CHAPTER I

INTRODUCTION
Declaration Synopsis Object Of The Study Objectives Of Project Methodology Of Project Scope Of The Project Limitations Of The Project

DECLARATION
I Rahul Sandhan, a student of MBA 2005-2007 studying at MGVs Institute of Management and research solemnly declare that the project work of Gold Futures with reference to multi commodity exchange was carried out by me in the partial fulfillment of an MBA programme under the University of Pune. This project was undertaken as a part of the academic curriculum according to rules and regulations of the university of Pune and by no commercial interest or motives.

SYNOPSIS

Ever since the dawn of civilization commodities trading has become an integral part in the lives of mankind. The very reason for this lies in the fact that the commodities represent the fundamental elements of utility for human beings. The term commodity refers to any material, which can be bought and sold. Commodities in the markets context refer to any movable property other than actionable claims, money and securities. Over the years, commodities markets have been experiencing tremendous progress, which is evident from the fact that the trade in this segment is standing as the boon for the global economy today. The promising nature of these markets has made them an attractive investment avenue for investors.

Derivatives are designed to manage risks, which arise from movements in markets. The derivatives markets enable traders, businessman, investors, bank treasures, and corporate to manage their risk more efficiently and allow them to hedge or speculate on markets.
The project aims at understanding the basics of Commodity Futures Market. The project covers the information about the evolution and presents status of the commodity futures market, about Forwards Market Commission, about NCDEX, trading in commodity futures etc.

OBJECT OF THE STUDY

As a part of curriculum of MBA programme of the University of Pune I underwent my summer training for the period of two months commencing from 1st Jun to 31st July 2006 at Angel Broking Limited. The aim behind is to let the student two draw out differences and similarities between the theoretical knowledge with the actual job condition so they can be able to perused and the cultivate strategy decision making capabilities and establish themselves as capable manager of tomorrows. This is to find out the correct analytical ability project by student under a certain prevailing situation in Nashik.

OBJECTIVES OF PROJECT
1) Study the concept of Gold future, their trading and

settlements procedure.

2)

Analyzing the Gold prices movements along with various

factors as its determinants to identify the future opportunities in Gold future.

METHODOLOGY OF PROJECT

Primary data On field study at M/s Angel Broking Ltd., Nashik Sample survey of 100 investors in Nashik Secondary data Use of research report of angel broking ltd., Karvy stock Broking Ltd. Use of publication of National stock Exchange on Commodities market. Use of internet

SCOPE OF THE PROJECT To Understand The Trend Of Prices Of Gold This project compares and contrasts the present and past prices of gold on New York Metal Exchange and Multi Commodity exchange In the volatile financial market, investors become risk averse and not willing to take risk on any commodity or financial instrument. Looking at the current scenario, investors have more choices for investment and intermediately operator. As well as considering global competitiveness, raising interest rates, raising crude prices and inverse Dollar-Euro relationship, geo-political tensions like wars, terrorism and shortage of resources. There is only commodity that will not depreciate or devaluate at any condition, and that is GOLD. This study tries to find out trend of gold prices and helps to get investors view about gold future on various parameters, which help researchers to understand investors perception about investment in gold and other commodities and their financial position and knowledge and interest.

LIMITATIONS OF THE PROJECT Identification of limitations of the project made the project more workable and solutions more practical. Although the best possible efforts were taken to make this project successful, it has some limitations.

1) The data so interpreted cannot be predicted to full accuracy, as there are many factors, which influence the commodity exchange and the ultimately Gold prices.

2) The time was the main constraint as to study the each commodity listed on MCX was difficult.

CHAPTER II

PROFILE OF THE ORGANIZATION

Organization Profile Introduction To Multi Commodity Exchange

ORGANIZATION PROFILE
The Angel Group has emerged as one of the top 5 retail stock broking houses in India, having memberships on BSE, NSE and the two leading commodity exchanges in the country i.e. NCDEX and MCX. Angel Broking Ltd is also registered as a depository participant with CDSL. The group is promoted by Mr. Dinesh Thakkar, who started this enterprise as a small sub-broker in 1987 with staff strength of 3 personnel. As on date, the group is managed by a team of 150 professionals & 1250+ support staff and a nation wide network comprising 54 branches, over 2900 + sub brokers and business associates and 10000 terminals which cater to the requirements of 130000+ retail clients. Vision OF Angel Broking Limited TO PROVIDE BEST VALUE FOR MONEY TO INVESTORS THROUGH INNOVATIVE PRODUCTS, TRADING / INVESTMENT ART TECHNOLOGY. PERSONALISED SERVICE Business Philosophy Ethical practices & transparency in all our dealings Customer interest above our own STRATEGIES, STATE-OF-THE-

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 Always deliver what we promise Effective cost management E-broking Services Multiple exchanges on a single screen Intra-day calls and flash news Historical charts with technical tools Streaming quotes 24x7 web enabled back office Auto pay-in of shares Online transfer of funds Angels e-broking facility is one such effort, which gives investor access to state-of-the-art trading platform with multiple exchanges, order and trade confirmations, research reports, e-contracts and a 24x7 on-line web enabled centralized back-office system at the click of a button. On-line trading facilities on BSE / NSE (Cash and F&O), NCDEX and MCX through our 3 unique trading softwares especially designed for traders as well as investors. Trading in securities / commodities using the internet platform is a convenient option. Angel provide an opportunity to trade on BSE / NSE

11

(Cash and F&O), NCDEX and MCX from the comfort of your home or office.

Salient features of Angel trade

Multiple exchanges on a single screen: Online trading on BSE / NSE (Cash and F&O), MCX and NCDEX on a single screen.

Speed: Angel Broking use the latest technology to generate efficient uptime and greater stability to give to investor high speed.

Competitive brokerage rates: Believe in providing to clients the best value added services at the most competitive brokerage rates.

Optimum margins: Angel gives investor the trading exposure at optimum margin level

Online funds transfer: The clients enjoy the convenience of online

transfer of funds from their bank accounts, to the margin account of Angel, online.

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Personalized service: Clients can avail of personalized advisory services from Angels trained and experienced dealers, regarding trading opportunities.

Off line services: Clients are free to make a telephone call to any of 54 well-equipped branches across the country.

Technology: Angel provides the latest infrastructure tools to support and integrate the backend and front office functionalities.

Back office infrastructure: Angel provide an automated web enabled centralized back-office whereby the clients can have access to their trade confirmation reports, holding statement, their net position, the margins and the statement of accounts and ledgers on a 24 X 7 basis.

Technical support: Angel remove technical difficulties through an online support system manned by qualified professionals.

E - Contract notes cum bills: Angel provide contract notes cum bills in electronic form resulting in ease of access to trades carried out by the clients on any particular day.

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Angel Commodities Services

At Angel, they provide a platform to participate and trade in Commodity Futures with both the leading Commodity Exchanges and offer mmense benefits. Angel group is engaged in various activities such as trading / advisory services in Indian capital markets viz., equity, futures and options etc. and also in Indian commodities markets viz., commodities futures.

ABOUT ANGEL COMMODITIES

ANGEL COMMODITIES BROKING (P) LIMITED promoted by ANGEL GROUP, started its operations in Indian commodities market by acquiring memberships in India's premier multi-commodity exchanges of NCDEX (Membership No:00220) and MCX (Membership No: 12685).

ANGEL COMMODITIES offers trading opportunities in commodity markets through the chain of its branches spread across the country. ANGEL COMMODITIES provides expert research / analysis to its clients in various commodities, listed in NCDEX and MCX including the international perspective of the commodities traded. It provides best technical analysis from desk of its trained and qualified analysts.

The research team of angel commodities consists of professionals who are industry veterans. The team is capable of formulating trading strategies

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depending on risk-return profile of the client. Today we offer a gamut of financial products to satisfy an array of financial needs.

Why investors trade with Angel Commodities?

Angel has the following application and services to provide you best trading opportunities available in the industry.

