Conclusion
We have modelled gold prices in India and shown it to have a long term relationship with the stock market index, exchange rate, US bond rates, oil prices and the consumer price index. We found evidence that the role of gold as a portfolio hedge dominates its use as a luxury good in India. Gold prices are negatively related with oil prices, further indicating the role of gold as a hedge. Gold prices go up when the rupee is weaker implying that gold is a good hedge against the dollar. When returns from investing outside the country are high, gold price in India is low. Finally, gold acts as a good inflation hedge as it moves in the same direction as CPI. We found evidence that the above variables are able to forecast gold over a 12-month horizon better than a random walk model. One implication of our results is that since gold seems to be a useful portfolio hedge as well as inflation hedge, government policies to curb the import of gold may be futile. Yet the large amounts of gold imports are a cause for concern as they have kept India’s current account deficit high leading to pressure on the rupee. Our research suggests that policies that directly address the causes of inflation and provide alternative investment opportunities for retail investors may better serve the objective of bringing down gold imports.
