market players and financial supervision during the financial
crisis showed that standard time series models have several shortages in precision and
robustness. Most of the conventional techniques have been trying to capture the patterns in the
examined data using linear relationships and assumptions. But because there is no empirical
evidence of linearity in stock returns, various researcher and financial practitioners have focused
on the nonlinear prediction methods.

The prudent investor should be capable of determining reasonable expectations that can
be relied upon to make intelligent long-term investing decisions. However, it should never be
forgotten that these decisions must be continuously monitored and kept up-to-date.
Those investors that have a realistic view of what their future returns may be are better prepared
to handle whatever challenges the marketplace may bring.
The financial market is not a linear dynamic system. Rather it is a complex, evolutionary system.
The financial estimating field is qualified by data strength, resound, fluctuation, amorphous
universe, uncertainty at high degree, and obscure kinships. Lots of factors act in finance letting in
governmental effects, ecumenical economical circumstances, plus dealers ' anticipations from an
investment. Thus, anticipating stock market returns trend is rather hard. Consorting to
academician investigations, trend in securities industry costs are not stochastic whereas their
behavior is a highly not linear, dynamic mode.

Prediction is a very difficult art, especially when it involves the future -Neils Bohr (Nobel
Laureate Physicist).

One of the important objectives of the market of stocks is to alleviate the recovery and the
borrowers, because it compiles the savings from number of pocket billiards and provide the
program to exchange them into productive investment funds. In different sectors of the economy
it is also helpful for reapportionment of funds. It also performs as a program where number of
factors collectively works together so that the wheel of the economy of any country drives. There
important interests in selecting the stocks uncommitted in the stock market.

A number of macroeconomic factors affect the stock returns. Researchers have applied various

models in order to establish a relationship. These relationships are studies in various studies by

applying co-relation, regression, ARDL, co integration testing etc (Atindhou & Gueyie, 2001),

(Omotor, 2010). For this study the macroeconomic variable selected are Inflation, Exchange rate

crude oil and Gold rates. With the changing environment the uncertainty rises, so the importance
of the study has increased as the desire to discover the relation of CPI (Inflation), crude oil, FX-

rates (exchange rates) and Gold rates with the returns of stocks has increased.

Inflation is a rise/increase in general price level. The power of buyer reduces when inflation rises

despite the rise in income of individuals. The increase in supply of money, devalues the money

resulting in Inflation. Furthermore, it poses problems in the lives of masses so it is the most

widely studied phenomenon across the globe.

In financial theory, Consumer Price Index (CPI) reflects inflation. By and large, CPI depicts rise

in prices of services and goods i.e. needing more money to purchase the same items. It impacts

consumers and investors in the same way. The investing power of investors reduces as well due

to inflation. CPI is categorized as Expected and Unexpected Inflation. Expected inflation rate

helps economists and consumers to plan yearly and investors hold less cash to invest it

somewhere to earn returns as money devalues. However, the unexpected inflation is beyond the

plans of economists, investors and general consumers. Generally, the results of latter are much

more drastic than that of prior for both investors and consumers.

Inflation is a main problem for measuring returns on stock markets over a longer period of time

as stock markets become volatile to it. When inflation hits an economy, the returns of stock

markets seldom sustain increase/rise in CPI (consumer prices index) and returns decline (Scott

Beyer, Dr Robert Johnson, Hughen, & Beyer, 2015). Furthermore, high inflation slows down the

economic activities thus reducing the corporate profits. Many researchers believe that stock

markets should provide hedging against inflation. But in reality stock markets provide very poor

hedging against inflation. Hence, inflation might increase the risk associated with the stock

returns.
Does holding gold protect an investor against inflation? Recent studies by Worthington and

Pahlavani(2007), Wangetal.(2011) and Beckman and Czudaj(2013) all, in effect, say yes.

Specifically, they all argue that the price of gold and the consumer price index (CPI) series are

cointegrated. Gold and the CPI share a common long term trend. Such an outcome is therefore

consistent with the view that gold should at least partially hedge inflation risk, lending support to

the long held view that gold is a durable commodity that should underpin the world's monetary

system. Nonetheless, the link between changes in the price of gold and inflation is not universal

in the literature (seeskeptical arguments in e.g. Blose, 2010;Baur, 2011;Erband Harvey,2013).

Infact, Erb and Harvey(2013) argue that any supportive evidence on the linkage between gold

and inflation stems from data in only one year,1982.

Many economists and market analysts believe that gold spot prices are influenced by expected

inflation. Analysts in the financial press routinely attribute substantial changes in the price of

gold to changes in expected inflation. When unexpected changes in the Consumer Price Index

(CPI) occur on the same day as large changes in the price of gold, analysts attribute the change in

gold price to the changes in the inflation indicators. Many gold analysts argue that upward

revisions in expected inflation will cause some investors to purchase gold, either to hedge against

the expected decline in money or to speculate in the associated increase in the price of gold. The

buying pressure will cause an immediate increase in the price of gold at the time of the revision

in expected inflation.

The nominal price and "inflation hedge" price of gold in the period 1895 to 1999 (annual

averages). The inflation hedge price is the dollar price that gold would have to be in order to

maintain its 1895 purchasing power (as measured by the US consumer price index). In 1895 the

price of gold was $20.70 per ounce, or about $379 in 1995 dollars, while in 1995 it was $387--
virtually no change in the real value of gold over a one-hundred year period. Fitting a trend line

indicates that the real price of gold increased on average by only 0.3 per cent per year in this

hundred-year period. For the period 1895 to 1999, the price elasticity of gold with respect to the

US Consumer Price Index (CPI) is 1.1. Long-run investment in gold appears to be an effective

long-run inflation hedge. Over the last few decades, however, gold has not been a reliable hedge

against inflation. The nominal price of gold was $384 (per ounce) in January 1982 and $283 in

December 1999. The price of gold would need to have risen to $691 by November 1995 in order

for it to be an inflation hedge for investors in the United States.

Exchange rate is actually the measurement of the currency under consideration or study in

another currency or rate at which currencies are traded. Since the rise in globalization in 19th

century, people have started investing in foreign currencies as FDI (Foreign Direct Investment).

