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Causal Relationship between Stock Market Indices and Gold Price: Evidence
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 Causal Relationship Between Stock Market
Indices and Gold Price: Evidence from India
Samveg A Patel*

This paper investigates the causal relationship between stock market indices and gold price in India. The monthly time
series data for Mumbai gold prices and three stock market indices, viz., Sensex, BSE 100 and S&P CNX Nifty, are
used for the period January 1991 to December 2011. By applying Augmented Dickey-Fuller unit root test, Johansen
cointegration test and Granger causality test in Error Correction Model framework, the study concludes that all series
are I(1)and there exists a long-run equilibrium relation between all the variables. The study also provides evidence
that the Granger causality runs from gold price to Nifty only. Hence, gold price contains some significant information
to forecast Nifty return.

Introduction
Stock market plays an important role in the development of an economy. It facilitates
mobilization of funds across the economy—from surplus units to deficit units. The escalation
in stock market is important from both industry as well as investors’ point of view. The
economic position of a country can be judged by the performance of its stock market. An
economic downturn escorts stock market towards collapse, and therefore, the government
closely monitors the movements in the stock market. The stock market indices are mainly
affected by the changes in the fundamentals of the economy. As India is a developing country,
many researchers have tried to find out the effect of macroeconomic variables on the Indian
stock market in the last few decades.1
There are two different views on the relationship between gold demand and income. The
classical theory argues that there exists a positive relationship between gold price and real
income, while Keynesian theory argues that more demand means more economic backwardness
hence low income, which indicates an inverse relationship. India and China are the major
gold purchasers in the world. In the last 10 years, Indian population has increased by 12%,
while the demand for Indian gold has increased by 13%. According to the World Gold Council
(WGC), Indians own more than 18,000 tons of gold, which represents 11% of the global
stock and is the largest in the world. And this stock is expected to grow over the next decade.
Indians roughly save 30% of their income, which is one of the highest in the world, and of
this 10% is invested in gold. Researchers have shown that gold as a strategic investment
* Faculty Member, S K Patel Institute of Management and Computer Studies, Sector 23, Nr. GH-6 Circle,
Gandhinagar, Gujarat, India. E-mail: samveg26@gmail.com

1
The studies have identified the following factors affecting share prices: earnings per share, foreign exchange rate,
employment rates, interest rates, inflation, gross domestic product, geopolitical events, commodity prices like
gold and silver, etc.

© 2013Relationship
Causal IUP. All Rights Reserved.
Between Stock Market Indices and Gold Price: Evidence from India 99
avenue can act as a hedge against inflation and exchange rate. Gold is the most liquid asset in
India. It is one of the means for accumulation of wealth (WGC, 2010). Against this backdrop,
this study focuses on the causal relationship between stock market indices and gold price.

Literature Review
Literature related to this study is divided into two parts. The first part focuses on the factors
affecting the stock market and gold price. And, the second part reviews the findings on the
relationship between stock market indices and gold prices.

Factors Affecting Stock Market Indices and Gold Price

Abdalla and Murinde (1997) found causality running from exchange rates to stock market
indices, except for the Philippines. Patel (2012) found that long-run equilibrium relationship
exists among gold price, other macroeconomic variables and Indian stock market indices.
Naka et al. (1999) found that long-term equilibrium relationship exists among Industrial
Production Index (IPI), inflation, money stock, interest rate and the Indian stock market.
Ray and Vani (2004) observed that interest rate, output, money supply, inflation rate and the
exchange rate had considerable influence on the stock market movement. Padhan (2007)
found that both the stock price and IPI are cointegrated, and bidirectional causality exists
between them. Agrawalla and Tuteja (2007) established that stable long-run equilibrium
relationship exists between stock market developments and economic growth in India. Ahmed
(2008) concluded that stock prices in India lead economic activity, except movement in
interest rate. Srivastava (2010) concluded that in the long term, stock market is more affected
by domestic macroeconomic factors like industrial production, wholesale price index and
interest rate than global factors. Agrawal and Srivastava (2011) found a bidirectional causality
between exchange rate and stock indices. Contrary to the above studies, Bhattacharya and
Mukherjee (2003) concluded that no causal linkage existed between stock prices and
macroeconomic variables.
There are several studies that have examined the relationship between macroeconomic
variables and gold price. Abken (1980) established that gold price can be modeled adequately
by using economic theories. Chua and Woodward (1982) found that gold acts as a hedge
against inflation. Gold also acts as a safe haven during stock market crisis (Gaur and Bansal,
2010). Ciner (2001) found that no cointegrating vector exists between gold and silver prices.
Kannan in his study of econometric analysis of Indian gold demand concluded that Indian
gold demand was affected not only by gold price but also by other macroeconomic variables
(Kannan, 2011 as cited in WGC, 2011).
Neuberger (2001) found that gold derivatives market has played an important role in
reducing the cost of capital for producers. Secondly, rapid growth of the derivatives market
over the last decade has accelerated the physical supply of gold, and probably lowered the
price of gold. However, Lawrence (2003) concluded that macroeconomic variables are
correlated with financial assets and other commodities (like aluminum, oil and zinc) but not