Online application based trading software Online web based trading platform Online daily, weekly and monthly research Transparent and fair trade execution Individual client attention 24*7 online back office Training/education facilities / conduct of seminars State-of-the-art technology Digital contract notes cum bill: View your accounts from any where, any time Efficient risk management Competitive brokerage rates

Achievement
Angel Broking Ltd has been awarded the coveted Major Volume Driver trophy for the year 2004-2005 by the CEO & MD of BSE Mr. Rajnikant Patel.

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INTRODUCTION TO MULTI COMMODITY EXCHANGE

The Forward Markets Commission under the Department of Consumer Affairs, Ministry of Consumer Affairs Food and Public Distribution, Government of India is the regulating authority of all Futures Trading in Commodity Futures Exchanges in India. The Government of India has removed all restriction on futures trading in almost all commodities under the Forward Contracts Regulation Act (FCRA), which includes agricultural commodities, industrial commodities, bullion and base metals. Multi Commodity Exchange of India Ltd. (MCX), with the permanent recognition from Forward Markets Commission, Government of India has established a demutualised Nation-wide Multi Commodity Online Exchange for Futures Trading in all the important and essential commodities.

Key Shareholders:
. State Bank of India Union Bank of India State Bank of Indore Bank of India State Bank of Hyderabad Canara Bank Bank of Baroda Corporation Bank Bank of Saurashtra SBI Life Insurance Co.
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With the Government of India allowing futures trading in Gold and Silver since October 2003, the vibrant domestic bullion market has received fresh air of exuberance for the new avenue of risk mitigation and price discovery. For centuries Gold and Silver are well ingrained in the Indian Society due to its characteristic charisma for the Indian consumers. Both these commodities have well-developed spot market to boost off, however for price discovery they had to rely upon international benchmark markets due to absence of future price discovery and risk management tools in the country. MCX has commenced futures trading in Gold & Silver on its online nationwide platform in November 2003 through its member network spread across the country and it is presently the most successful and liquid futures contract in India.

MCX Trading system

Multi Commodity Exchange of India Ltd., established in 2003 and already the largest commodity (bullion) futures exchange in India, provides the premier forum for managing the price risk associated with bullion market. MCX is a dominant center for gold and silver futures trading. MCXs liquidity, price transparency and financial integrity make it a benchmark for bullion markets in this part of the world. Orders are entered through MCX Trader Work Station terminals. A credit controlled module verifies credit worthiness based on clearing member predetermined parameters.

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Orders are matched on price and time priority matched orders are confirmed at each originating terminal. Meanwhile, all unmatched orders remain in the system until matched or withdrawn. The instant a trade is executed, all participating quote vendors receive last sale price and quantity data, as well as updated information on best bid and offer and size of each order. As each trade is confirmed, it is routed to the MCX clearing system for settlement Clearing member firms adjust buyers and sellers accounts for positions and margins.

MCX Clearing and Settlement

The Clearing House of the MCX through the MCX.s clearing member firms guarantees the performance for each futures contract. Daily Settlement (Pay-in and Pay-out) MCX has daily settlement of all transaction conducted on the Exchange. This process begins with the daily settlement price, which is calculated for each futures contract. Once established, the settlement price is used for all new and open (un-liquidated) positions to compute the pay-in and payout. Every account holding futures positions is adjusted in cash daily when it is marked-to market.

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Delivery / Cash Settlement Traditionally contracts are fulfilled by taking an offsetting position. (Thereby avoiding giving or taking delivery). But when open contracts run into the delivery period (which is usually 1st to 15th of the delivery month), then contracts are initiated for a delivery. The seller has the option in tendering a delivery and seller initiates the delivery process on the First Notice Day of the delivery period. However when neither the seller nor the buyer has intended to give or take delivery, then those open contracts on the expiry day of the contract are cash settled at the due-date rate of the contract. Due-date rate is the average of the last 5 days closing in the spot market of the underlying commodity and the futures contract, which ever is higher.

FUTURES Futures contracts are firm commitments to make or accept delivery of a specific quantity and quality of a commodity during a specific month in the future at a price agreed upon at the time the commitment is made. Approximately 2 % of bullion futures contracts traded result in delivery of the underlying commodities. Instead the traders generally offset their futures positions before their contracts mature. The difference between the initial purchase or sale price and the price of the offsetting transaction represents the realized profit or loss.
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Futures trading system

The trading system on the MCX provides a fully automated screen-based trading for futures on commodities on a nationwide basis as well as an online monitoring and surveillance mechanism. It supports an order driven market and provides complete transparency of trading. operations. The trade timings on the MCX are 10.00 a.m. to 11.00 p.m. After hours trading has also been proposed for implementation at a later stage. The MCX system supports an order driven market, where orders match automatically. Order matching is essentially on the basis of commodity, its price, time and quantity. All quantity fields are in units and price in rupees. The exchange specifies the unit of trading and the delivery unit for futures contracts on various commodities. The exchange notifies the regular lot size and tick size for each of the contracts traded from time to time. When any order enters the trading system, it is an active order. It tries to find a match on the other side of the book. If it finds a match, a trade is generated. If it does not find a match, the order becomes passive and gets queued in the respective outstanding order book in the system. Time stamping is done for each trade and provides the possibility for a complete audit trail if required.

Commodity futures trading cycle

MCX trades commodity futures contracts having one month, two month and three month expiry cycles. All contracts expire on the 5th of the expiry month. Thus a January expiration contract would expire on the 5th of January and a February expiry contract would cease trading on the 5th of

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February. If the 5th of the expiry month is a trading holiday, the contracts shall expire on the previous trading day. New contracts will be introduced on the trading day following the expiry of the near month contract.

Margin Requirement
The Multi Commodity Exchange of India Ltd requires its members to deposit and maintain in their accounts a certain minimum amount of funds for each open position held. These funds are known as margin and represent a good faith deposit that serves to provide protection against losses in the market. The Clearinghouse collects margins directly from each of MCX clearing members who in turn are responsible for the collection of funds from their clients. Margin requirements and contract specifications are subject to change.

Types of Margins
Initial margin: The amount that must be deposited by a customer at the time of entering into a contract is called initial margin. This margin is meant to cover the largest potential loss in one day. The margin is a mandatory requirement for parties who are entering into the contract. Maintenance margin: A trader is entitled to withdraw any balance in the margin account in excess of the initial margin. To ensure that the balance in

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the margin account never becomes negative, a maintenance margin, which is somewhat lower than the initial margin, is set. If the balance in the margin account falls below the maintenance margin, the trader receives a margin call and is requested to deposit extra funds to bring it to the initial margin level within a very short period of time. The extra funds deposited are known as a variation margin. If the trader does not provide the variation margin, the broker closes out the position by offsetting the contract.

Margins for trading in futures

Margin is the deposit money that needs to be paid to buy or sell each contract. The margin required for a futures contract is better described as performance bond or good faith money. The margin levels are set by the exchanges based on volatility (market conditions) and can be changed at any time. The margin requirements for most futures contracts range from 2% to 15% of the value of the contract. In the futures market, there are different types of margins that a trader has to maintain.

