Gold Price and Sensex

Most of us invest in Gold and Shares as a short term and long term investment. Indians might be the largest consumer of gold in the world. Indians buying gold is not something new, this has been there for centuries now. According to me, people in India invest in gold so that it can be exchanged easily for currency if there is an emergency. The same people attach so much sentimental value to gold that we hardly see them converting gold to cash. Even today there are people who talk about gold and maybe trade gold at the time of wedding. Similarly, a large section of people have started investing in shares. Some of them do regular trading and some invest for long term. How many of us have understood how is price of gold determined and how is Sensex calculated. Let me do my best to explain this.

Gold Given below are some of the key factors that can affect the price of gold.

Supply and Demand – Supply of gold is the key component to determine the price. Supply of gold is driven by mining production. Similarly demand for gold is also a key factor. Gold price can change significantly if there is a significant change in demand or supply.

Central Bank Reserves – Central Bank holds paper currencies and gold. Any shift in Central Bank from paper currencies to gold can lead to change in gold price.

Import – The natural gold reserves and gold production in India is very minimum now and most of the gold is now imported. Hence, the import duty plays an important role in determining the price.

US Dollar – The Price of gold is also dependent on the value of US dollar. Since, most of the gold in India is imported and payment is in US dollars, the rate of US dollar is a key factor that can affect the price of gold.

The Indian Bullion Jewelers Association (IBJA) plays a key role in determining the gold price. The gold imported by Banks are mostly procured by IBJA. The IBJA consults with the ten biggest gold dealers by asking the “buy” and “sell” Price for gold. IBJA arrives at the price by computing the average of buy and sell price quoted by dealers to determine the gold price.

Sensex This term refers to Stock Market Indicator for Bombay Stock Exchange. We read in newspaper or watch on television that the Sensex went up by 500 points or Sensex is down 300 points. Sensex refers to Market Weighed Stock Index of 30 companies which are financially sound. There are certain parameters for selecting these 30 companies and they are selected by Index Committee at periodic intervals. Sensex is calculated by Free-Float method effective Sep 2003. Free-Float refers to stock that can be traded in market and does not include promoter’s share and any locked in share that cannot be traded. The factors determining Sensex are market capitalization which is the product of shares issued and market price per share and free-float market capitalization which is the proportion of total shares issued by shares available for trading. The base period used for Sensex is 1978-79 and base index is 100. Let’s take an example to understand this:

Let’s assume there are 2 Companies A and B which determine the Sensex. A has 500 shares issued, 250 shares are held by promoters. B has 1000 shares, 500 shares are held by promoters. Market Price of Company A share is Rs. 10 and Market Price of Company B share is Rs. 20. Market Capitalization of A is Rs.5,000 and B is Rs. 20,000. Free-Float Market Capitalization of A is Rs.2,500 and B is Rs. 10,000. So, the value of Market Capitalization is Rs.25,000 and Free-Float Market Capitalization is Rs.12,500. The Base year is 1978-79 and Base index is 100. Let’s assume the market capitalization in the base year was Rs.5,000, Value of Index is 12,500 multiplied by 100 and divided by 5,000 which is 250. This is how Sensex is calculated in Bombay Stock Exchange on the 30 stocks.

Reference – Bank Bazaar and rediff.

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