Tag Archives: geopolitical risk

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.

Forecasting – Climate Change and Infrastructure

You really have to become something like a social philosopher to enter the climate change and infrastructure discussion. I mean this several ways.

Of course, there is first the continuing issue of whether or not climate change is real, or is currently being reversed by a “pause” due to the oceans or changes in trade winds absorbing some of the increase in temperatures. So for purposes of discussion, I’m going to assume that climate change is real, and with a new El Niño this year global temperatures and a whole panoply of related weather phenomena – like major hurricanes – will come back in spades.

But then can we do anything about it? Is it possible for a developed or “mature” society to plan for an uncertain, but increasingly likely future? With this question come visions of the amazingly dysfunctional US Congress, mordantly satirized in the US TV show House of Cards.

The National Society of Professional Engineers points out that major infrastructure bills relating to funding the US highway system and water systems are coming up in Congress in 2014.

Desperately needed long-term infrastructure projects were deferred to address other national priorities or simply fell victim to the ongoing budget crisis. In fact, federal lawmakers extended the surface transportation authorization an unprecedented 10 times between 2005 and 2012, when Congress finally authorized the two-year Moving Ahead for Progress in the 21st Century Act (MAP-21). Now, with MAP-21 set to expire before the end of 2014, two of the most significant pieces of infrastructure legislation are taking center stage in Congress. The Water Resources Reform and Development Act (WRRDA) and the reauthorization of the surface transportation bill present a rare opportunity for Congress to set long-term priorities and provide needed investment in our nation’s infrastructure. Collectively, these two bills cover much, though not all, of US infrastructure. The question then becomes, can Congress overcome continuing partisan gridlock and a decades-long pattern of short-term fixes to make a meaningful commitment to the long-term needs of US infrastructure?

Yes, for sure, that is the question.

Hurricane Sandy – really by the time it hit New Jersey and New York a fierce tropical storm – wreaked havoc on Far Rockaway, flooding the New York City subway system in 2012. This gave rise to talk of sea walls after the event.  And I assume something like that is in the planning stages on drawing boards somewhere on the East Coast. But the cost of “ten story tall pilings” on which would be hinged giant gates is on the order of billions of US dollars.


I notice interesting writing coming out of California, pertaining to the smart grid and the need to extend this concept from electricity to water.

The California Energy Commission (CEC) publishes an Integrated Energy Policy Report (IEPR – pronounced eye-per) every two years, and the 2013 IEPR was just approved ..Let’s look at two climate change impacts – temperature and precipitation.  From a temperature perspective, the IEPR anticipates that as the thermometer rises, so does the demand for electricity to run AC.  San Francisco Peninsula communities that never had a need for AC will install a couple million units to deal with summer temperatures formerly confined to the Central Valley.  PG&E and municipal utilities in Northern California will notice impacts in seasonal demand for electricity in both the duration of heat waves and peak apexes during the hottest times of day.  In the southern part of the state, the demand will also grow as AC units work harder to offset hotter days. At the same time, increased temperatures decrease power plant efficiencies, whether the plant generates electricity from natural gas, solar thermal, nuclear, or geothermal.  Their cooling processes are also negatively impacted by heat waves.  Increased temperatures also impact transmission lines – reducing their efficiency and creating line sags that can trigger service disruptions. Then there’s precipitation.  Governor Jerry Brown just announced a drought emergency for the state.  A significant portion of California’s water storage system relies on the Sierra Mountains snowpack, which is frighteningly low this winter.  This snowpack supplies most of the water sourced within the state, and hydropower derived from it supplies about 15% of the state’s homegrown electricity.  A hotter climate means snowfall becomes rainfall, and it is no longer freely stored as snow that obligingly melts as temperatures rise.  It may not be as reliably scheduled for generation of hydro power as snowfalls shift to rainfalls. We may also receive less precipitation as a result of climate change – that’s a big unknown right now.  One thing is certain.  A hotter climate will require more water for agriculture – a $45 billion economy in California – to sustain crops.  And whether it is water for industrial, commercial, agricultural, or residential uses, what doesn’t fall from the skies will require electricity to pump it, transport it, desalinate it, or treat it.