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GOLD CONTRACT SPECIFICATIONS

Trading unit Quotation/Base Value Maximum order size Tick size (minimum price movement) Daily price limits 1 Kg (for gold mini-100 grams) 10 grams 10 Kg Re. 1 per 10 grams 2.5%

Price Quote - Ex-Mumbai (inclusive of all taxes and levies relating to import duty, customs and sales tax calculated @ 1% on landed cost but excluding any other additional tax or surcharge on sales tax, local taxes and octroi. Maximum Allowable - For individual client: 1 MT Open Position - For a member collectively for all clients: Not more than 25 % of the markets open position in Contract at any point of time Trading period - Mondays through Saturdays Trading session - Monday to Friday 1st session: 10 am to 5.00pm 2nd session: 5.30 pto11.55pm (with adjustment of 1 hour on the basis of time zone difference in winter and summer) Saturday: 10 am to 2.00pm

Margins
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Initial margin - 3.5 % Special Margin - In case of additional volatility, a special margin of 2 % or such other percentage, as deemed fit, will be imposed immediately on both buy and sale sides in respect of all outstanding position, which will remain in force for next 3 days, after which the special margin will be relaxed. Delivery period margin - 25 % of the value of the open position during the delivery period Delivery unit - 1 Kg Delivery center(s) Mumbai and Ahmedabad at designated Clearing House facilities of Group 4 Securities at these centers. Quality Specifications 995 purity - It should be serially numbered Gold bars supplied by LBMA approved suppliers or other suppliers as maybe approved by MCX to be submitted along with suppliers quality certificate. If the seller offers - Seller will get a proportionate Delivery of 999 purity premium and sale proceeds will be calculated in the manner of Rate of delivery* 999/ 995. If the quality is less than 995, it is rejected. Mode of communication - Fax or Courier USING COMMODITY FUTURE

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Hedging
Many participants in the commodity futures market are hedgers. They use the futures market to reduce a particular risk that they face. This risk might relate to the price of wheat or oil or any other commodity that the person deals in. The classic hedging example is that of wheat farmer who wants to hedge the risk of fluctuations in the price of wheat around the time that his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by locking in to a predetermined price. Hedging does not necessarily improve the financial outcome; it could make the outcome worse. What it does however is, that it makes the outcome more certain. Hedgers could be government institutions, private corporations like financial institutions, trading companies and even other participants in the value chain, for instance farmers, extractors, ginners, processors etc., who are influenced by the commodity prices.

Basic principles of hedging

When an individual or a company decides to use the futures markets to hedge a risk, the objective is to take a position that neutralizes the risk as much as possible. Take the case of a company that knows that it will gain Rs.1, 00,000 for each 1 rupee increase in the price of a commodity over the next three months and will lose Rs.1,00,000 for each 1 rupee decrease in the price of a commodity over the same period. To hedge, the company should take a short futures position that is designed to offset this risk. The futures position should lead to a loss of Rs.1,00,000 for each 1 rupee increase in the price of the commodity over the next three months and a gain of Rs.1,00,000 for each 1 rupee decrease in

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the price during this period. If the price of the commodity goes down, the gain on the futures position offsets the loss on the commodity. There are basically two kinds of hedges that can be taken. A company that wants to sell an asset at a particular time in the future can hedge by taking short futures position. This is called a short hedge. Similarly, a company that knows that it is due to buy an asset in the future can hedge by taking long futures position. This is known as long hedge.

Short hedge
A short hedge is a hedge that requires a short position in futures contracts. As we said, a short hedge is appropriate when the hedger already owns the asset, or is likely to own the asset and expects to sell it at some time in the future. For example, a short hedge could be used by a cotton farmer who expects the cotton crop to be ready for sale in the next two months. A short hedge can also be used when the asset is not owned at the moment but is likely to be owned in the future. For example, an exporter who knows that he receives a dollar payment three months later. He makes a gain if the dollar increases in value relative to the rupee and makes a loss if the dollar decreases in value relative to the rupee. A short futures position will give him the hedge he desires.

Long hedge
Long Hedging that involve taking a long position in a futures contract are known as long hedges. A long hedge is appropriate when a company knows

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it will have to purchase a certain asset in the future and wants to lock in a price now. Suppose that it is now January 15. A firm involved in industrial fabrication knows that it will require 300 kgs of silver on April 15 to meet a certain contract. The spot price of silver is Rs.1680 per kg and the April silver futures price is Rs.1730. A unit of trading is 5 Kgs. The fabricator can hedge his position by taking a long position in sixty units of futures on the MCX. If the fabricator closes his position on April 15, the effect of the strategy would be to lock in a price close to Rs.1730 per kg.

Speculation
An entity having an opinion on the price movements of a given commodity can speculate using the commodity market. While the basics of speculation apply to any market, speculating in commodities is not as simple as speculating on stocks in the financial market. For a speculator who thinks the shares of a given company will rise, it is easy to buy the shares and hold them for whatever duration he wants to. However, commodities are bulky products and come with all the costs and procedures of handling these products. The commodities futures markets provide speculators with an easy mechanism to speculate on the price of underlying commodities. To trade commodity futures on the MCX, a customer must open a futures trading account with a commodity derivatives broker. Buying futures simply involves putting in the margin money. This enables futures traders to take a position in the underlying commodity without having to actually hold that commodity. With the purchase of futures contract on a commodity, the
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holder essentially makes a legally binding promise or obligation to buy the underlying security at some point in the future (the expiration date of the contract).

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INSTRUMENTS AVAILABLE FOR TRADING In recent years, derivatives have become increasingly popular due to their applications for hedging, speculation and arbitrage. While futures and options are now actively traded on many exchanges, forward contracts are popular on the OTC market.

Forward contracts
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, the parties to the contract negotiate price and quantity bilaterally. The forward contracts are normally traded outside the exchanges. The salient features of forward contracts are: 1) They are bilateral contracts and hence exposed to counter party risk. 2) Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. 3) The contract price is generally not available in public domain. 4) On the expiration date, the contract has to be settled by delivery of the asset. 5) If the party wishes to reverse the contract, it has to compulsorily go to the same counter party, which often results in high prices being charged.

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However forward contracts in certain markets have become very standardized, as in the case of foreign exchange, thereby reducing transaction costs and increasing transactions volume. This process of standardization reaches its limit in the organized futures market. Forward contracts are very useful in hedging and speculation. The classic hedging application would be that of an exporter who expects to receive payment in dollars three months later. He is exposed to the risk of exchange rate fluctuations. By using the currency forward market to sell dollars forward, he can lock on to a rate today and reduce his uncertainty. Similarly an importer who is required to make a payment in dollars two months hence can reduce his exposure to exchange rate fluctuations by buying dollars forward. If a speculator has information or analysis, which forecasts an upturn in a price, then he can go long on the forward market instead of the cash market. The speculator would go long on the forward, wait for the price to rise, and then take a reversing transaction to book profits. Speculators may well be required to deposit a margin upfront. However, this is generally a relatively small proportion of the value of the assets underlying the forward contract. The use of forward markets here supplies leverage to the speculator.

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CHAPTER III

RELATED THEORY
Commodity Future Market Gold Profile

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INTRODUCTION TO COMMODITY FUTURES MARKET Commodities Futures trading is a class of Derivatives trading, in which futures contracts derive their value from the ruling price of underlying commodities. This is a mechanism by which participants can enter into transactions for purchase and sale of commodities at a price, where the performance of delivery and payment obligation becomes due on a future date. There are different classes of participants in this market having varied interests. Manufacturing companies participate in this market so as to ensure uninterrupted supply of raw material of guaranteed quality at a predetermined price, which facilitates immunity against any price fluctuation in such raw materials prices. Exporters participate in this market for purchasing futures contracts so as to procure materials from an organized market and also for the purpose of hedging against their overseas exposure. Similarly, importers' interest is to avail the facility of a liquid market for the purpose of hedging their outstanding position by way of selling futures contracts in this market. Dealers are associated with this market so as to avail the benefit of better price discovery mechanism for getting better price for their goods and also to estimate the future demand and price movement. Farmers are able to decide the specific crop pattern, which would give them the maximum profit by sowing those commodities, which are fetching highest prices in futures market. Last but not the least, speculators are involved in this market so as to take advantage of price fluctuation by way of planning their entry and exit in an efficient manner on the basis of
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technical analysis of the market behavior, demand and supply status and future estimates. Besides, a number of members do the business on behalf of their clients so as to earn handsome brokerage. The Commodity Exchange endeavors to serve the varied interests of all such participants effectively and transparently. Futures trading in commodities in India is governed by the provisions of the Forward Contracts (Regulation) Act, 1952. As per provisions of this Act, futures trading in commodities can be conducted only by such Commodity Exchanges, which have got recognition from the Forward Markets Commission (FMC) under Section 6 of the Forward Contracts (Regulation) Act and have got specific permission from FMC to launch futures trading in specified commodities.

