NCFM : Commodities Gold & Silver Market

Gold futures trading debuted at the Winnipeg Commodity Exchange (Comex) in Canada in November 1972. Delivery was also available in gold certificates issued by Bank of Nova Scotia and the Canadian Imperial Bank of Commerce. The gold contracts became so popular that by 1974 there was as many as 10,00,000 contracts floating in the market. The futures trading in gold started in other countries too. This included the following:

• The London gold futures exchange started operations in the early 1980s.

• The Sydney futures exchange in Australia began functioning with a contract in 1978. This exchange had a relationship with the Comex where participants could take open positions in one exchange and liquidate them in the other.

• The Singapore International Monetary Exchange (Simex) was set up in 1983 by way of an alliance between the Gold Exchange of Singapore and the International Monetary Market (TMM) of Chicago.

• The Tokyo Commodity Exchange (Tocom), which launched a contract in 1982, was one of the few commodity exchanges to successfully launch gold futures. Trading volume on the Tocom peaked with seven million contracts.

• On December 31, 1974, the Commodity Exchange, the Chicago Board of Trade, the Chicago Mercantile Exchange and the Mid-America Commodity Exchange introduced gold futures contracts.

• The Chinese exchange, Shanghai Gold Exchange was officially opened on 30 October 2002.

• Mumbai's first multi-commodity exchange, the National Commodities and Derivatives Exchange, NCDEX launched in 2003 by a consortium of ICICI Bank Limited, Life Insurance Corporation, National Bank for Agriculture and Rural Development and National Stock Exchange of India Limited, introduces gold futures contracts.

Gold has a very active derivative market compared with other commodities. Gold accounts for 45 per cent of the worlds commercial banks commodity derivatives portfolio.

Gold

For centuries, gold has meant wealth, prestige, and power, and its rarity and natural beauty have made it precious to men and women alike. Owning gold has long been a safeguard against disaster. Many times when paper money has failed, men have turned to gold as the one true source of monetary wealth. Today is no different. While there have been fluctuations in every market and decided downturns in some, the expectation is that gold will hold its own. There is a limited amount of gold in the world, so investing in gold is still a good way to plan for the future. Gold is homogeneous, indestructible and fungible. These attributes set gold apart from other commodities and financial assets and tend to make its returns insensitive to business cycle fluctuations. Gold is still bought (and sold) by different people for a wide variety of reasons - as a use in jewellery, for industrial applications, as an investment and so on.

Precious metals
Table : Country-wise share in gold production, 1968 and 1999
Country	Tonnes, 1968	Share 1968	Tonnes, 1999	Share, 1999
South Africa	972	67	437	17
Australia			309	12
Canada	87	6	154	6
USA	44	3	334	13
China			154	6
Indonesia			154	6
India			51	2
Rest of the world	87	6	463	18
Total	1450	100	2571	100

Production

Traditionally South Africa has been the largest producers of gold in the world accounting for almost 80% of all non-communist output in 1970. Although it retained its position as the single largest gold producing country, its share had fallen to around 17% by 1999 because of high costs of mining and reduced resources. Table 4.1 gives the country-wise share in gold production. In contrast other countries like US, Australia, Canada and China have increased their output exponentially with output from developing countries like Peru and other Latin American countries also increasing impressively.

Mining and production of gold in India is negligible, now placed around 2 tonnes (mainly from the Kolar gold mines in Karnataka) as against a total world production of about 2,272 tonnes in 1995.

Melting & refining assaying facility in India

At present, gold is mainly refined in Bombay where a few refineries like the India Government Mint and National refinery are active. Some private refineries are also operating elsewhere with limited capacity. As none of the refineries is LBMA recognised, there is a need to upgrade and also increase the refining capacity.

Global and domestic demand-supply dynamics

The demand for gold may be categorised under two heads - consumption demand and investment demand. Consumption of gold differs according to type, namely industrial applications and jewellery. The special feature of gold used in industrial and dental applications is that some of it cannot be salvaged and thus is truly consumed. This is unlike consumption in the form of jewellery, which remains as stock and can reappear at future time in market in another form. Consumer demand accounts for almost 90% of total gold demand and the demand for jewelry forms 89% of consumer demand.

Commodities traded on the NCDEX platform

In markets with poorly developed financial systems, inaccessible or insecure banks, or where trust in the government is low, gold is attractive as a store of value. If gold is held primarily as an investment asset, it does not need to be held in physical form. The investor could hold gold-linked paper assets or could lend out the physical gold on the market attaining a higher return in addition to savings on the storage costs. Japan has the highest investment demand for gold followed closely by India. These two countries together account for over 50% of total world demand of gold for retail investment. Investment demand can be split broadly into two, private and public sector holdings.