100 The IUP Journal of Applied Finance, Vol. 19, No. 1, 2013
with gold return. Even gold return is less correlated with financial assets like equity index
and bond. Bhar and Hamori (2004) found evidences of a strong simultaneous causality and
lagged causality running from percentage price change to trading volume of gold.
Levin and Wright (2006) confirmed that the long-run price of gold moves only to the US
price level. Short-run movements in the gold price are related to exchange rate, gold lease
rate, gold’s beta, US inflation, US inflation volatility, credit risk and political uncertainty.
Ismail et al. (2009) forecasted 85.2% variation of gold price by using inflation, exchange rate,
money supply, equity market indices and treasury bills. Toraman et al. (2011) found a negative
and significant relationship between the return of gold and the return of US dollar.
Pulvermacher (2005) concluded that a relationship exists between economic growth and
demand of metals like gold, but the extent to which economic growth affected the metal
prices was not clear. Starr and Tran (2007) examined the determinants of physical demand by
using panel data on gold imports of 21 countries. They concluded that determinants of
physical demand differed from those of portfolio demand and between the developed and
developing countries as well.

Relationship Between Stock Market Indices and Gold Price

Twite (2002) studied the exposure of the stock prices of Australian gold-mining firms to
changes in gold prices for 12 gold-mining firms over the period January 1985 to December
1998. He observed a substantial effect of gold prices on the stock price of gold-mining
companies. Similarly, Gilmore et al. (2009) explored the dynamic relationship between gold
prices, stock price indices of gold-mining companies and broad stock market indices using
weekly data over the period June 5, 1996 through January 31, 2007. The study concluded that
short-term unidirectional causal relationships were running from large-cap stock prices to
stock prices of gold-mining companies and from stock prices of gold-mining companies to
gold prices. A long-term relationship between gold and large-cap stock prices was also noted.
Likewise, Mishra et al. (2010) analyzed the causality relationship between gold prices and
stock market returns in India for the period January 1991 to December 2009. By applying
Granger causality in the Vector Error Correction Model (VECM), the study provided the
evidence of two-way causality between the variables. As a result, both the variables contained
some significant information for the prediction of one in terms of another. All these studies
supported that gold prices and stock market indices were cointegrated and there existed a
causal relationship between them.
At the same time, there are some studies like Smith (2001) and Wang et al. (2010), which
contradicted these findings. According to them, gold prices and stock market indices are not
cointegrated. Smith (2001) studied the gold market and stock market of US and provided
empirical evidence on the relationship between the prices of gold and stock price indices for
the US over the period January 1991 to October 2001. He concluded that gold prices and US
stock price indices were not cointegrated and unidirectional causality ran from US stock
returns to returns on the gold price. Identically, Wang et al. (2010) explored the impacts of
fluctuations in crude oil price, gold price, and exchange rates of the US dollar versus various

Causal Relationship Between Stock Market Indices and Gold Price: Evidence from India 101
currencies on the stock price indices of the US, Germany, Japan, Taiwan, and China by using
daily data from 2006 to February 2009. The study concluded that there existed cointegration
among fluctuations in oil price, gold price and exchange rates of the dollar versus various
currencies, and the stock markets in Germany, Japan, Taiwan and China and have two-way
feedback relations. However, there is no cointegration relationship among these variables
and the US stock market indices.
Gold can also be used as a diversifying asset at the time of equity slowdown. This proposition
was supported by Coudert and Raymond (2010). They tried to analyze the role of gold as a safe
haven against stocks during recessions and bear markets by using monthly data for gold and
several stock market indices (France, Germany, UK, US, G7) over the period 1978:2-2009:1.
In the short run, gold acts as a ‘weak safe haven’, but in the long run, a negative relationship
exists between gold and some stock markets (France, UK, US). Further, the findings on the
effect of movements in gold prices on the stock market return are also mixed. While
Buyuksalvarci (2010) found that gold price did not have any significant effect on stock index
return, Ghosh et al. (2010) found that gold price had significant impact on stock market
return.
As discussed above, the literature provides contradictory views on the relationship
between stock indices and gold price. At the same time, some common macroeconomic
variables affect both stock market indices and gold price. Furthermore, this relationship
varies in different stock markets as much as it varies for different time horizons.
R
Data and Methodology
The data for gold price and stock market indices was collected from secondary sources. Monthly
data of gold prices was collected from Reserve Bank of India. The information on the stock
market indices like Sensex, BSE 100 and S&P CNX Nifty was collected from respective stock
exchange websites. The study used the monthly data for the period January 1991 to December
2011 which yielded a total of 252 observations.
There can be both short-run and long-run relationships between financial time series.
Short-run relationship between the stock market indices and gold price is determined by the
coefficient of correlation. The population correlation coefficient,  (–1    1) measures the
degree of linear association between two random variables and is the ratio of the covariance
between them and the product of their standard deviations. When the sample information is
used, we have the coefficient of linear correlation, ‘the correlation coefficient’, Pearson’s r.
With financial markets, correlation coefficients are usually calculated between returns. If G
is the price of gold and S is a stock price index,