This foreign investment has led to risks as well. Pakistani currency has devalued in the near past

in relation to dollars. Exchange rates are more uncertain and keep on changing with any change

in economy so they are more volatile (Atindhou & Gueyie, 2001). The relationship of exchange

rate and stock returns is highly under estimated. Hence this relationship requires attention as

well. Exchange rates are linked to inflation. If inflation rises, that means supply of money has

risen and investors purchasing power reduces. So they can invest less in the foreign economies.

Gold rates are those rates at which gold is traded. Pakistan is an economy where gold is

considered as an asset. Most of the residents either invests in stock markets, property or gold as

they are highly profit oriented investments. Gold rates do change with the change in economy,

but most of the times they stay stable. Gold rates are also linked to inflation, because if inflation

rises, the purchasing power of investors reduces and gold rates tend to rise up.
Since exchange rates and gold rates are linked to inflation, so it is necessary to incorporate these

macroeconomic variables in nature in this study alongside Inflation with the rationale to

scrutinize the relationship amid these variables (CPI, FX-rates & gold rates) and returns on stock

of KSE-100 index.

All the sectors under KSE are affected by these variables. These sectors include Commercial

Banks, Beverages, Cement (Construction and Materials), Chemicals, Electricity, Electrical

Goods, Electronic and Engineering, Financial Services, Fixed Line Telecommunication, Future

Contracts, Forestry (Paper and Board), Food Producers, Household Goods, Equity Investment

Instruments, General Industrials, Automobile and Parts, Industrial metals and Mining, Health

Care Equipment and Services, & etc.

As mentioned above, due to changing environment, the inflation is continuously rising in

Pakistani economy. Moreover, the investments in the public sector are not only confined to the

local investors, the international investors are also investing in Pakistani economy.

However, despite its growth prospects, a number of challenges are being faced by public sector

in Pakistani economy. Energy cost is one of the major and biggest challenges being faced by this

sector. When we look at the current situation of Pakistan, we can see the major crisis in Energy

sector which impacts the many goods manufacturing industries directly in public sector of KSE-

100 index. The fluctuations (increase/decrease) in the energy impacts the manufacturing costs.

Other cost challenges faced are due to changes in prices of sectors such as oil, petroleum,

electricity, multi utilities (gas & water), industrial metals and mining, electronic and electrical

goods and chemicals.

The great financial crisis of 2007-08 has impacted the majority of the countries throughout the

world including Pakistan. This was followed by mortgage crisis of 2008-09, though its direct
impact on Pakistani economy was little but overall the economy had to struggle itself to

betterment than ever. Thus, public sector had to pull itself to recovery after these crises and had

to compete with the dynamic environment more than ever before. This study intends to evaluate

the impact/affect and relationship of Inflation, FX rate (foreign exchange rates in dollars), Gold

rates and return of stocks of KSE-100 post crises so as to evaluate the existence of a causal

relation amid returns of stocks of KSE-100 and other three macroeconomic variables (Gold

Rates, FX rates, CPI).

The demand for gold can be divided into two categories. The first is the "use demand", where it

is used directly in the production of jewelry, medals, coins, electrical components, etc. The

second is the "asset demand" for gold, where it is used by governments, fund managers and

individuals as an investment. The asset demand for gold is traditionally associated with the view

that gold provides an effective "hedge" against inflation and other forms of uncertainty.

However, the reality is somewhat different. Gold may be an inflation hedge in the long-run but it

is also characterised by significant short-run price volatility (Aggarwal, 1992).

Investment is such money which is put away for the purpose of future use. There is a lot of way

through which investors can invest their money for example in the shape of gold, foreign

currency etc .In the shape of investment of gold investors have found significant benefits. The

investment in gold is known as tangible assets investments .According to different investors the

gold is known as much trusted investments .Gold is also known as quite safe investment from the

financial crisis. It has been seen that gold is less risky investment then others assets. Past studies

have proved that there is significant relationship between gold prices and stock market. It could

be consider the gold as a safe heaven investment. In Pakistan from last few decades the Gold

prices was very high .It has reached till 55 thousands in these years the international gold market
were also affected. Increase in the prices of gold have badly affected on the economy. Gold

prices are known as the best indicator for the economy of healthy economy. The decrease in the

gold prices means economy is going downward direction. Oil cost is known as the basic aspect

for determining the industrial production. Gold cost has effected on the worldwide development

of economy. In 2005, the international economy was in the position of downturn because cost of

gold was near about US $416 per ounces. According to different researchers gold is known as

the store of the value. In nov 2010 the gold cost was at the peak it was US$ 1421 per ounces. The

association between gold rate and interest rate is negative. Marx s concept of cash was very

crucial aspect for describing about adoption of cash. Prices of gold can be predicated on the basic

on the predication. Researchers have proved that there is no connection between oil costs and

gold costs. Pakistan has financial development is 7%while it is seen that after its freedom its

financial development is not more than 5%.pakistan financial development has been dropped at

2.7%.low financial development is the first barrier for the development of country. Due to these

financial crises the Pakistan s hardship was affected badly. Governments of Pakistan have taken

715 billion for the improvement of poverty of Pakistan. Pakistan has financial development is

7%while it is seen that after its freedom its financial development is not more than 5%.pakistan

financial development has been dropped at 2.7%.low financial development is the first barrier for

the development of country. Due to these financial crises the Pakistan hardship was affected

badly. Government of Pakistan have taken 715 billion for the improvement of poverty of

Pakistan. In the modern era the oil crisis is the blood for every economics. It is true that oil prices

have helped out the maintain the level of oil prices. We are trying to find out the impact of oil

prices on stock market. We also try to explore that investors would like to invest in stock market

or gold prices. There is reserved work related to impact of oil crisis on the stock exchange.
There are three main researchers related prediction of economy growth. According to Swarovski

(1999) have proved that oil prices have on the economic growth of India. There are three main

researchers related to explore the impact of oil prices on the stock exchange. According to Kabul

oil prices increases and decrease have impact on the growth of any economy. Oil prices are the

resource of economic growth instability.

Alternatively, the prices of precious metals and crude oil are influenced by common

macroeconomic factors such as economic growth, political aspects, U.S. interest rates, exchange

rates, inflation, and even people's psychological expectations, etc. (Hammoudeh et al., 2008).