Characteristics of futures trading:

A "Futures Contract is a highly standardized contract with certain distinct features. Some of the important features are as under: a. Futures trading is necessarily organized under the auspices of a market association so that such trading is confined to or conducted through members of the association in accordance with the procedure laid down in the Rules & Bye-laws of the association. b. It is invariably entered into for a standard variety known as the "basis variety" with permission to deliver other identified varieties known as "tenderable varieties".

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c. The units of price quotation and trading are fixed in these contracts, parties to the contracts not being capable of altering these units. d. The delivery periods are specified. e. The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other prespecified delivery centers. In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any physical delivery of goods taking place.

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ABOUT FORWARD MARKETS COMMISSION Forward Markets Commission (FMC) headquartered at Mumbai, is a regulatory authority which is overseen by the Ministry of Consumer Affairs and Public Distribution, Govt. of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952. " The Act provides that the Commission shall consist of not less than two but not exceeding four members appointed by the Central Government out of them being nominated by the Central Government to be the Chairman thereof. Currently Commission comprises four members among whom Shri S. Sundareshan, IAS, is the Chairman and Dr. Kewal Ram, IES, Dr. (Smt) Jayashree Gupta, CSS, and Shri Rajeev kumar Agarwal, IRS, are the Members of the Commission." The functions of the Forward Markets Commission are as follows: (a) To advise the Central Government in respect of the recognition or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of the Forward Contracts (Regulation) Act 1952. (b) To keep forward markets under observation and to take such action in relation to them, as it may consider necessary, in exercise of the powers assigned to it by or under the Act. (c) To collect and whenever the Commission thinks it necessary, to publish information regarding the trading conditions in respect of goods to which any of the provisions of the act is made applicable, including information

35

regarding supply, demand and prices, and to submit to the Central Government, periodical reports on the working of forward markets relating to such goods; (d) To make recommendations generally with a view to improving the organization and working of forward markets; (e) To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considerers it necessary.

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HISTORICAL BACKGROUND OF COMMODITY FUTURES Evolution of Futures Trading Organized futures market evolved in India by the setting up of "Bombay Cotton Trade Association Ltd." in 1875. In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name "Bombay Cotton Exchange Ltd." was constituted. Futures trading in oilseeds was organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut, castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab. Futures trading in Raw Jute and Jute Goods began in Calcutta with the establishment of the Calcutta Hessian Exchange Ltd., in 1919. Later East Indian Jute Association Ltd. was set up in 1927 for organizing futures trading in Raw Jute. These two associations amalgamated in 1945 to form the present East India Jute & Hessian Ltd., to conduct organized trading in both Raw Jute and Jute goods. In case of wheat, futures markets were in existence at several centers at Punjab and U.P. The most notable amongst them was the Chamber of Commerce at Hapur, which was established in 1913. Other markets were located at Amritsar, Moga, Ludhiana, Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda in Punjab and Muzaffarnagar, Chandausi, Meerut, Saharanpur, Hathras, Gaziabad, Sikenderabad and Barielly in U.P.

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Futures market in Bullion began at Mumbai in 1920 and later similar markets came up at Rajkot , Jaipur , Jamnagar , Kanpur, Delhi and Calcutta. In due course several other exchanges were also created in the country to trade in such diverse commodities as pepper, turmeric, potato, sugar and gur (jaggory). After independence, the Constitution of India brought the subject of "Stock Exchanges and futures markets" in the Union list. As a result, the responsibility for regulation of commodity futures markets devolved on Govt. of India. A Bill on forward contracts was referred to an expert committee headed by Prof. A. D. Shroff and Select Committees of two successive Parliaments and finally in December 1952 Forward Contracts (Regulation) Act, 1952, was enacted. The Act provided for 3-tier regulatory system; 1. 2. 3. An association recognized by the Government of India on the recommendation of Forward Markets Commission, The Forward Markets Commission (it was set up in September 1953) and The Central Government.

Forward Contracts (Regulation) Rules were notified by the Central Government in July 1954 The Act divides the commodities into 3 categories with reference to extent of regulation, viz: (a) The commodities in which futures trading can be organized under the auspices of recognized association.
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(b) The Commodities in which futures trading is prohibited. (c) Those commodities, which have neither been regulated for being traded under the recognized association nor prohibited, are referred as Free Commodities and the association organized in such free commodities is required to obtain the Certificate of Registration from the Forward Markets Commission. In the seventies, most of the registered associations became inactive, as futures as well as forward trading in the commodities for which they were registered came to be either suspended or prohibited altogether. The Khusro Committee (June 1980) had recommended reintroduction of futures trading in most of the major commodities, including cotton, kapas, raw jute and jute goods and suggested that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few markets in Punjab and Uttar Pradesh. After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalization in both the domestic and external sectors, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra. The Committee submitted its report in September 1994. The majority report of the Committee recommended that futures trading be introduced in:

39

1) Basmati Rice 2) Cotton and Kapas 3) Raw Jute and Jute Goods 4) Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower seed, copra and soybean, and oils and oilcakes of all of them. 5) Rice bran oil 6) Castor oil and its oilcake 7) Linseed 8) Silver and, The committee also recommended that some of the existing commodity exchanges particularly the ones in pepper and castor seed may be upgraded to the level of international futures markets. The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management.

40

INTRODUCTION TO DERIVATIVES
The origin of derivatives can be traced back to the need of farmers to protect them against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest, farmers would face price uncertainty. Through the use of simple derivative products, it was possible for the farmer to partially or fully transfer price risks by locking in asset prices. These were simple contracts developed to meet the needs of farmers and were basically a means of reducing risk. A farmer who sowed his crop in June faced uncertainty over the price he would receive for his harvest in September. In years of scarcity, he would probably obtain attractive prices. However during times of oversupply, he would have to dispose off his harvest at a very low price. Clearly this meant that the farmer and his family were exposed to a high risk of price uncertainty. On the other hand, a merchant with an ongoing requirement of grains too would face a price risk that of having to pay exorbitant prices during dearth, although favorable prices could be obtained during periods of oversupply. Under such circumstances, it clearly made sense for the farmer and the merchant to come together and enter into a contract whereby the price of the grain to be delivered in September could be decided earlier. What they would then negotiate happened to be a futures type contract, which would enable both parties to eliminate the price risk. In 1848, the Chicago Board of Trade, or CBOT, was established to bring farmers and Merchants together. A group of traders got together and created
41

the `ton arrive' contract that Permitted farmers to lock in to price upfront and deliver the grain later. These to-arrive contracts proved useful as a device for hedging and speculation on price changes. These were eventually standardized, and in 1925 the rest futures clearing house came into existence. Today, derivative contracts exist on a variety of commodities such as corn, pepper, cotton, Wheat, silver, etc. Besides commodities, derivatives contracts also exist on a lot of financial underlings like stocks, interest rate, exchange rate, etc.

Derivative Definition
A derivative is a product whose value derived from the value of one or more underlying variables or assets in a contract manner. The underlying asset can be equity, foreign exchange, commodity or any other asset. The wheat farmer may wish to sell their harvest at a future date to eliminate the risk of a change in price by that date. Such transaction is an example of a derivative. Derivative contracts are of different type. The most commons are forwards, futures, options and swaps.

Derivative Markets
Derivative markets can be broadly classified as commodity derivatives and financial derivatives market. Commodity derivatives market trade contracts for which the underlying assets is commodity. It can be an agricultural commodity like wheat, soybeans, cotton etc., precious metals like gold, silver etc. Financial derivative markets trade contracts that have a financial

42

asset or variable as the underlying. The most popular financial derivatives are those, which have equity, interest rates and exchange rates as the underlying. The most commonly used derivatives contracts are forwards, futures and options.

