Forecasting the Price of Gold – 3

Ukraine developments and other counter-currents, such as Janet Yellen’s recent comments, highlight my final topic on gold price forecasting – multivariate gold price forecasting models.

On the one hand, there has been increasing uncertainty as a result of Ukrainian turmoil, counterbalanced today by the reaction to the seemingly hawkish comments by Chairperson Janet Yellen of the US Federal Reserve Bank.


Traditionally, gold is considered a hedge against uncertainty. Indulge your imagination and it’s not hard to conjure up scary scenarios in the Ukraine. On the other hand, some interpret Yellen as signaling an earlier move to moving the Federal funds rate off zero, increasing interest rates, and, in the eyes of the market, making gold more expensive to hold.

Multivariate Forecasting Models of Gold Price – Some Considerations

It’s this zoo of factors and influences that you have to enter, if you want to try to forecast the price of gold in the short or longer term.

Variables to consider include inflation, exchange rates, gold lease rates, interest rates, stock market levels and volatility, and political uncertainty.

A lot of effort has been devoted to proving or attempting to question that gold is a hedge against inflation.

The bottom line appears to be that gold prices rise with inflation – over a matter of decades, but in shorter time periods, intervening factors can drive the real price of gold substantially away from a constant relationship to the overall price level.

Real (and possibly nominal) interest rates are a significant influence on gold prices in shorter time periods, but this relationship is complex. My reading of the literature suggests a better understanding of the supply side of the picture is probably necessary to bring all this into focus.

The Goldman Sachs Global Economics Paper 183 – Forecasting Gold as a Commodity – focuses on the supply side with charts such as the following –


The story here is that gold mine production responds to real interest rates, and thus the semi-periodic fluctuations in real interest rates are linked with a cycle of growth in gold production.

The Goldman Sachs Paper 183 suggests that higher real interest rates speed extraction, since the opportunity cost of leaving ore deposits in the ground increases. This is indeed the flip side of the negative impact of real interest rates on investment.

And, as noted in an earlier post,the Goldman Sachs forecast in 2010 proved prescient. Real interest rates have remained low since that time, and gold prices drifted down from higher levels at the end of the last decade.


Elasticities of response in a regression relationship show how percentage changes in the dependent variable – gold prices in this case – respond to percentage changes in, for example, the price level.

For gold to be an effective hedge against inflation, the elasticity of gold price with respect to changes in the price level should be approximately equal to 1.

This appears to be a credible elasticity for the United States, based on two studies conducted with different time spans of gold price data.

These studies are Gold as an Inflation Hedge? and the more recent Does Gold Act As An Inflation Hedge in the US and Japan. Also, a Gold Council report, Short-run and long-run determinants of the price of gold, develops a competent analysis.

These studies explore the cointegration of gold prices and inflation. Cointegration of unit root time series is an alternative to first differencing to reduce such time series to stationarity.

Thus, it’s not hard to show strong evidence that standard gold price series are one type or another of a random walk. Accordingly, straight-forward regression analysis of such series can easily lead to spurious correlation.

You might, for example, regress the price of gold onto some metric of the cumulative activity of an amoeba (characterized by Brownian motion) and come up with t-statistics that are, apparently, statistically significant. But that would, of course, be nonsense, and the relationship could evaporate with subsequent movements of either series.

So, the better research always gives consideration to the question of whether the variables in the models are, first of all, nonstationary OR whether there are cointegrated relationships.

While I am on the topic literature, I have to recommend looking at Theories of Gold Price Movements: Common Wisdom or Myths? This appears in the Wesleyan University Undergraduate Economic Review and makes for lively reading.

Thus, instead of viewing gold as a special asset, the authors suggest it is more reasonable to view gold as another currency, whose value is a reflection of the value of U.S. dollar.

The authors consider and reject a variety of hypotheses – such as the safe haven or consumer fear motivation to hold gold. They find a very significant relationship between the price movement of gold, real interest rates and the exchange rate, suggesting a close relationship between gold and the value of U.S. dollar. The multiple linear regressions verify these findings.

The Bottom Line

Over relatively long time periods – one to several decades – the price of gold moves more or less in concert with measures of the price level. In the shorter term, forecasting faces serious challenges, although there is a literature on the multivariate prediction of gold prices.

One prediction, however, seems reasonable on the basis of this review. Real interest rates should rise as the US Federal Reserve backs off from quantitative easing and other central banks around the world follow suit. Thus, increases in real interest rates seem likely at some point in the next few years. This seems to indicate that gold mining will strive to increase output, and perhaps that gold mining stocks might be a play.

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