There are several ways in which investors can invest in gold either directly or through a variety of investment products, each of which lends it to specific investor preferences:

• Coins and small bars

• Gold accounts: allocated and unallocated

• Gold certificates and pool accounts

• Gold Accumulation Plan

• Gold backed bonds and structured notes

• Gold futures and options

• Gold-oriented funds

Demand

The Consumer demand for gold is more than 3400 tonnes per year making it whopping $40 billion worth. More than 80% of the gold consumed is in the form of jewellery, which is generally predominated by women. The Indian demand to the tune of 800 tonnes per year is making it the largest market for gold followed by USA, Middle East and China. About 80% of the Physical gold is consumed in the form of jewellery while bars and coins occupy not higher than 10% of the gold consumed. If we include jewellery ownership, then India is the largest repository of gold in terms of total gold within the national boundaries.

Regarding pattern of demand, there are no authentic estimates, the available evidence shows that about 80% is for jewellery fabrication for domestic demand, and 15% is for investor-demand (which is relatively elastic to gold-prices, real estate prices, financial markets, tax-policies, etc.). Barely 5% is for industrial uses. The demand for gold jewellery is rooted in societal preference for a variety of reasons - religious, ritualistic, a preferred form of wealth for women, and as a hedge against inflation. It will be difficult to prioritise them but it may be reasonable to conclude that it is a combined effect, and to treat any major part as exclusively a store of value or hedging instrument would be unrealistic. It would not be realistic to assume that it is only the affluent that creates demand for gold. There is reason to believe that a part of investment demand for gold assets is out of black money.

Rural India continues to absorb more than 70% of the gold consumed in India and it has its own role to fuel the barter economy of the agriculture community. The yellow metal used to

Precious metals

play an important role in marriage and religious festivals in India. In the Hindu, Jain and Sikh community, where women did not inherit landed property whereas gold and silver jewellery was, and still is, a major component of the gifts given to a woman at the time of marriage. The changeover hands of gold at the time of marriage are from few grams to kgs. The gold also occupies a significant position in the temple system where gold is used to prepare idol and devotees offer gold in the temple. These temples are run in trust and gold with the trust rarely comes into re-circulation. The existing social and cultural system continues to cause net gold buyer market and the government policies have to take note of the root cause of gold demand, which lies in the social and cultural system of India. The annual consumption of gold, which was estimated at 65 tonnes in 1982, has increased to more than 700 tonnes in late 90s. Although it is likely that, with prosperity and enlightenment, there may be deceleration in demand, particularly in urban areas, it would be made good by growing demand on account of prosperity in rural areas. In the near future, therefore, the annual demand will continue to be over 600 tonnes per year.

Supply

Indian gold holding, which are predominantly private, is estimated to be in the range of 10000-13000 tonnes. One fourth of world gold production is consumed in India and more than 60% of Indian consumption is met through imports. The domestic production of the gold is very limited which is around 9 tonnes in 2002 resulting more dependence on imported gold. The availability of recycled gold is price sensitive and as such the dominance of the gold supply through import is in existence. The fabricated old gold scraps is price elastic and was estimated to be near 450 tonnes in 2002. It rose almost more than 40% compared to the previous year because of rise in gold price by more than 15%.

The demand-supply for gold in India can be summed up thus:

• Demand for gold has an autonomous character. Supply follows demand.

• Demand exhibits income elasticity, particularly in the rural and semi-urban areas.

• Price differential creates import demand, particularly illegal import prior to the commencement of liberalisation in 1990.

Price trends and factors that influence prices

Indian gold prices follow more or less the international price trends. However, the strong domestic demand for gold and the restrictive policy stance are reflected in the higher price of gold in the domestic market compared to that in the international market at the available exchange rate.

Since the demand for gold is closely tied to the production of jewelry, gold prices tend to increase during the time of year when demand for jewellery is greatest. Christmas, Mothers Day and Valentine Day are all major shopping seasons and hence the demand for metals tends to be strong a few months ahead of these holidays. Also, the summer wedding season sees a large increase in the demand for metals, so price strength in March and April is not uncommon. On the

other hand in November, December, January and February prices tend to decline and jewellers tend to have holiday inventory to unwind.

..............................................................

Silver

The dictionary describes it as a white metallic element, sonorous, ductile, very malleable and capable of high degree of polish. It also has the highest thermal and electrical conductivity of any substance. Silver is somewhat harder than gold and is second only to gold in malleability and ductility. Silver remains one of the most prominent candidates in the metals complex as far as futures' trading is concerned. Thanks to its unique volatility, silver has remained a hot favourite speculative vehicle for the small time traders. Though futures trading was banned in India since late sixties, parallel futures markets are still very active in Delhi and Indore. Speculative interest in the white metal is so intense that it is believed that combined volume of Indian punters represent almost 40 percent of volume traded at New York Commodity Exchange. Delhi, Rajasthan, MP and UP are the active pockets for the silver futures. Until recently, Rajkot and Mathura were conducting futures but now players have diverted toward comex trade.

Most of the world's silver is mined in the US, Australia, Mexico, Peru, and Canada. Cash markets remain highly unorganised in the silver and impurity and excessive speculation remain key issue for the trade. Taking cue from gold, government of India is planning to introduce hallmarking in silver which is likely to address quality and credibility of Indian silverware and jeweller industry. The unique properties of silver restrict its substitution in most applications.