The prices of crude oil and precious metals have great significance in determining the prices of

other commodities; in contrast, the prices of precious metals depend on the rise-and-fall of oil

prices. A sudden increase in oil prices causes an economic slowdown and the change of other

commodity prices. The importance of the economic behavior of crude oil and precious metals

shows the economic importance of analyzing the relationship between these commodities. If the

volatility of the prices of crude oil and precious metals (especially gold) is analyzed, information

for forecasting the price trends of the whole commodity market can be obtained. The relationship

between the price of crude oil and precious metals (especially gold) is one of the fundamentals

that drive the prices of precious metals.

Gold is a precious metal used in every part of this world. Apart from its personal use, in

ancient times it was used as a substitute of the currency, but now it is used as investment.

Investment in Gold is considered a safe haven than other investments. Investors seek comfort in

investing gold. They normally acquire gold as harbor against crises of political, social,

economical (including stock market failure), growing in national debt, inflation and currency

failure. Since history witnesses that investing in gold does not give loss to its investors, so a large
chunk of investors put their money in gold reserves. Another reason for acquiring gold is cultural

effect. In almost all cultures and regions gold is used as ornaments and jewelry.

Normally gold prices in Pakistan vary owing to two main factors. First is the international

trend, when gold prices increase or decrease internationally the prices in Pakistan also increase

or decrease accordingly. This trend is also applicable in rest of the world. Secondly, gold prices

change owing to dollar-rupee rates. Gold prices increase whenever exchange rate of Pakistani

rupee decreases and gold prices decrease when exchange rate of Pakistani rupee increases. These

two factors also contribute in changing of gold prices with other factors.

Generally the performance of gold is compared with stock owing to its basic distinction.

Several investors consider gold as store of value missing its growth, while stock is considered

as return on value growth by speculation in real price increase and dividend. Stock shows best

results in a politically stable environment. Whereas gold shows best results in all circumstances

despite of unstable and turmoil conditions in the country or globally. So investors buy gold when

there are crises in stock market and catastrophic conditions in the country. As a result, gold

prices increase owing to its increasing demand.

Some studies show that there is not significant relation between gold prices and stock

market return in long run, rather in short run. The prices of gold and investment in gold increase

due to stock market collapse.

Crude oil market and gold market are two of the main components of large commodity markets,

which make it essential to monitor the price trends that prevail in both the markets. Both the

commodities are priced in US dollars, and any fluctuation in the prices of each of these has an

impact on a number of other commodities prices as well as other factors such as exchange rate
depreciation or stock market changeability. Due to the high importance given to crude oil price

and gold price, analysts keep an eye on any variation that occurs in their prices, and make sure

that they are forecasting prices keeping in mind the trends followed. This helps in knowing

beforehand whether there will be an increase or decrease in the prices of both or any one of the

commodity, as well as how the variation would impact the overall economy of the country or

global economic conditions.

Since it is important for risk managers and analysts to forecast the prices of gold and oil, it gives

rise to investigate the relationship between the prices of two commodities as well. For a better

know how of the economic conditions that might prevail in the future, other than individual

trends of crude gold and oil, it is vital to examine the impact that crude oil prices have on gold

prices and vice versa. For countries that import oil, an analysis of forecasts of crude oil prices is

binding since neglecting it can cause the economy of that country to be affected negatively. For

instance, the fluctuations that are present in the demand and supply of crude oil in the

international market lead to a difference in the price of oil, which then impacts the economy

negatively in case of a rise. The negative impact could be the depreciation of currency, which

then further leads to increase in inflation rates.

In 2002, the prices of gold and oil began to rise, and kept rising at almost the same time till mid

2008. A number of factors which included depreciation of US dollar, increased inflation around

the world, and manipulation of oil supply by OPEC contributed to this flow of increase in the

prices of these commodities. However, the financial crisis that hit the global economy in second

half of 2008 had a severe effect on the prices of large commodity markets which included crude

oil and gold, and led to a decrease in their prices. These reductions were later eradicated by the

anticipated economic recovery. Recently, the price trends in prices of both variables have not
been influenced by demand and supply; in fact there are other features that have an effect on

their prices as well as a close correlation among the trends of the two markets (Zhang & Wei,

2010). This study will not only look at the trends and effects that these prices have, in fact it will

look into the reasons that cause these changes to take place as well. The knowhow of these

factors are fundamentals for the determination of prices of large commodity markets and risks

attached to them, as well as the projected movement and development of the market activity.

Research Question and Significance of the study:

The purpose of this study is to explore the relationship between the Gold prices, Stock market

return and Oil prices. The data is taken from KSE100 return, Gold price and Oil prices from

2000 to 2010(monthly). This study applied Descriptive statistics, Augmented Dickey Fuller test

Phillip Perron test, Johansen and Jelseluis Co-integration test, Variance Decomposition test to

find relationship between oil prices and Gold prices with KSE 100 Returns. This study concludes

that Gold prices growth, Oil prices growth and KSE100 return have no significant relationship in

the long run. Further research will be conducted on why Gold prices and oil prices have not

significant relationship with KSE 100 returns. Further research will be also conducted on Gold

prices and Oil prices relationship with other stock markets returns.

The purpose of this research will be to focus on the trends of crude oil pricing, gold pricing, and

a relationship between the pricing of these two commodities. The results of this research will be

beneficial for analysts in order to predict what economic development would result when the

prices of both commodity markets deviate, and to evaluate how it would affect the economic

conditions globally. Not only would it be easier to forecast trends in economy, but results from

carrying out this research would prove significant in analyzing what prices could be charged for
both the commodities in future as well. To summarize, this paper would focus on the relationship

of prices of the two large commodities after the global economic crisis of 2008.

Problem identification;
To analyze market breadth because there are multiple problems with investing based on
economics. The economists whose predictions you value could be all wet, even if the economic
analysis is correct, the investment decision that follows from it often isnt. Its human instinct to
want to know the future and to protect our nest egg based on that perceived knowledge. It takes
real fortitude to ignore those economic forecasts from brilliant, well-meaning experts with very
impressive credentials. Their logic is always compelling but investing based on that logic can be
hazardous to your wealth.