Difference between commodity and financial derivatives

The basic concept of a derivative contract remains the same whether the underlying happens to be a commodity or a financial asset. However there are some features, which are very peculiar to commodity derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Even in the case of physical settlement, financial assets are not bulky and do not need special facility for storage. Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. Similarly, the concept of varying quality of asset does not really exist as far as financial underlying are concerned. However in the case of commodities, the quality of the asset underlying a contract can vary largely. This becomes an important issue to be managed. We have a brief look at these issues.

Commodity
Commodity includes all kinds of goods. FCRA defines goods as every kind of movable property other than actionable claims, money and securities. Futures trading is organized in such goods or commodities as are permitted by central Government. At present, all goods and products of agricultural, minerals and fossil origin are allowed for future trading under the auspices of the commodity exchange organized under the FCRA. The

43

national commodity exchange have been recognized by the central Government for organizing trading in all permissible commodities which includes precious (gold and silver) and non-ferrous metals, cereals and pulses, ginned and unlined cotton, oilseeds, raw jute and jute goods, sugar and gur, potatoes and onions, etc.

Commodity Derivative
Derivative as a tool for managing risk first organized in the commodities markets. They were then found useful as a hedging toll in financial market as well. In India trading in commodity futures has been in existence from the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. Over a period of time, other commodities were permitted to be traded in futures exchanges. Regulatory constraints in 1960s resulted in virtual dismantling of the commodities future markets. It is only in the last decade that commodity future exchanges have been actively encouraged. However the markets have been thin with poor liquidity that has not grown to any significant level.

The Kabra committee report

After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalization in both the domestic and external sectors, the Government of India appointed in June 1993 a committee on Forward Markets under chairmanship of Prof. K.N. Kabra. The committee was setup with the following objectives:

44

1. To assess (a) The working of the commodity exchanges and their trading practices in India and to make suitable recommendations with a view to making them compatible with those of other countries. (b) The role of the Forward Markets Commission and to make suitable recommendations with a view to making it compatible with similar regulatory agencies in other countries so as to see how effectively these agencies can cope up with the reality of the fast changing economic scenario. 2. To review the role that forward trading has played in the Indian commodity markets during the last 10 years. 3. To examine the extent to which forward trading has special role to play in promoting exports. 4. To suggest amendments to the Forward Contracts (Regulation) Act, in the light of the recommendations, particularly with a view to effective enforcement of the Act to check illegal forward trading when such trading is prohibited under the Act. 5. To suggest measures to ensure that forward trading in the commodities in which it is allowed to be operative remains constructive and helps in maintaining prices within reasonable limits. 6. To assess the role that forward trading can play in marketing/ distribution system in the commodities in which forward trading is possible, particularly in commodities in which resumption of forward trading is generally demanded.
45

ECONOMIC BENEFITS OF THE FUTURES TRADING AND ITS PROSPECTS

Futures contracts perform two important functions of price discovery and price risk management with reference to the given commodity. It is useful to all segments of economy. It is useful to producer because he can get an idea of the price likely to prevail at a future point of time and therefore can decide between various competing commodities, the best that suits him. It enables the consumer get an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and also cover his purchases by making forward contracts. The futures trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market. Other benefits of futures trading are: (i) A Price stabilization-in time of violent price fluctuations - this mechanism dampens the peaks and lifts up the valleys i.e. the amplititude of price variation is reduced. (ii) (iii) (iv) (v) Leads to integrated price structure throughout the country. Facilitates lengthy and complex, production and manufacturing activities. Helps balance in supply and demand position throughout the year. Encourages competition and acts as a price barometer to farmers and other trade functionaries.

46

Futures trading is also capable of being misused by unscrupulous speculators. In order to safeguard against uncontrolled speculation certain regulatory measures are introduced from time to time. They are:
a. Limit on open position of an individual operator to prevent over

trading;
b. Limit on price fluctuation (daily/weekly) to prevent abrupt upswing or

downswing in prices;
c. Special margin deposits to be collected on outstanding purchases or

sales to curb excessive speculative activity through financial restraints;

d. Minimum/maximum prices to be prescribed to prevent future prices

from falling below the levels that are un remunerative and from rising above the levels not warranted by genuine supply and demand factors. During shortages, extreme steps like skipping trading in certain deliveries of the contract, closing the markets for a specified period and even closing out the contract to overcome emergency situations are taken.

Prospects
With the gradual withdrawal of the government from various sectors in the post-liberalization era, the need has been felt that various operators in the commodities market be provided with a mechanism to hedge and transfer their risks. India's obligation under WTO to open agriculture sector to world trade would require futures trade in a wide variety of primary commodities and their products to enable diverse market functionaries to cope with the price volatility prevailing in the world markets.

47

INTRODUCTION TO FUTURES
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. The standardized items in a futures contract are: 1) Quantity of the underlying 2) Quality of the underlying 3) The date and the month of delivery 4) The units of price quotation and minimum price change 5) Location of settlement

48

FUTURES TERMINOLOGY
1)

Spot price: The price at which an asset trades in the spot market.

2)

Futures price: The price at which the futures contract trades in the futures market.

3)

Contract cycle: The period over which a contract trades. The commodity futures contracts on the MCX have one month, two months and three months expiry cycles, which expire on the 20th or 5th day of the delivery month. Thus a January expiration contract expires on the 5th of January and a February expiration contract ceases trading on the 5th of February. On the next trading day following the 5th, a new contract having a one month or two months expiry is introduced for trading.

4)

Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.

5)

Delivery unit: The amount of asset that has to be delivered less than one contract. For instance, the delivery unit for futures on Long Staple Cotton on the NCDEX is 55 bales. The delivery unit for the Gold futures contract is 1 kg.

49

6)

Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

7)

Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

8)

Marking-to-market (MTM): In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking to market.

9)

Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.

50

Basic payoffs
A payoff is the likely profit/ loss that would accrue to a market participant with change in the price of the underlying asset. This is generally depicted in the form of payoff diagrams that show the price of the underlying asset on the X-axis and the profits/ losses on the Y-axis.

1 Payoff for buyer of Future: Long asset.

In this basic position, an investor buys the underlying asset, gold for instance, for Rs.9000 per 10 gms, and sells it at a future date at an unknown price, Once it is purchased, the investor is said to be long the asset. Figure shows the payoff for a long position on gold.

Profit

8500 Loss

9000

9500

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2) Payoff for seller of Future: Short asset

In this basic position, an investor shorts the underlying asset, cotton for instance, for Rs.6500 per Quintal, and buys it back at a future date at an unknown price, once it is sold, the investor is said to be short the asset. Figure shows the payoff for a short position on cotton.

Profit

6000

6500

7000

Loss

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CLEARING MECHANISM
Only clearing members including professional clearing members (PCMs) are entitled to clear and settle contracts through the clearinghouse. The clearing mechanism essentially involves working out open positions and obligations of clearing members. This position is considered for exposure and daily margin purposes. The open positions of PCMs are arrived at by aggregating the open positions of all the TCMs clearing through him, in contracts in which they have traded. A TCM's open position is arrived at by the summation of his clients' open positions, in the contracts in which they have traded. Client positions are netted at the level of individual client and grossed across all clients, at the member level without any setoffs between clients. Proprietary positions are netted at member level At MCX, after the trading hours on the expiry date, based on the available information, the matching for deliveries takes place firstly, on the basis of locations and then randomly, keeping in view the factors such as available capacity of the vault/ warehouse, commodities already deposited and dematerialized and offered for delivery etc. Matching done by this process is binding on the clearing members. After completion of the matching process, clearing members are informed of the deliverable/ receivable positions and the unmatched positions. Unmatched positions have to be settled in cash. The cash settlement is only for the incremental gain/ loss as determined on the basis of Final settlement price.