Boom – A Journal of California packs more punch in discussing the “worst case”

“The choice before us is not to stop climate change,” says Jonathan Parfrey, executive director of Climate Resolve in Los Angeles. “That ship has sailed. There’s no going back. There will be impacts. The choice that’s before humanity is how bad are we going to do it to ourselves?”

So what will it be? Do you want the good news or the bad news first?

The bad news. OK.

If we choose to do nothing, the nightmare scenario plays out something like this: amid prolonged drought conditions, wildfires continuously burn across a dust-dry landscape, while potable water has become such a precious commodity that watering plants is a luxury only residents of elite, gated communities can afford. Decimated by fires, the power grid infrastructure that once distributed electricity—towers and wires—now loom as ghostly relics stripped of function. Along the coast, sea level rise has decimated beachfront properties while flooding from frequent superstorms has transformed underground systems, such as Bay Area Rapid Transit (BART), into an unintended, unmanaged sewer system..

This article goes on to the “good news” which projects a wave of innovations and green technology by 2050 to 2075 in California.

Sea Level Rise

Noone knows, at this point, the extent of the rise in sea level in coming years, and interestingly, I never seen a climate change denier also, in the same breath, deny that sea levels have been rising historically.

There are interesting resources on sea level rise, although projections of how much rise over what period are uncertain, because no one knows whether a big ice mass, such as parts of the Antarctic ice shelf are going to melt on an accelerated schedule sometime soon.

An excellent scientific summary of the sea level situation historically can be found in Understanding global sea levels: past, present and future.

Here is an overall graph of Global Mean Sea Level –


This inexorable trend has given rise to map resources which suggest coastal areas which would be underwater or adversely affected in the future by sea surges.

The New York Times’ interactive What Could Disappear suggests Boston might look like this, with a five foot rise in sea level expected by 2100


The problem, of course, is that globally populations are concentrated in coastal areas.

Also, storm surges are nonlinearly related to sea level. Thus, a one (1) foot rise in sea level could be linked with significantly more than 1 foot increases in the height of storm surges.

Longer Term Forecasts

Some years back, an interesting controversy arose over present value discounting in calculating impacts of climate change.

So, currently, the medium term forecasts of climate change impacts – sea level rises of maybe 1 to 2 feet, average temperature increases of one or two degrees, and so forth – seem roughly manageable. The problem always seems to come in the longer term – after 2100 for example in the recent National Academy of Sciences study funded, among others, by the US intelligence community.

The problem with calculating the impacts and significance of these longer term impacts today is that the present value accounting framework just makes things that far into the future almost insignificant.

Currently, for example, global output is on the order of 80 trillion dollars. Suppose we accept a discount rate of 4 percent. Then, calculating the discount factor 150 years from today, in 2154, we have 0 .003. So according to this logic, the loss of 80 trillion dollars worth of production in 2154 has a present value of about 250 billion dollars. Thus, losing an amount of output in 150 years equal to the total productive activity of the planet today is worth a mere 250 billion dollars in present value terms, or about the current GDP of Ireland.

Now I may have rounded and glossed some of the arithmetic possibly, but the point stands no matter how you make the computation.

This is totally absurd. Because as a guide to losing future output of $80 trillion dollars in a century and one half, it seems we should be willing to spend on a planetary basis more than a one-time cost of $35 per person today, when the per capita global output is on the order of $1000 per person.

So we need a better accounting framework.

Of course, there are counterarguments. For example, in 150 years, perhaps science will have discovered how to boost the carbon dioxide processing capabilities of plants, so we can have more pollution. And looking back 150 years to the era of the horse and buggy, we can see that there has been tremendous technological change.

But this is a little like waiting for the amazing “secret weapons” to be unveiled in a war you are losing.

Header photo courtesy of NASA

Geopolitical Outlook 2014

One service forecasting “staff” can provide executives and managers is a sort of list of global geopolitical risks. This is compelling only at certain times – and 2014 and maybe 2015 seem to be shaping up as one of these periods.

Just a theory, but, in my opinion, the sustained lackluster economic performance in the global economy, especially in Europe and also, by historic standards, the United States adds fuel to the fire of many conflicts. Conflict intensifies as people fight over an economic pie that is shrinking, or at least, not getting appreciably bigger, despite population growth and the arrival of new generations of young people on the scene.