The future is the realm of surprises; no one, no matter how expert, can reliably foresee

what will happen and how people will react to it. As the economist Friedrich von Hayek said in

his lecture "The Pretence of Knowledge" when he won the 1974 Nobel prize in economics, "in

the study of such complex phenomena as the market, which depend on the actions of many

individuals, all the circumstances which will determine the outcome of a process. Will hardly

ever be fully known or measurable?"

Therefore, while most pundits tend to cluster around a safe consensus, a few stake out the

risky but potentially lucrative ground of extremely bullish or bearish predictions. If they turn out

to be right, their accuracy will seem miraculous and they will be famous; if they turn out to be

wrong, most people will forget.

The present research applies the ARDL approach to cointegration and error correction models

(ECM) to determine whether any evidence of causality exists between the exchange rate and

stock prices in the long and short run. The exchange rate actually influences stock prices and
shows a positive correlation, as suggested by the goods market theory for an import-oriented

economy. We also found that the money supply strongly positively influences stock prices.

Objective of the Study:

The objective of this study is to check how stock Index is affected the gold prices and oil prices

in Pakistani stock market. The study was conducted by taking stock index as independent

variable and oil price and gold prices as dependent variables.

Literature Review

While conducting an appraisal analysis, plenty of work was found that accepted and rejected the

relationship amid gold prices, FX-rates (foreign exchange rates), inflation to Stock returns. But

only the most recent studies and works, (done precisely after 2000) are inculcated and considered

for the literature review of this study.

The desire to find relationship amid Inflation (CPI) and returns on stocks goes back to 1960s and

1970s era, when Schwert and Fama found a momentous relationship sandwiched between two

variables CPI and returns of stocks in 1977 without signifying the direction of this relationship

(Fama and Schwert 1977). Most of the studies conducted to elucidate and assess the relationship

amid inflation (CPI) and returns on stocks have the work of Fama as foundation.

A study was conducted (Engsted & Tanggaard, 2002) with an anticipation to scrutinize the link

of inflation with stock returns and bonds (i.e. at short horizons and long horizons) with reference

to two economies U.S and Denmark. Vector auto regressive method was used to establish a link

between the variables selected. The result depicted that bonds issued in U.S and stock returns of

Danish economy show a strong relationship with inflation even when the time horizons are long.

But for U.S stock and Danish bonds, the result was vice versa. Hence, the latter situation rejected

the Fisher Hypothesis.

A study in U.S (Jones & Wilson, 2004) studied that how bond and stock volatility has changed

from the time period 1871 to 2000. The underlying concept/theory was to justify the asset

allocation theory. Moreover via standard deviations and geometric means, monthly returns

(nominal and inflation adjusted) were calculated. The time period was divided into 26 non

overlapping periods with 5 year periods each from 1871 to 2000. The stock returns were showing
a positive trend throughout, but the bond returns were showing a negative trend for two

consecutive 5 year time. The correlation showed that for some periods, stock returns were

positive and for other time periods the returns were negative. Same is the case with bonds. But

the overall results demonstrate that the inflation does impact the returns of the stocks and bonds.

A study conducted by (Omotor, 2010) was projected to analyze the link amid CPI stock returns

of Stock Exchange of Nigeria. The data taken was from 1985 to 2008. The tests run were

Correlation, Granger Causality Tests and ADF (Augmented Dicky Fuller). The results showed

the positive relation amid inflation and stock returns. That is surprising. Hence, Nigerian markets

are actually strong hedge against the inflation. Or in other words, the Nigerian stock returns,

provide the hedging against inflation.

A study (Muradoglu, Taskin, & Bigan, 2000) was conducted with the objective, to explain

expected returns over time with respect to macroeconomic variables (industrial production,

inflation, interest rates, and oil prices and Stock Returns) in 19 countries. Granger causality was

run and results revealed that Inflation and interest rates in Argentina and Brazil, and only interest

rates in Pakistan and Zimbabwe, Granger cause the stock returns. In countries such as Brazil,

Colombia, Greece, Korea, Mexico, and Nigeria, exchange rates precede stock returns; only in

Colombia, Mexico, and Portugal domestic stock returns follow the S&P index. Domestic stock

returns Granger cause domestic inflation in Argentina, Jordan, and Zimbabwe, and interest rates

in Argentina, Korea, and Mexico. The real sector and domestic production follow the stock

returns in countries such as India and Mexico. Exchange rates are also Granger caused by stock

returns in the latter country.

Another study conducted (Scott Beyer, Dr Robert Johnson, Hughen, & Beyer, 2015) took the

stock returns over past 40 years of U.S and classified according to the monetary policy. The tests
revealed that when the value of dollar appreciated due to loose monetary policy, the returns are

high. On contrary, when the dollar depreciated due to tight monetary policy, the returns are low.

In other words, inflation/deflation does impact the returns in U.S economy as well. The returns

were 2.6 times high when the dollar was trending up vs. down.

Since the dawn of globalization, the studies testing the impact of foreign exchange rates have

become very crucial. Since, investors are no longer restricted to invest in the local businesses;

they can invest in the international businesses as well. Now money/funds know no boundaries,

they can flow out of an economy and can flow inside an economy.

A thorough research was conducted to find what literature and previous studies say about the

linkage among the stock returns and FX-rates (foreign exchange rates). Like CPI, the journals

after 2000 are considered for exchange rate as well.

Chartered banks of Canadas sensitivity were analyzed with respect to exchange rate risk

(Atindhou & Gueyie, 2001). The time period chosen was from 1988-1995. The sensitivity was

estimated by utilizing Three-Factor Asset Pricing Model. The three factors/variables used were

Market rate, Exchange Rates and Interest rates. The returns were positively associated to the

market return but negatively associated to the actual realized returns. The regression tests run

showed that the returns on the stocks of banks are sensitive to exchange rate. But the sensitivity

is not stable over time. Rather it is unstable. If the US dollar appreciates with reference to the

Canadian dollar, the stock returns on the Canadian banks increase. So overall, it can be said that

if a bank has the liabilities in the Canadian dollar, then only the bank is profitable, and returns

increase with the depreciation of Canadian dollar.