Settlement
Futures contracts have two types of settlements, the MTM settlement, which happens on a continuous basis at the end of each day, and the final

53

settlement, which happens on the last trading day of the futures contract. On the MCX, daily MTM settlement and final MTM settlement in respect of admitted deals in futures contracts are cash settled by debiting/ crediting the clearing accounts of CMs with the respective clearing bank. All positions of a CM, brought forward, created during the day or closed out during the day, are marked to market at the daily settlement price or the final settlement price at the close of trading hours on a day. 1) Daily settlement price: Daily settlement price is the consensus closing price as arrived after closing session of the relevant futures contract for the trading day. However, in the absence of trading for a contract during closing session, daily settlement price is computed as per the methods prescribed by the exchange from time to time. 2) Final settlement price: Final settlement price is the closing price of the underlying commodity on the last trading day of the futures contract. All open positions in a futures contract cease to exist after its expiration day. Settlement of commodity futures contracts is a little different from settlement of financial futures that are mostly cash settled. The possibility of physical settlement makes the process a little more complicated.

Daily mark to market settlement

Daily mark to market settlement is done till the date of the contract expiry. This is done to take care of daily price fluctuations for all trades. All the open positions of the members are marked to market at the end of the day and the profit/ loss is determined as below:

54

1) On the day of entering into the contract, it is the difference between the entry value and daily settlement price for that day.
2) On any intervening days, when the member holds an open position, it

is the difference between the daily settlement price for that day and the previous day's settlement price.

55

GOLD PROFILE 1. Introduction

Gold is a unique asset based on few basic characteristics. First, it is primarily a monetary asset and partly a commodity. As much as two thirds of golds total accumulated holdings relate to store of value considerations. Holdings in this category include the central bank reserves, private investments, and high-caratage jewelry bought primarily in developing countries as a vehicle for savings. Thus, gold is primarily a monetary asset. Less than one third of golds total accumulated holdings can be considered a commodity, the jewelry bought in Western markets for adornment, and gold used in industry. The distinction between gold and commodities is important. Gold has maintained its value in after-inflation terms over the long run, while commodities have declined. Some analysts like to think of gold as a currency without a country. It is an internationally recognized asset that is not dependent upon any governments promise to pay. This is an important feature when comparing gold to conventional diversifiers like T-bills or bonds, which unlike gold do have counter-party risk.

WHAT MAKES GOLD SPECIAL?

Timeless and Very Timely Investment: For thousands of years, gold has been prized for its rarity, its beauty, and above all, for its unique characteristics as a store of value. Nations may rise

56

and fall, currencies come and go, but gold endures. In todays uncertain climate, many investors turn to gold because it is an important and secure asset that can be tapped at any time, under virtually any circumstances. But there is another side to gold that is equally important, and that is its day-today performance as a stabilizing influence for investment portfolios. These advantages are currently attracting considerable attention from financial professionals and sophisticated investors worldwide. Gold is an effective diversifier: Diversification helps protect your portfolio against fluctuations in the value of any one-asset class. Gold is an ideal diversifier, because the economic forces that determine the price of gold are different from, and in many cases opposed to, the forces that influence most financial assets. Gold is the ideal gift: In many cultures, gold serves as a family treasure or a wealth transfer vehicle that is passed on from generation to generation. Gold bullion coins make excellent gifts for birthdays, graduations, weddings, holidays and other occasions. They are appreciated as much for their intrinsic value as for their mystical appeal and beauty. And because gold is available in a wide range of sizes and denominations, you dont need to be wealthy to give the gift of gold. Gold is highly liquid: Gold can be readily bought or sold 24 hours a day, in large denominations and at narrow spreads. This cannot be said of most other investments, including stocks of the worlds largest corporations. Gold is also more liquid
57

than many alternative assets such as venture capital, real estate, and timberland. Gold proved to be the most effective means of raising cash during the 1987 stock market crash, and again during the 1997/98 Asian debt crisis. So holding a portion of your portfolio in gold can be invaluable in moments when cash is essential, whether for margin calls or other needs. Gold responds when you need it most: Recent independent studies have revealed that traditional diversifiers often fall during times of market stress or instability. On these occasions, most asset classes (including traditional diversifiers such as bonds and alternative assets) all move together in the same direction. There is no cushioning effect of a diversified portfolio leaving investors disappointed. However, a small allocation of gold has been proven to significantly improve the consistency of portfolio performance, during both stable and unstable financial periods. Greater consistency of performance leads to desirable outcome an investor whose expectations are met. Gold as Investment Vehicle Gold is valued in India as a savings and investment vehicle and is the second preferred investment behind bank deposits. India is the worlds largest consumer of gold in jewellery (much of which is purchased as investment). Gold Futures in India The Indian gold market has always been linked to international gold market in view of large requirements of imported gold. Given the inevitable integration between the global and local gold markets, there is considerable

58

merit in following the global practice of integration of gold markets with financial markets and introducing forward trading. Uncontrolled and uncertain supply Besides new mining supply, the available supply of gold in the market is made up of three major above-ground sources. In recent years, the growth in gold supply has come from these aboveground sources. a. Reclaimed scrap, or gold reclaimed from jewelry and other industries such as electronics and dentistry; b. Official, or central bank, sales c. Gold loans made to the market from official gold reserves for borrowing and lending purposes. Following the growing pattern of liberalization of the gold trade since the early 1990's the local markets and exchanges of countries like India and Turkey can flourish legitimately. Consequently the pattern of gold flows from mine to end-user, whether in jewellery, industry or investment, is more direct. This pattern has also been influenced by growing gold production, particularly in Australia and the United States, which are now major sources of supply for Asian markets. World gold output rose from only 1,311 tons in 1980 to 2,604 tons in 2001, i.e. almost double. In 1993 the Indian government permitted non-resident Indians to bring 5kg of gold into the country twice yearly on the payment of import tax of Rs. 250 per 10 grammes (at current rates this equates to US$14.56/ounce or 4.2%). The allowance was raised to 10 kg per trip in January 1997.
59

1997 Open General License (OGL) was introduced in India, paving the way for substantial direct imports by local banks from the international market for sale or loan to jewelers and exporters, thus partly eliminating the regional supplies from Dubai, Singapore and Hong Kong. At present, 13 banks are active in the import of gold. The quantum of gold imported through these banks has been in the range of 500 tons per year. Gold consumers are very aware of its price movements and very sensitive to them. Gold is sold in times of financial need but holders frequently take profits and sell gold back to the market if the price rises. Thus the supply of scrap gold normally automatically rises if the gold price rises. Even gold used for industrial purposes such as electrical contacts in electronic equipment is frequently recovered as scrap and a rise in the gold price increases the incentive for such recovery.

Likely Benefits from Gold Futures

Development of gold futures would help in efficient price discovery and emergence of healthy and transparent practices in the market. The basic framework for such an exchange already exists with 13 banks active in import of precious metals. Five of them have launched the Gold Deposit Scheme also. They can also enter into forward contracts in a limited way. To begin with the banks can start trading among themselves and then with MMTC, STC and also with big traders according to the demand/supply dynamics. The demand driven gold market of India may well become the dictator of gold prices over a period of a few years displacing the supplier driven
60

international market. Futures trading will facilitate to bring down hoarding demand and help in bringing the idle gold into the market/official pool (mobilize domestic gold) or permit their use as a financial asset in the banking sector.

Gold Jewelry
From the first discoveries of gold in ancient times, its beauty and the ease with which it could be worked inspired craftsmen to create it into ornaments, not just for adornment, but as symbols of wealth and power. Today, gold jewellery is more a mass- market product, although in many countries still treasured as a basic form of saving. Jewellery fabrication is the crucial cornerstone of the gold market, annually consuming all gold that is newly mined. Pure gold is used in those parts of the world where jewellery is purchased as much for investment as it is for adornment, but it tends to be vulnerable to scratching. Elsewhere, it is usually mixed, or alloyed, with other metals. Not only do they harden it, but influence the colour; white shades are achieved by alloying gold with silver, nickel or palladium; red alloys contain mainly copper. A harder alloy is made by adding nickel or a tiny percentage of titanium.