Cov(R G , R S )
r ...(1)
 RG  RS

where RG = G = lnG and  R G is the standard deviation of gold returns.

102 The IUP Journal of Applied Finance, Vol. 19, No. 1, 2013
 Then, VECM is implemented. As an essential step of VECM, first unit root test is employed,
followed by Johansen’s cointegration test.
Here, Augmented Dickey-Fuller (ADF) (1979 and 1981) test has been applied, as it is the
most frequently used test of unit root. This test was built on the logic that stationary process
possesses mean reversion characteristic and the variance of such series remains constant.
This test is conducted by adding the lagged value of dependent variable. Therefore, it behaves
like AR (1) process with  = 1. Dickey-Fuller test is designed to examine if  = 1.
Let,
yt   yt 1   t ...(2)

yt  yt 1   yt 1  yt 1   t ...(3)

yt  (1   )yt 1   t ...(4)

yt   yt 1   t ...(5)

Similarly, the deterministic terms such as intercepts and trends may also be included in
the model. The complete model looks like this:
m
yt       yt 1    y
i 1
i t 1  t ...(6)

The null hypothesis of ADF unit root test that  = 0 means the series has a unit root; it
RG
is tested against the alternative hypothesis that  < 0, and that the series is stationary. If the
calculated ADF statistic is smaller than the test critical value, then the null hypothesis is
rejected. If the variable is non-stationary at level, the ADF test will be run at the first difference
of the variable. In this case, the variable is said to be cointegrated of order one, I(1).
In the second step, the Johansen’s cointegration test (Johansen and Juselius, 1990) has
been applied to check whether the long-run equilibrium relationship exists between the
variables. The Johansen cointegration test is performed by calculating trace test statistic and
maximum eigenvalue test statistic. The trace test statistic is calculated by using maximum
likelihood ratio as per the following formula:

k
Trace( r, k)   T  ln(1   )
i  r 1
i
...(7)

where i represents the largest eigenvalue of cointegrating vectors, and the number of
observations is indicated by T. The trace statistic considers whether the trace is increased by
adding more eigenvalues beyond the rth eigenvalue. The trace test examines the null hypothesis
that the number of cointegrating vector(s) is less than or equal to the number of cointegrating
vectors (r). The maximum eigenvalue test is based on the method of finding characteristic
root. The null hypothesis for this test is that exactly r cointegrating vectors exist, and

Causal Relationship Between Stock Market Indices and Gold Price: Evidence from India 103
alternative hypothesis is r+1 cointegrating vectors exist. The formula for calculating
maximum eigenvalue is as follows:

max ( r, r  1)  T ln(1  r 1 ) ...(8)

Finally, Granger causality test (Engle and Granger, 1987) is applied to find out the direction
of causality between gold price and stock market indices. This direction guides us in forecasting
the future values of the series. To test for Granger causality, following bivariate regression
model can be used.

m n
yt   0  
i 1
 i yt  i   x
j 1
j t 1  t
...(9)

m n
x t  0  
i 1
 i yt  i   x
j 1
j t 1  t
...(10)

If all the coefficients of x in first regression equation of y, i.e., j for j = 1......n, are significant,
then the null hypothesis that x does not cause y is rejected.