In a study (Ramasamy & Yeung, 2005) the relationship linking stock prices to exchange rates

was tested. Granger Causality tests were run. Nine Asian countries were selected namely

Thailand, Taiwan, Hong Kong, South Korea, Japan, Indonesia, Singapore, Malaysia and

Philippines. The data was selected from 1997 to 2000 i.e. the study was precisely short term

based. The causality tests showed that for countries Thailand, Taiwan, Malaysia and Singapore,

the changes in FX-rates (foreign exchange rates) are caused by the changes in prices of stocks of

the stocks markets of respective countries. Bi causality was depicted by Hong Kong only, in the

underlying study. Japans stock prices have causal effect on the exchange rates. For South Korea

and Philippines, the causality moves from FX-rates towards the stock prices.

Researchers (El-Masry, El-Masry, Abdel-Salam, & Alatraby, 2007) studied the relationship amid

the foreign exchange rates (FX-rate) and returns of stocks of nonfinancial companies of United

Kingdom. The data was taken from 1981 to 2001 and regression was run between two variables.

The study suggested that a strong relationship exists between two variables.

A study conducted (El-Masry & Hyde, 2007) tested the sensitivity/relationship of returns of

stocks at a macro level (i.e. at the level of industry) to market, exchange,

and interest rate changes or sudden shocks. The foremost European countries selected were four

i.e. Germany, Italy, UK and France. In this paper the systematic risk was decomposed into

further components i.e. market rates, exchange rates and interest rates risk. The study found that

the changes/fluctuations in foreign exchange rates has a considerable link to returns on stocks in

all four major European economies United Kingdom, France, Italy, Germany. The paper further

identified which industry portfolios had a significant exposure and decomposed these risks.

(Leong & Hui, 2014) The study had the purpose to study the impact of both the macro and non

macro variables on the returns of Singaporean hotels. Only data of listed hotels was gathered.
The other variables selected were supply of money, industrial production (taken as proxy of

GDP), inflation (CPI), Exchange rates (FX-rates), and interest rates at long and short-term. The

data was gathered from time period January 1991 to December 2005 i.e. for 15 years and it was

monthly data. The tests run were Multi-linear Regression and Residual tests using the

econometric package, E-views. The result of regression tests indicates that the increase in the

industrial production (proxy to GDP) and supply of money also increases the returns of the listed

hotels. However, the relation of the hotel returns with the other variables, i.e. CPI, FX-rates, long

and short term interest rates is negative. The study showed that the returns of the hotels increase

when the local currency appreciated. Moreover, the results of the study demonstrated that the

peace and war conditions are the important aspects/determinants and impact the returns of hotels.

Furthermore, the non macro variables were more successful in explaining the returns of hotels

rather than the macro economic variables.

To conduct tests on the relationship amid variables; gold prices and stock returns, a deep analysis

was done. But only a few valid and published studies were found. In the developed countries,

most investments are done in stock and debt markets. However, Pakistan being an emerging

economy and due to the cultural factors, considers gold as an important asset. Since, gold is

considered as an important asset in Pakistan, it was mandatory to inculcate this variable in this

study. After the stock market, investments in gold and property are very prominent in Pakistan.

A study was conducted on U.S stock returns and gold prices by taking data from 1991 to 2001

(Smith, 2001). Correlations were tested both on long run and short run data. On the shorter run

time frame, the correlation was little and was negative. But on the longer run time period no

significant correlations and co integration was found. The Granger Causality tests were also run.
The result depicted the presence of unidirectional causality. This causality has a direction of

stock returns of U.S toward the commodity gold.

A study by (Mustafa & Nishat, 2008) conducted to test the relationship/linkage amid the

variables prices of gold and stock market. The study was tested via monthly data from 1981 to

2004. The study also revealed that exchange rates are negatively associated to stock market.

However, with the reference to gold prices and stock market, no significant relationship was

found. The study suggested that with reference to gold prices, Pakistani stock market is

inefficient.

A study conducted in Pakistan to test the relationship between prices of commodity gold and

returns on stocks of KSE-100 index (Shahzadi & Chohan, 2012). The study took the data on gold

prices and KSE-100 index from year 2006 to year 2010. The tests run were Co-integration tests,

Unit Root Test of ADF (Augmented Dicky Fuller), GCT (Granger Causality Test) and Unit Root

Test of Phillip Perron. The results of correlations showed that there exists a weak and negative

relationship between both variables. Since correlation does not tell the cause and effect between

both variables, further Johnsons co-integration and ADF were run which revealed that both

variables are independent of each other and long run relationship does not exist between them.

Phillip Perron revealed that both the variables are less dependent. Granger causality was not run

because no long term relationship exists between both variables as depicted by co-integration.

Overall no significant relationship exists between both variables; only weak and negative

relationship exists.

A study conducted by (Mensi, Beljid, Boubaker, & Managi, 2013) to find the correlations

between food, gold, energies to stock markets found that the maximum correlation exist amid the

Standard & Poor-500 (S&P-500) index and the gold rates. Hence, the relationship amid gold
prices and S&P-500 index was successfully established. The paper employed the VAR-GARCH

model to verify the correlations between gold, energy, food to stock returns by taking the data

from 2000 to 2011 period.

A study (Arouri, Lahiani, & Nguyen, 2015) conducted on Chinese stock markets, intended to

study the relationship among the Chinese stock returns and the gold prices by using the GARCH

test. The period selected was between 2004 and 2011. The world gold prices were taken. The

tests proved that the historic gold prices play a vital role in explaining or predicting the returns

on stock markets in China. So in order to predict the future stock returns, gold prices should be

taken into account. Moreover, the study also proved that the gold investment is the safest

investment in Chinese market.

Hence, on the basis of above discussions, a solid foundation or base is present to examine the

relationship amid the variables i.e. between FX-rates, Gold Prices and Inflation to Stock Returns

of KSE-100 index.

Stock markets reflect of the economy of any country(Khalid, Altaf, b, & hussain, 2011).

The importance of stock markets has opened new horizons for research of stock market

development and economic growth. Stock prices largely depend upon macroeconomic factors

such as exchange rates, inflation rate, interest rate, industrial production etc. So these factors

influence the investors decisions to diversify their investment plan and argue them to disinvest

from existing investment or invest in new investment plan. Gold may be the best choice for

investors to park their funds in purchasing of gold.