Production

Silver ore is most often found in combination with other elements, and silver has been mined and treasured longer than any of the other precious metals. Mexico is the worlds leading producer of silver, followed by Peru, Canada, the United States, and Australia. The main consumer countries for silver are the United States, which is the worlds largest consumer of silver, followed by Canada, Mexico, the United Kingdom, France, Germany, Italy, Japan and India. The main factors affecting these countries demand for silver are macro economic factors such as GDP growth, industrial production, income levels, and a whole host of other financial macro economic indicators.

Demand

Demand for silver is built on three main pillars; industrial and decorative uses, photography and jewelry & silverware. Together, these three categories represent more than 95 percent of annual silver consumption. In recent years, the main world demand for silver is no longer monetary, but industrial. With the growing use of silver in photography and electronics, industrial demand for silver accounts for roughly 85% of the total demand for silver. Jewelry and silverware is the second largest component, with more demand from the flatware industry than from the jewelry industry in recent years. India, the largest consumer of silver, is gearing up to start hallmarking of the white precious metal by April. India annually consumes around 4,000 tonnes of silver,

Precious metals

Major markets like the London market (London Bullion Market Association), which started trading in the 17th century provide a vehicle for trade in silver on a spot basis, or on a forward basis. The London market has a fix which offers the chance to buy or sell silver at a single price. The fix begins at 12:15 p.m. and is a balancing exercise; the price is fixed at the point at which all the members of the fixing can balance their own, plus clients, buying and selling orders.

Trading in silver futures resumed at the Comex in New York in 1963, after a gap of 30 years. The London Metal Exchange and the Chicago Board of Trade introduced futures trading in silver in 1968 and 1969, respectively. In the United States, the silver futures market functions under the surveillance of an official body, the Commodity Futures Trading Commission (CFTC). Although London remains the true center of the physical silver trade for most of the world, the most significant paper contracts trading market for silver in the United States is the COMEX division of the New York Mercantile Exchange. Spot prices for silver are determined by levels prevailing at the COMEX. Although there is no American equivalent to the London fix, Handy & Harman, a precious metals company, publishes a price for 99.9% pure silver at noon each working day.

with the rural areas accounting for the bulk of the sales. India's demand for silver increased by 177 per cent over the past 10 years as compared to 517 tonnes in 1991. According to GFMS, India has emerged as the third largest industrial user of silver in the world after the US and Japan.

Supply

The supply of silver is based on two facts, mine production and recycled silver scraps. Mine production is surprisingly the largest component of silver supply. It normally accounts for a little less than 2/3 rd of the total (last year was slightly higher at 68%). Fifteen countries produce roughly 94 percent of the worlds silver from mines. The most notable producers are Mexico, Peru, the United States, Canada and Australia. Mexico, the largest producer of silver from mines. Peru is the worlds second largest producer of silver. Silver is often mined as a byproduct of other base metal operations, which accounts for roughly four-fifths of the mined silver supply produced annually. Known reserves, or actual mine capacity, is evenly split along the lines of production. The mine production is not the sole source - others being scrap, disinvestments, government sales and producers hedging. Scrap is the silver that returns to the market when recovered from existing manufactured goods or waste. Old scrap normally makes up around a fifth of supply. Scrap supply increased marginally last year up by 1.2%. The other major source of silver is from refining, or scrap recycling. Because silver is used in the photography industry, as well as by the chemical industry, the silver used in solvents and the like can be removed from the waste and recycled. The United States recycles the most silver in the world, accounting for roughly 43.6 million ounces. Japan is the second largest producer of silver from scrap and recycling, accounting for roughly 27.8 million troy ounces in 1997. In the United States and Japan, three-quarters of all the recycled silver comes from the photographic scrap, mainly in the form of spent fixer solutions and old

X-ray films.

Factors influencing prices of the silver

The prices of silver, like that of other commodities, are dictated by forces of demand and supply and consumption. Besides, a host of social, economic and political factors have powerful bearing on silver prices. As in the case of gold prices, political tensions, the threat affects the price of silver too. When trading and movement of silver is restricted, within or outside national boundaries, prices move in accordance with demand and supply conditions prevalent in mat environment Price of silver is also influenced by changes in factors such as inflation (real or perceived), changing values of paper currencies, and fluctuations in deficits and interest rates, etc. Although prices and incomes are important factors, they are also influenced by factors such as tastes, technological change and market liberalisation.

Approximately 70 percent of the silver mined in the western hemisphere is mined as a by­product of other metal products, such as gold, copper, nickel, lead, and zinc. As such, the price of these metals greatly affects the supply of silver mined in any year. As die price of die omer metal products increases, die increased profit margin to mine operations stimulates greater production of die omer metals, and as a result, die production of silver increases in tandem. Because silver is a precious metal, its price is determined by die supply and demand ratio at any given moment. As is the case with other precious metals, there is a limited amount of silver in the world. It is not a product mat can be manufactured en masse, and, merefore, is subject to issues such as weamer and politics mat may affect silver mining operations.