International Gold Exchanges

The major exchanges for gold forward trading are the COMEX division of the New York Mercantile Exchange, Chicago Board of Trade, Hong Kong Gold and Silver Exchange.

61

At the Chicago Board of Trade, Futures contract is of 33.2 fine troy ounces of gold, no less than 0.995 fine contained in no more than one bar. Variations in the quantity of the delivery unit is not allowed in excess of 10% of 33.2 fine troy ounces. All gold is required to be certified as to fineness and weight by an Exchange approved refiner or assayer. The trading Unit of gold is 100 troy ounces at New York Mercantile Exchange. (5%) of refined gold, assaying not less than .995 fineness, cast either in one bar or in three one-kilogram bars, and bearing a serial number and identifying stamp of a refiner approved and listed by the Exchange.

Indian Gold Market

Gold is valued in India as a savings and investment vehicle and is the second preferred investment after bank deposits. India is the world.s largest consumer of gold in jewellery as investment. In July 1997 the RBI authorized the commercial banks to import gold for ale or loan to jewellers and exporters. At present, 13 banks are active in the import of gold. This reduced the disparity between international and domestic prices of gold rom 57 percent during 1986 to 1991 to 8.5 percent in 2001. The gold hoarding tendency is well ingrained in Indian society. Domestic consumption is dictated by monsoon, harvest and marriage season. Indian jewellery off take is sensitive to price increases and even more so to volatility.

62

In the cities gold is facing competition from the stock market and a wide range of consumer goods. Facilities for refining, assaying, making them into standard bars in India, as compared to the rest of the world, are insignificant, both qualitatively and quantitatively.

63

FIFTEEN FUNDAMENTAL REASONS FOR BULLISH RUN OF GOLD 1. Global Currency Debasement:
The US dollar is fundamentally & technically very weak and should fall dramatically. However, other countries are very reluctant to see their currencies appreciate and are resisting the fall of the US dollar. Thus, we are in the early stages of a massive global currency debasement, which will see tangibles, and most particularly gold, rise significantly in price.

2. Investment Demand for Gold is Accelerating:

When the crowd recognizes what is unfolding, they will seek an alternative to paper currencies and financial assets and this will create an enormous investment demand for gold. To facilitate this demand, a number of new vehicles like Central Gold Trust and gold Exchange Traded Funds (Elf's) are being created.

3. Alarming Financial Deterioration in the US:

In the space of two years, the federal government budget surplus has been transformed into a yawning deficit, which will persist as far as the eye can see. At the same time, the current account deficit has reached levels, which have portended currency collapse in virtually every other instance in history.

64

4. Negative Real Interest Rates in Reserve Currency (US dollar):

To combat the deteriorating financial conditions in the US, interest rates have been dropped to rock bottom levels, real interest rates are now negative and, according to statements from the Fed spokesmen, are expected to remain so for some time. There has been a very strong historical relationship between negative real interest rates and stronger gold prices.

5. Dramatic Increases in Money Supply in the US and Other Nations:

US authorities are terrified about the prospects for deflation given the unprecedented debt burden at all levels of society in the US. Fed Governor Ben Bernanke is on record as saying the Fed has a printing press and will use it to combat deflation if necessary. Other nations are following in the US's footsteps and global money supply is accelerating. This is very gold friendly.

6. Existence of a Huge and Growing Gap between Mine Supply and Traditional Demand:
Gold mine supply is roughly 2500 tones per annum and traditional demand (jewellery, industrial users, etc.) has exceeded this by a considerable margin for a number of years. Some of this gap has been filled by recycled scrap but central bank gold has been the primary source of above ground supply.

65

7. Mine Supply is anticipated to Decline in the next Three to Four Years:

Even if traditional demand continues to erode due to ongoing worldwide economic weakness, the supply demand imbalance is expected to persist due to a decline in mine supply. Mine supply will contract in the next several years, irrespective of gold prices, due to a dearth of exploration in the post Bre-X era, a shift away from high grading which was necessary for survival in the sub-economic gold price environment of the past five years and the natural exhaustion of existing mines.

8. Large Short Positions:

To fill the gap between mine supply and demand, central bank gold has been mobilized primarily through the leasing mechanism, which facilitated producer hedging and financial speculation. Strong evidence suggests that between 10,000 and 16,000 tones (30- 50% of all central bank gold) is currently in the market. This is owed to the central banks by the bullion banks, which are the counter party in the transactions.

9. Low Interest Rates Discourage Hedging:

Rates are low and falling. With low rates, there isn't sufficient contain go to create higher prices in the out years. Thus there is little incentive to hedge, and gold producers are not only hedging, they are reducing their existing hedge positions, thus removing gold from the market.

66

10. Rising Gold Prices and Low Interest Rates Discourage Financial Speculation on the Short Side:
When gold prices were continuously falling and financial speculators could access central bank gold at a minimal leasing rate (0.5 - 1% per annum), sell it and reinvest the proceeds in a high yielding bond or Treasury bill, the trade was viewed as a lay up. Everyone did it and now there are numerous stale short positions. However, these trades now make no sense with a rising gold price and declining interest rates.

11. The Central Banks are Nearing an Inflection Point when they will be Reluctant to Provide more Gold to the Market:
The central banks have supplied too much already via the leasing mechanism. In addition, Far Eastern central banks who are accumulating enormous quantities of US dollars are rumored to be buyers of gold to diversify away from the US dollar.

12. Gold is Increasing in Popularity:

Gold is seen in a much more positive light in countries beginning to come to the forefront on the world scene. Prominent developing countries such as China, India and Russia have been accumulating gold. In fact, China with its 1.3 billion people recently established a National Gold Exchange and relaxed control over the asset. Demand in China is expected to rise sharply and could reach 500 tones in the next few years.

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13. Gold as Money is Gaining Credence:

Islamic nations are investigating a currency backed by gold (the Gold Dinar), the new President of Argentina proposed, during his campaign, a gold backed peso as an antidote for the financial catastrophe which his country has experienced and Russia is talking about a fully convertible currency with gold backing.

14. Rising Geopolitical Tensions:

The deteriorating conditions in the Middle East, the US occupation of Iraq, the nuclear ambitions of North Korea and the growing conflict between the US and China due to China's refusal to allow its currency to appreciate against the US dollar headline the geopolitical issues, which could explode at anytime. A fearful public has a tendency to gravitate towards gold.

15. Limited Size of the Total Gold Market Provides Tremendous Leverage:
All the physical gold in existence is worth somewhat more than $1 trillion US dollars while the value of all the publicly traded gold companies in the world is less than $100 billion US dollars. When the fundamentals ultimately encourage a strong flow of capital towards gold and gold equities, the trillions upon trillions worth of paper money could propel both to unfathomably high levels.

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GOLD IMPORT SCENARIO IN INDIA

INTERPRETATION As per above graph, India is worlds largest consumer for the gold India importing almost 600 mt gold each year, As compared to USA import of gold, India importing more than 200 mt gold. India has large consumer base for gold and India is biggest jewelry exporter. .

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CHAPTER IV

DATA ANALYSIS AND INTERPRETATION

70

SURVEY RESULT
For understanding investors point of view on various parameters such as factors influencing the prices of Gold and outlook of Gold future prices. I have conducted a survey of 100 investors in Nashik on the base of questionnaire. The result of survey is as follows_ 1. OTHER COMMODITY INVESTMENTS ALONG WITH GOLD Silver Other Metals Energy Agri- Commodities 22 19 12 47

22% Silver Other Metals Energy Agri Commodities

47% 19% 12%

Interpretation:- Along with the Gold investors invests in silver, 19 investors invests in other metals that is zinc and copper, 12 people invest in crud oil and natural gas, 47 people invests in agricultural commodities.