As study conducted by (McDonald & Solnik, 1974) gold has been lucrative among

individuals and institutional investors. They analyzed the association between gold mining stock
and variation, both in level of stock market and prices of gold of US and London. They found

that investment in gold mining stocks gives more return than investing in gold and stock markets.

They also warned investors that investment in gold mining stock despite of its lucrative results

may be risky because prices of gold mining stocks increase or decrease more than gold prices.

The consumption of gold is increasing with the passage of time owing to its attraction,

people not only use gold as jewelry but also use it for investment purposes,50% is used as

jewelry, 40% as investment and 10 as industrial purposes. India is leading in the world for its

consumption using 25% of the total gold of the world ("Gold Demand Trends Q4 and Full Year

2012," 2013).Consumption of gold is part of Indian culture. According to a study (Bhunia &

Das) in India, gold is held through generation to generation. This phenomenon tends to generate

positive return in crises of stock markets.In India, when stock markets go down people invest in

gold.

As tested by (Ray, 2013) gold has inverse relationship with stock. Investors tend to buy

more gold when stock markets goes down resultantly gold prices goes up because of its

increasing demand. Investors withdraw their investment from stock market and wait for fair

weather. Another study (Bilal, Talib, Haq, Khan, & Naveed, 2013)substantiates inverse behavior

of two stock markets of Asia; KSE (Karachi Stock Exchange) and BSE (Bombay Stock

Exchange). This study finds that there is no significant long term relationship between gold

prices and KSE 100 index stock return, whereas in BSE stock returns are significantly related

with gold prices.

Graham Smith (Smith, 2001) tested the association between gold prices and stock market

indices. He advocates that in catastrophic circumstances people park their investment in gold. As

after 9/11 incident worldwide stock market crashed and NYSE (New York Stock Exchange)
remained closed for four days. Owing to this event gold stock index went up and prices of gold

in London also rose by 5.6%. In his test he examined 4 gold prices and 6 stock returns. He found

that there is short term and negative correlation between god prices and stock market return.

In addition to Smith analysis, (Gilmore, McManus, Sharma, & Tezel, 2009) analyzed the

association among gold prices, gold related stock and common stocks. He explains that gold

prices are deemed to be more correlated with gold related securities than the common stocks.

They (Gilmore et al., 2009) tested two gold prices, two gold stock prices and three common

stock market indices. They applied multivariate co-integration analysis to check long term

relationship among three variable; gold prices, gold stock prices and common stock indices.

They found that in long term gold prices and common stock indices are positively correlated

whereas in short run their results advocate the results of (Smith, 2001) indicating negative

relation.

Investors like to diversify their investment portfolio, as a common proverb Dont put

your all eggs in one basket, so investors tend to park their investment to offset the expected loss

from stock markets. A study (Mulyadi et al., 2012) says that investment in gold is more

trustworthy that give prolific results. In this study it was tested to substantiate gold as a safe

heaven. For this purpose they analyzed the 11 years data from 1997 to 2011 from Indonesian

markets of both gold prices returns and stock returns. They succeed to substantiate that gold is

safe heaven despite of US 2008 crises. Another study (Baur & Lucey, 2010) proves that gold is

trustworthy in extreme condition which is short term. So investment in gold gives positive results

for shorter period of time.

A study (Baur & McDermott, 2010) was conducted to test the role of gold in international

financial system. They analyzed the thirty years data (1979-2009) of major emerging countries to
examine the gold as safe heaven against the common stock. They found that gold is not only the

safe heaven but also the hedge against risk in US and major European stock markets, but not in

Canada, Australia, Japan and other emerging markets such as BRIC countries. They substantiate

that gold remained safe haven in developed markets in time of 2008 US and global crises.

Several studies advocate gold as a safe heaven or trustworthy, nevertheless this

phenomenon has some limitations. In the study of ("Perspectives on Investing in Gold," 2010), it

describes some limitations which are; primarily gold investment does not yield in long term,

secondly unlike other goods such as steel, oil or corn, gold is not consumable product which

price may be affected by demand/ supply factors. Thirdly, although attraction in gold, evidences

prove that gold as inflationary hedge is temporal. Other studies (Economics, 2011) also

substantiate that in crises or turmoil circumstances people park their funds in gold to dilute

inflation, financial crises and credit defaults.

Many researchers have studied the relationship between oil prices with both gold prices

and gold mining stock. When oil prices surge it affects the stock markets negatively and with this

increased oil prices the extraction of gold become more expensive. So the profit margin of gold

mining companies reduces. Youngho Chang (Le & Chang, 2011) analyzed the relationship

between oil and gold prices with the help of inflation way and mutual action with the index of

the US dollar. They found that association between gold prices and oil prices is not asymmetric

but non-linear.

In the perspective of Pakistan, its history since inception is full of crises with socio-economic

and political instability. The stock markets are very sensitive to these circumstances, sostock

markets are more volatile due to these circumstances. (Sabika Khan, 2013). To sustain a stable

investment portfolio people diversify their investment by including gold in their investment
plans. In Pakistan a large chunk of investors park their funds in gold investment to dilute the

expected loss from stock markets investments.

El-Sharif et al. (2005) did a research on evidence on the nature and extent of relationship

between oil prices and equity values, specifically in the UK. The research stated that previous

researches were based on areas like stock market level of North America or Australia. For the

purpose of carrying out this research, the authors took oil and gas sector, where the dependent

variable was oil prices and independent variable was equity values. The results showed that a

positive relationship existed among oil prices and stock market values with a high level of

significance.

Changes in oil prices, metal prices and exchange rates were researched by Sari, Hammoudeh &

Soymas in 2009. The focus of this study was to look at any changes that took place due to a

change in the price of metals such as gold, silver, palladium and platinum and oil prices as well

as exchange rate of US dollar with euro. It was found out that any change in the price of one

metal had a weak impact on the prices of other metals and exchange rate. It was also found out

that by investing in metals, euro or oil, the risk of investors could be diversified to some extent.