Empirical Analysis
It is clear from Table 1 that correlation between all the three stock market indices and gold
price is very high. However, as seen in Table 2, correlation coefficient between return of stock
market indices and return of gold price is insignificant. Hence, it may be possible that high
correlation in Table 1 is spurious.
Table 1: Results of Correlation Coefficient Between Sensex, BSE 100,
Nifty and Gold Price
Sensex BSE 100 Nifty Gold
Sensex 1.000000 0.999059 0.997082 0.873618
BSE 100 0.999059 1.000000 0.997257 0.871435
Nifty 0.997082 0.997257 1.000000 0.882564
Gold 0.873618 0.871435 0.882564 1.000000

Table 2: Results of Correlation Coefficient Between Return of Stock Indices

and Return of Gold Price
lnSensex lnBSE 100 lnNifty lnGold
lnSensex 1.000000 0.975529 0.716343 –0.112343
lnBSE 100 0.975529 1.000000 0.722708 –0.109058
lnNifty 0.716343 0.722708 1.000000 0.009033
lnGold –0.112343 –0.109058 0.009033 1.000000

104 The IUP Journal of Applied Finance, Vol. 19, No. 1, 2013
 The results of ADF unit root test are reported in Table 3. It is clear from Table 3 that the
null hypothesis of no unit roots for all the time series is rejected at their first difference in
both the models (i.e., constant and constant and trend) since the ADF test statistic values
are less than the critical values at 10%, 5% and 1% levels of significance. Therefore, Sensex,
BSE 100, S&P CNX Nifty and gold price are first difference stationary series.

Table 3: Results of Augmented Dickey-Fuller Unit Root Test

Level First Difference
Constant Constant and Trend Constant Constant and Trend
Sensex –0.7282 –1.9118 –15.102* –15.0804*
BSE 100 –0.7659 –2.0026 –14.840* –14.8175*
S&P CNX Nifty –1.0087 –2.4936 –6.9584* –6.9511*
Gold 5.8532 3.3714 –6.9175* –15.3609*
Note: * indicates significance of ADF test value at 1% level. For constant model, critical value at 1% level of
significance is –3.4563 and for constant and trend model, critical value at 1% level of significance is
–3.9950.

After testing for stationarity, Johansen cointegration test is applied to find out the long-
run cointegrating relationship between stock market indices and gold price. The results of
trace test and maximum eigenvalue test are presented in Table 4. At 5% level of significance,
both these tests found one cointegrating equation.

Table 4: Results of Johansen’s Cointegration Test

5% Critical Maximum 5% Critical

H0 Trace Test
Value Eigenvalue Test Value

Sensex and Gold r=0 32.02960 15.49471 31.57013 14.26460

r1 0.459468 3.841466 0.459468 3.841466
BSE 100 and Gold r=0 31.86961 15.49471 31.50590 14.26460
r1 0.363705 3.841466 0.363705 3.841466
S&P CNX Nifty r=0 29.95369 15.49471 28.32620 14.26460
and Gold
r1 1.627489 3.841466 1.627489 3.841466
Note: Trace test and Max.-eigenvalue test indicate 1 cointegrating equation(s) at 0.05 level.

The results of Granger causality test are presented in Table 5. This test is used to find out
which variable is causing the other variable to change. It is concluded that only the null
hypothesis of gold prices do not Granger cause Nifty returns is clearly rejected at lag 2. All other
hypotheses are not rejected. These findings inevitably suggest that the gold price contains
some significant information to forecast Nifty return.

Causal Relationship Between Stock Market Indices and Gold Price: Evidence from India 105
 Table 5: Results of Granger Causality Test
Null Hypothesis F-Statistic Probability Decision
lnGold does not Granger cause lnSensex 0.16268 0.6870 Fail to Reject
lnSensex does not Granger cause lnGold 0.11711 0.7325 Fail to Reject
lnGold does not Granger cause lnBSE 100 0.14947 0.699 Fail to Reject
lnBSE 100 does not Granger cause lnGold 0.76538 0.3825 Fail to Reject
lnGold does not Granger cause lnNifty 3.14296 0.0449 Reject
lnNifty does not Granger cause lnGold 0.04354 0.9574 Fail to Reject

Conclusion
This paper investigated the causal relationship between stock market indices and gold price
in India. The study used the monthly data of Gold Price, Sensex, BSE 100 and S&P CNX
Nifty for the period January 1991 to December 2011 and a total of 252 samples. The empirical
analysis found three interesting results. First, ADF test concludes that all variables are
stationary at first difference, i.e., I(1). Second, Johansen’s cointegration test infers that there
exists a long- run equilibrium relationship between all stock market indices and gold prices.
Third, Granger causality test in the VECM suggests the evidence of causality running from
gold price to Nifty. Thus, gold price contains some significant information to forecast Nifty
return. In future, it would be meaningful to develop a model by using econometric modeling
techniques which can forecast gold price and stock market indices. 
Acknowledgment: The author would like to thank Dr. M Mallikarjun for his constant support without
which this work would not have been possible. He would also like to thank Dr. Abhishek Ranga and
Prof. Nikunj Patel for their advice at various stages of this research work. He also thanks the anonymous
reviewers for their valuable comments.

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