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2. FACTORS INFLUENCING THE GOLD PRICES

Demand & Supply US $ Interest Rates Stock market Returns Agricultural output Producer/ Miner Hedging interest 35 10 8 16 22 9

9%

35% 22%

Demand & Supply US $ Interest Rates Stock market Returns Agricultural output

16% 8%

10%

Producer/ Miner Hedging interest

Interpretation: - 35 investors feel that Gold prices are mostly affected by Demand and supply situation, 10 percent investors feel that rise and fall in US dollar and fluctuation in crud oil prices, 8 percent people says that the recent changes in interest rates by Federal bank have cause for fluctuation in
72

gold prices. 16 percent people who invests in both stock market and commodity market says about inverse relationship in stock market performance and Gold prices.22percent people says about the agricultural output, and 9 percent says Gold producer interest.

3. VOLATILITY OF GOLD PRICES DURING A YEAR

Jan-Mar Apr-June July-Sept Oct-Dec 13 55 10 22

Gold Price Volatality in Months

55 50
NO OF INVESTORS

40 30 20 10 0 Jan-Mar Apr-June
MONTHS

22 13 10

July-Sept

Oct-Dec

Interpretation: - 55 percent people feel that April-June is marriage season in India tremendous activities is seen in buying and selling of gold leading to the price volatility, as per 22 percent said that because of festivals in the month of Oct-Dec the prices are volatile.

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4. TRADING ON DELIVERY OR NON-DELIVERY BASE

Yes No

3 97

Yes 3%

Yes

No

No 97%

Interpretation:- As per chart only 3 percent people take delivery and 97 percent people not taking delivery, it shows that 97 percent people are speculators.

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5. RANGE OF YOUR INVESTMENT MARGIN

20 49 21 10

7000-25000 25000-50000 50000-100000 Above 100000

FOR BOTH MINI GOLD AND GOLD

60 50 40 30 20 10 0 7000-25000 25000-50000 50000-100000 Above 100000 Investment Margin in Rs.

Interpretation:- Most of the investors are speculators so they play in mini gold because margin for mini gold is affordable for common investor. As per survey 20 percent people have margin range between 7000-25000, and there are very few who invests more than Rs 100000 in gold trading.

NO OF INVESTORS

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6. EXPESTED RETURN ON INVESTMENT

1%- 3% 4%-5% Above 5%

22 62 16

Expected Monthly Return on investment

70 60 50 40 30 20 10 0 1%- 3% 4%-5% Above 5% 22 16 62

Interpretation; - People are more interested in profit making through Gold trading as per my survey, 62 percent people expecting 4 to 5 percent and 22 percent people expects 1 to 3 percent returns and 16 percent people expects return above 5 percent on their investment.

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7. FACTORS CONSIDERED BEFORE INVESTMENT

24 36 21 19

Macro Economic Factors Current Market trends Technical Analysis Stock Market Returns

19%

24%
Macro Economic Factors Current Market trends

Technical Analysis

21%
Stock Market Returns

36%

Interpretation:- 24 percent investors said they consider macro economic factors such as crude oil price, interest rates. 36 percent investors follows current market trends, 21 percent people use technical analysis. 19 percent investors consider stock market performance before investment.

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8. OUTLOOK FOR FUTURE GOLD PRICES

13 23 40 24

8200-9000 9000-9500 9500-10000 Above 10000

40 35 NO OF INVESTORS 30 25 20 15 10 5 0 8200-9000 9000-9500 13 23

40

24

9500-10000

Above 10000

EXPECTED GOLD PRICE

Interpretation: - 13 percent people said there would be bearish trend for gold in future. 23 percent people opined gold would stay between ranges of 9000-9500 ranges. 40 percent said that gold would be range bound between 9500-10000. 24 percent investors were bullish to opine that Gold will cross 10000 in future.

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TECHNICAL ANALYSIS
Analysis Of Price Movement Gold Future In NYMEX And MCX During The Month Of July06. Exchange-nymex,Commodity-Gold,Contract-August2006,Unit-US Dollar/Ounce

Exchange-MCX,Commodity-Gold,Contract-August 2006,Unit-Rupees/10 Gram

INTERPRETATION

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The graphs showing the price movements of Gold in New York metal exchange and the Multi Commodity, for the month of July and August. From the 3rd of July to 15th price of gold in NYMEX rising from the level of $620 to $670, similarly in MCX also price from 1st July to 15th July is continually rising up to Rs 10100 level. On YM-MEX there is some correction in the Gold price up to $ 620 level and it is clearly shows that the MCX also having correction up to 9200 level. From the 1st August both market found good support price and started rising. On 21st of July the MCX found a good support of 9500 level so there is less chances for correction in next future because the market is also showing upward trend so there is good opportunity for investing in gold in MCX.

Analysis Of Price Movement Gold Future In NYMEX And MCX During The Month Of Jun06. Exchange-nymex,Commodity-Gold,Contract-June
80

2006,Unit-US

Dollar/Ounce

Exchange-MCX,Commodity-Gold,Contract-June Gram

2006,Unit-Rupees/10

INTERPRETATION: From the above two graphs it shows that the prices of gold in New York Mercantile Exchange and the Multi Commodity Exchange India are moving in same direction.

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On the 1st of May the price of Gold in NY-MEX was around $ 650 per ounce, and in India the price was around Rs 9700 per 10 grm. From the 1st of May it is clearly shows that the prices are rising day by day in both the exchanges, on 11th of May the Gold prices started declining on the NY-MEX and the same time on MCX also prices started decline on NYMEX till 20th of May. From 21st of May there is some ups and downs on NYMEX, similarly it shows in MCX also. On NYMEX the prices of Gold are continually decline till the 31st of May and the same impact is shows on MCX also, so it is clearly shows that price movements on MCX is depends on the price changes in NY-MEX.

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CHAPTER V

KEY FINDINGS AND CONCLUSION

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FINDINGS
Futures contracts perform two important functions: price

discovery and hedging of price risk in a commodity. Gold Future play major role in determining prices of gold Investors have recognized the opportunities in gold trading Given the Geo-political uncertainties, falling Stock Markets,

Bubble in the real estate prices, gold certainly offers safe investment avenue for the long term. Commodity Future Market has been introduced for the purpose

of hedging but there are more speculators than hedgers The prices of gold future in Multi Commodity Exchange of

India have been greatly affected by price movement in New York Mercantile Exchange.

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CONCLUSION
Multi Commodity Exchange is a mechanism by which participants can enter into transactions for purchase and sale of commodities at a price, where the performance of delivery and payment obligation becomes due on a future date. Commodity markets are of great help not only for their participants but also for the economy as a whole. Despite a long history, the commodity markets in India are still in their initial stages of development. Commodity markets have a huge potential in the Indian context particularly because of the Agri-based economy. With the recent boom in commodities markets, Indian participants are gearing up for exploiting the potential opportunities in the future. Investors refer to keep gold future on their portfolio because gold prices having less price volatility as compared to shares and other financial instruments. According to survey and current gold prices scenario on NYMEX and MCX it is shows that, there is good opportunity for investors to invest in gold future

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CHAPTER VI

REFERENCES

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REFERENCES

BOOKS AND REPORTS 1. NSEs commodity market (study material) 2. Commodity market, ICFAI publication.
3. Angel brokings weekly Review

WEBSITES 1. www. Mcxindia.com 2. www. Karvy.com 3. www.angelbroking.com

4. www.commodityindia.com

5. www.bulliiondesk.com 6. www.nymex.com

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CHAPTER VI

ANNEXURE
Questionnaire BHAV COPY (price chart)

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Name: Contact No.

Qualification: Occupation:

1) Along with the gold in which commodity do you invest? 2) According to you which factors influence the price of GOLD? 3) In which month of a year the gold prices are more volatile? 4) What is base of your investment? a) Delivery base b) Non- delivery base

5) What is the range of your investment amount as margin?

a) 7000-25000 b) 25001-50000 c) 50001-100000 d) Above 100000

6) How much monthly return do you expect on your investment? a) 1- 3% b) 4-5% c) Above 5%

7) Which factor do you consider before investment? 8) What is your expectation for Gold Future prices? a) 8200-9000 b) 9001-9500 c) 9501-10000 d) Above 10000

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