Soytas et al. (2009) did a research on the global oil prices, metal prices and its impact on the

macro economy of Turkey. The metals include gold and silver, and macroeconomic factors

include exchange rate of Turkey and US dollar, and Turkish interest rate. In case of Turkey, it

was found out that international oil prices were unable to impact the Turkish exchange rate,

interest rate or any metal prices. The indices of these variables present in Turkey were also of no

use in the long run in forecasting any trend for world oil prices. It was found out that like the rest

of the world, gold was considered to be a safe haven when the currency was depreciating. Even

in the short run there was no impact of global oil prices on the indices of Turkish markets. These
findings provided useful information for portfolio managers to look into international oil market

and Turkish stock market, as well as other emerging markets.

Shafiee & Topal (2010) did a research on the overall gold market prices and forecasting. This

study was carried out after the global financial crisis that took place globally, which resulted in

6% increase in gold prices. Two macroeconomic variables that had an effect on gold prices were

crude oil prices and global inflation. It was found out that high levels of correlation existed

between gold and oil prices, which were around 85%. It was also found out that inflation had -

9% correlation with inflation, without having any significance. The forecasting of gold prices

indicated that if the price jump of gold in 2007 was similar to that of price jump in 1987, it

would remain high till 2014, and fall back to the long term trend till 2018.

Zhang & Wei (2010) conducted a research on the gold and crude oil market since these

represented the large commodity markets, which made it highly important to analyze their co

integration, causality, and their particular input in order to completely understand their dynamics

in the market. Results showed that not only was there positive trends between the two variables,

they were significant as well as with positive correlation from time ranging between January

2000 and March 2008. Long term equilibrium also existed between the two commodity markets,

where crude oil price changes caused change in gold prices but not vice versa. The input of

crude oil price was higher than that of gold price, which indicated that crude oil changes had a

large and long run impact on the global economic conditions overall.

Wang & Chueh (2012) conducted a research on the effects of changes between interest rate, oil

prices, gold prices and US dollar. The research looked at both short and long term association

that each variable and its change had on other variables. It was also investigated that whether oil

prices and interest rates had an inverse relationship with international gold prices. Co-integration
technique was used for carrying out different analyses. Data for interest rates was obtained from

Fed and data for gold and oil prices and US dollar index was taken from Taiwan Economic

Statistical Databanks. It was found out that gold and oil prices had a positive impact on each

other in short term. Interest rates had positive impact on oil prices in the future whereas negative

impact on future gold prices. The long run results showed that the influence of interest rate on

US dollar led to an impact on crude oil prices. It was also found out that as interest rates

decreased, investors speculated decrease in value of US dollar, which led to their investment in

gold for the purpose of preservation of capital.

Jain & Ghosh (2012) studied the dynamics of exchange rates, metal prices and global oil prices

in India. Metals that were used in this study were platinum, silver and gold, with platinum and

silver being alternatives of investment to gold. Since gold was the third largest import of India, it

had an effect on the exchange rate of Indian rupee with US dollar. Substantial importance was

being given to relationship of gold and oil prices after the 2008 global financial disaster. Data

taken for this study ranged from January 2009 to December 2011, and the purpose of this study

was to test and analyze whether there existed co integration and Granger causality among the

variables or not. It was found out that there existed co integration among variables when

exchange rates and gold prices were used as dependent variables, which was also backed by the

economy. Since demand of metals and oil had to be fulfilled by importing huge quantities of oil

and gold, both of which were traded in US dollars, any change in the price had an adverse

change in exchange rate, thereby increasing inflation. The co integration relationship where gold

was used as dependent variable showed that since changes in oil price affect inflation, investing

in gold as hedging and diversification, this led to a long term reliance of gold prices on oil prices.
Reboredo (2013) conducted a research studying that whether gold is a hedge in opposition to any

changes in oil prices. The dependence of both the variables markets, oil and gold, has been

tested. Weekly data chosen for this research ranges from January 2000 to September 2011, and

the analysis was done by using a measure of copulas. The results obtained showed that there

existed positive and significant relationship between the two variables, concluding that gold was

not a hedge against any variation in price movements. Another conclusion drawn from analysis

was that against any tremendous movements in oil prices, gold can act as a safe haven. The

results of this study were useful for any policy makers or risk managers who wanted to diversify

the risk of oil price movements with the help of hedging it by investing in gold.

Bildirici & Turkmen (2015) studied the muddled association between gold, silver and copper

returns and oil returns in Turkey, with the help of Non Linear ARDL and Augmented Non

Linear Granger Causality. The data for price indices comprised from 1973 to 2012. The results

indicated that price of gold had positive inverse relationship with oil prices both in short and long

run, there existed a unidirectional and Granger Causality among oil prices and metal prices, and

a unique relationship existed between the prices of gold, , copper, silver and oil.

Gokmenoglu & Fazlollahi (2015) studied the connections between oil, gold and stock market and

analyzed if gold price or gold price volatility and oil price or oil price volatility had any impact

on the stock market index. The properties of the data led to the choice of using ARDL co

integration to find the long term results of gold and oil price volatilities and S&P500 price index.

Due to the role of oil and gold prices and their volatilities, the S&P500 price index met its long

run level by 1.2% speed of daily alteration. Findings also indicated that other variables had long

term influence on the stock market index but gold had the maximum influence on stock market

in both short and long run. However, the volatilities of oil and gold prices had no impact on
stock market price index in the short run. This showed that short run did not push investors to

move their investment from one market to another, however in the long run they responded to

the instabilities of oil and gold prices.

Tiwari & Sahadudheen (2015) conducted a research to find out the connection between the real

prices of gold and oil. The data chosen for this study ranged from April 1990 to August 2013.

Returns on real oil and real gold prices were used to find out the impact that real oil price had on

real gold. The techniques used to carry out the results were categories of GARCH, which

concluded that increased real oil price had positive influence on real gold. Another conclusion

was drawn from the EGARCH model indicating that 4.7% increase in gold was result of a 10%

increase in returns on real oil price. It was also found out that any shock in the gold market had

asymmetric effect, showing that positive or negative shocks had dissimilar impact on gold prices.

