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.

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.

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 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.

Applied Finance Journal, Causal Relationship, Stock Market, Indices, Gold Price, Evidence, India.