Some Hotspots


First, the recent election in Thailand solved nothing, so far. The tally of results looks like it is going to take months – sustaining a kind of political vacuum after many violent protests. Economic growth is impacted, and the situation looks to be fluid.

But the big issue is whether China is going to experience significantly slower economic growth in 2014-2015, and perhaps some type of debt crisis.

For the first time, we are seeing municipal bond defaults and the run-on effects are not pretty.

The default on a bond payment by China’s Chaori Solar last week signalled a reassessment of credit risk in a market where even high-yielding debt had been seen as carrying an implicit state guarantee. On Tuesday, another solar company announced a second year of net losses, leading to a suspension of its stock and bonds on the Shanghai stock exchange and stoking fears that it, too, may default.

There are internal and external forces at work in the Chinese situation. It’s important to remember lackluster growth in Europe, one of China’s biggest customers, is bound to exert continuing downward pressure on Chinese economic growth.


Michael Pettis addresses some of these issues in his recent post Will emerging markets come back? Concluding that –

Emerging markets may well rebound strongly in the coming months, but any rebound will face the same ugly arithmetic. Ordinary households in too many countries have seen their share of total GDP plunge. Until it rebounds, the global imbalances will only remain in place, and without a global New Deal, the only alternative to weak demand will be soaring debt. Add to this continued political uncertainty, not just in the developing world but also in peripheral Europe, and it is clear that we should expect developing country woes only to get worse over the next two to three years.

Indonesia is experiencing persisting issues with the stability of its currency.


In general, economic growth in Europe is very slow, tapering to static and negative growth in key economies and the geographic periphery.

The European Commission, the executive arm of the European Union, on Tuesday forecast growth in the 28-county EU at 1.5 per cent this year and 2 per cent in 2015. But growth in the 18 euro zone countries, many of which are weighed down by high debt and lingering austerity, is forecast at only 1.2 per cent this year, up marginally from 1.1 per cent in the previous forecast, and 1.8 per cent next year.

France avoided recession by posting 0.3 % GDP in the final quarter of calendar year 2013.

Since margin of error for real GDP forecasts is on the order of +/- 2 percent, current forecasts are, in many cases, indistinguishable from a prediction of another recession.

And what could cause such a wobble?

Well, possibly increases in natural gas prices, as a result of political conflict between Russia and the west, or perhaps the outbreak of civil war in various eastern European locales?

The Ukraine

The issue of the Ukraine is intensely ideological and politicized and hard to evaluate without devolving into propaganda.

The population of the Ukraine has been in radical decline. Between 1991 and 2011 the Ukrainian population decreased by 11.8%, from 51.6 million to 45.5 million, apparently the result of very low fertility rates and high death rates. Transparency International also rates the Ukraine 144th out of 177th in terms of corruption – with 177th being worst.


“Market reforms” such as would come with an International Monetary Fund (IMF) loan package would probably cause further hardship in the industrialized eastern areas of the country.

Stratfor and other emphasize the role of certain “oligarchs” in the Ukraine, operating more or less behind the scenes. I take it these immensely rich individuals in many cases were the beneficiaries of privatization of former state enterprise assets.

The Middle East

Again, politics is supreme. Political alliances between Saudi Arabia and others seeking to overturn Assad in Syria create special conditions, for sure. The successive governments in Egypt, apparently returning to rule by a strongman, are one layer – another layer is the increasingly challenged economic condition in the country – where fuel subsidies are commonly doled out to many citizens. Israel, of course, is a focus of action and reaction, and under Netanyahu is more than ready to rattle the sword. After Iraq and Afghanistan, it seems always possible for conflict to break out in unexpected directions in this region of the world.

A situation seems to be evolving in Turkey, which I do not understand, but may be involved with corruption scandals and spillovers from conflicts not only Syria but also the Crimea.

The United States

A good part of the US TV viewing audience has watched part or all of House of Cards, the dark, intricate story of corruption and intrigue at the highest levels of the US Congress. This show reinforces the view, already widely prevalent, that US politicians are just interested in fund-raising and feathering their own nest, and that they operate more or less in callous disregard or clear antagonism to the welfare of the people at large.