Raza et al. (2016) studied the asymmetric impact of gold and oil prices and what instability it

caused on the stock price index of emerging markets. Data chosen for this study was monthly

ranging from January 2008 to June 2015. To locate the unbalanced effect, nonlinear ADRL

approach was used for the short and long term analysis. The emerging economies chosen for this

study included Mexico, Malaysia, Thailand, Chile, China, India, Brazil, Russia, South Africa and

Indonesia. The results obtained showed that gold prices had a positive impact on larger emerging

economies such as China, India, Brazil, Russia and South Africa, whereas it had a negative

impact on the stock market prices of the rest of the emerging economies. In case of oil prices, it

had a negative influence on the stock market prices of all the emerging economies. This led to

the conclusion being drawn that emerging markets were more prone to uncertainty in economic

situations due to any volatility in prices of gold or oil as they were more exposed to any bad

news related to unpredictability in the stock markets.

Jain & Biswal (2016) studied the relationship that existed between oil and gold price, exchange

rate and stock market in India. To examine the coexistent links among variables, DCC-GARCH

models were used, and to examine lead lag connections, Non Linear Causality tests were run.

The results obtained indicated that reduction in gold and oil prices led to a depreciated Indian

rupee as well as stock index. The indication of results was also towards gold being an emergent

investment asset. This study also called for policies to be made in India to restrain the instability

of exchange rate and stock index unpredictability by using oil and gold prices as mechanisms.

Yaya, Tumala & Udomboso (2016) studied the volatility and returns spillovers among oil and

gold prices, by dividing the data into two portions of before and after financial crisis. The data

taken for this study was from 1986 to 2015. In order to measure volatility persistence, log

returns, absolute and squared log returns were used as of gold and oil prices were taken as

alternatives, and to measure the spillover effect, Constant Conditional Correlation (CCC) was

used. In case of volatility among the two markets, it was lesser in gold market as compared to oil

market in both the periods before and after the crisis. The spillovers effect, however, was

bidirectional before the crisis, but turned unidirectional afterwards from gold to oil. There were

no spillovers from oil to gold market after the prices, which indicated that the optimal allotment

of weights and hedging had been in practice. The results were of help to financial analyst in ways

that they could use gold market as hedge against any oil market fluctuation, and that the

instability of oil market could be used to establish gold market behavior.

Ftiti, Fatnassi & Tiwari (2016) analyzed the connection between the movement of gold and oil

prices using the wavelet approach to consider the time and frequency among the variables. The

results found out showed that there were huge co-movements in prices of both the variables in

times of crisis. It was also found out that when preventive demand shocks of oil took place, the
gold prices reacted slowly to the changes in oil prices, for a short period of time. Due to this

variation in gold prices, oil prices reacted by this impact for a medium time frame.

The goods market approach assumes that the exchange rate is determined largely by a

countrys current account or trade balance performance. This approach posits that changes

in exchange rates affect international competitiveness and trade balance, thereby influencing

real economic variables such as real income and output (Dornbusch and Fischer 1980). Stock

prices, usually defined as the present value of the future cash flow of companies, should

adjust to economic perspectives.3 Depending on these and other factors, an appreciation

(depreciation) of the home currency may cause a net increase (net decrease) in the share

market index. For example, currency appreciation is expected to stimulate the share market

of an import-dominated country (a positive effect) and depress that of an export-dominated

economy (a negative effect) (Obben et al. 2007).

Alternatively, the portfolio approach suggests that changes in stock prices may influence

movements in exchange rates via portfolio adjustments (inflows/outflows of foreign capital).

Under this model, if a persistent upward trend in stock prices occurs, inflowof foreign capital

rises. However, a decrease in stock prices would induce a reduction in domestic investor

wealth, leading to a fall in demand for money and lower interest rates, causing capital

outflows that would result in currency depreciation. Therefore, under the portfolio balance

approach, stock prices would influence exchange rates with a negative correlation.

The relationship between stock prices and the exchange rate has been empirically analyzed

over the past three decades. The results are somewhat mixed as to the significance

and direction of influences between stock prices and exchange rates. Bahmani-Oskooee

and Sohrabian (1992) found that in the short run, a causal relationship exists between US
stock prices and the effective exchange rate of the US dollar. Ajayi and Mougoue (1996)

found conflicting short-run and long-run causalities for advanced countries. Amihud (1994)

and Bartov and Bohnar (1994) found that lagged but not contemporaneous changes in US

dollar exchange rates explain firms current stock returns.

Positive relationship was observed in gold price and stock prices in US by Levin and Wright

(2006), the study reveals the positive relationship between changes in the gold price and changes

in the US dollar trade-weighted rate and the gold lease rate. Mu-Lan Wang, Ching-Ping Wang

and Tzu-Ying Huang (2010) also investigate the impact of fluctuations in gold price, crude oil

prices, and exchange rates of the U.S. dollar vs. various currencies on the stock price indices of

the United States, Germany, Japan, Taiwan and china. The result shows that there exists co-

integration and long term stable relationship among these variables. But contrary to it there is no

co-integration and long term stable relationship among these variables in USA.

Researchers also concluded the negative relationship between these variables, Moore (1990)

investigated the negative correlation between gold price and the stock/bond markets. It means

that when gold prices are rising, the stock/bond markets are declining. The result derived on the

basis of empirical result from 1970 to 1988.

Similarly Neda (2011) investigated during the period of 2006 to 2010 the negative relationship

between stock exchange index and gold price in Iran and Armenia. Tests also show that the time

series of study are stationery and there exists long run relationship between them. on the other

hand Ratanapakorn and Sharma (2007) investigate the long-term and short-term relationship

among the U.S. stock price index and macroeconomic variables and were able to conclude that

the stock price index and long-term interest rate are negatively correlated, but money supply,

industrial production index, inflation rate, exchange rate, and short-term interest rate are
positively correlated. Turkish market also observed the conduct of this and Ahmet (2010)

analyzed that the interest rate, industrial production index, oil price, foreign exchange rate have a

negative effect on ISE-100 index returns but money supply positively affect the ISE-100 index

returns. But the inflation rate and price of gold do not affect the ISE-100 index returns. Hina &

Naveed (2010) also investigated the negative relationship between the gold rates and KSE-100

Index for data collected on monthly basis for the period of 2006 to 2010, Graham smith (2002)

investigate the relationship between the gold price and stock price indices for Europe and Japan.

He conclude that the short run correlation is small and negative in European markets and Japan,

there is no long run equilibrium between them and no co integration occur. Data was collected

from the period 1991 to 2001.