This is really too bad, in a way, since more than ever the US needs people to participate in the political process.

I wonder whether the consequence of this general loss of faith in the powers that be might fall naturally into the laps of more libertarian forces in US politics. State control and policies are so odious – how about trimming back the size of the central government significantly, including its ability to engage in foreign military and espionage escapades? Shades of Ron Paul and maybe his son, Senator Rand Paul of Kentucky. 

South and Central America

Brazil snagged the Summer 2016 Olympics and is rushing to construct an ambitious number of venues around that vast country.

While the United States was absorbed in wars in the Middle East, an indigenous, socialist movement emerged in South American – centered around Venezuela and perhaps Bolivia, or Chile and Argentina. At least in Venezuela, sustaining these left governments after the charismatic leader passes from the scene is proving difficult.


Observing the ground rule that this sort of inventory has to be fairly easy, in order to be convincing – it seems that conflict is the order of the day across Africa. At the same time, the continent is moving forward, experiencing economic development, dealing with AIDS. Perhaps the currency situation in South Africa is the biggest geopolitical risk.

Bottom Line

The most optimistic take is that the outlook and risks now define a sort of interim period, perhaps lasting several years, when the level of conflict will increase at various hotspots. The endpoint, hopefully, will be the emergence of new technologies and products, new industries, which will absorb everyone in more constructive growth – perhaps growth defined ecologically, rather than merely in counting objects.

Geopolitical Risk

USA Today has a headline today What Wall Street is watching in Ukraine crisis and a big red strip across the top of the page with Breaking News Russia issues surrender ultimatum to Ukrainian forces in Crimea.

But the article itself projects calming thoughts, such as,

History also shows that market shocks caused by war, terrorism and other fear-rattling events tend to be short-lived.

In 14 shocks dating back to the attack on Pearl Harbor in December 1941, the median one-day decline has been 2.4%. And the shocks, which also include the Sept. 11 terror attacks and the 1962 Cuban missile crisis, lasted just eight days, with total losses of 7.4%, data from S&P Capital IQ show. The market recouped its losses 14 days later.

Similarly, the Economist February 26 ran an article The return of geopolitical risk noting that,

If there is a consensus, it is probably that geopolitical risks have a tendency to go away. Think back over the last 24 years, going all the way back to the Kuwait crisis, and you will recall that markets sold off initially but recovered as the conflicts turned out either to be shorter, or less economically damaging, than they feared. Hence, while the markets have sold off today, the declines have hardly been substantial (between 0.8% and for the FTSE and 1.4% for the Dax at the time of writing).

Professional organizations in the geopolitical risk space offer to provide information to companies operating in risk-prone areas or with vital interests in, say, natural gas markets globally.

One of these is Stratfor, founded by George Friedman in 1996, with subscription services and reports for purchase by business and other organizations. For the interested, here is a friendly but critical review of Friedman’s supposedly best-selling The Next 100 Years: A Forecast for the 21st Century (2009). Friedman actually predicts the disintegration of Russia in the 2020’s, following a re-assertion of Russian power westward, toward Europe. Hmmm.

Currently, Stratfor is highlighting the potential for the emergence of extreme right-wing groups in the Ukraine. This is a similar focus to one developed in an excellent article in Le Monde Diplomatique Ukraine beyond politics.

I don’t want to comment too extensively on the US role in the Ukraine, or the inevitable saber-rattling and accusations that not enough is being done.

Rather, I think it’s important to look at one particular graphic, presented initially by Business Insider and extensively tweeted thereafter.


So from a purely predictive standpoint, it seems unlikely the United States can originate and see implemented significant economic sanctions against Russia – since then, clearly, Russia has the power to retaliate through its control of significant natural gas supplies for western Europe.

The risk – plunging western Europe back into recession, again threatening the US economic recovery.

Economic rationality may provide some constraints to wild responses and actions, but the low performance of many economies since 2009 creates a fertile environment for the emergence of hot-heads, demagogues, and madmen.

So, what I guess I worry about is that the general geopolitical dynamics seem to be moving into greater and greater vulnerability to some idiotic minor event which functions as a tipping point.

But then again, the markets may go forth to a new stabilization very shortly, and it will be business as usual, with more than a modicum of background noise from politics.