Gold is one of the most popular metallic elements. It has the symbol Au which means “shining dawn” or Latinaurum. The word “gold” however, comes from the old English word that means “yellow” (WiseGeek, 2013). Belonging to the group 11 in the periodic table of elements, Gold is known as a “transition metal” which means it is highly ductile and malleable. It is also very precious.
Gold was known and used as early as 6,000 B.C. for jewellery and other ornamentation. In early times, it was not used for much anything else other than decoration, even though it had a long history with the great civilizations of the past. Gold is mostly found in South Africa but there are also large deposits in Russia, the United States and other places.
Gold is an important commodity and an even more important metric of the world’s financial system. All the currencies in the world are backed up by gold deposits, gold being one of the monetary standards utilized in the old world. Gold is also a universal commodity and any currency is backed up by gold making gold the world’s true monetary standard.
Purpose of the Study
This paper is presented with the objective of determining the factors that influence the price of gold in the market. Several resources were utilized to determine the salient factors that affect gold prices. These factors are:
- The value of the US Dollar
- The inflation rate
- The world production and consumption of gold
- Bank interest rates
A regression analysis is conducted to determine the relationship between gold prices and these factors. The Microsoft Excel file showing the data set and statistical analysis is presented as an annex to this report.
Data
The data used for the analysis is presented in Table 1 below. The data sources are the U.S. Bureau of Mines (USBM) and the U.S. Geological Survey (USGS) various publications including the Minerals Yearbook (MYB), the Mineral Resources of the United States (MR), the Mineral Commodity Summaries (MCS) and the Commodity Data Summaries (CDS). Data on consumption and consumption of gold is acquired from the Gold Fields Mineral Services Ltd. (GFMS) Gold annual reports. The price of gold is acquired from the Metal Prices in the United States through 1998 (MP98). Bank interest rate data is acquired from the US Federal Reserve website. The data acquired is between the year 1960 t0 2010. Gold Price Bullion (GPB) is shown in UK Pounds (English), the normal currency used for pricing gold. The value of gold is recognized with respect to the value of the dollar and is presented as GPB in USD (US Dollars). The CPI or consumer price index for the period is also presented. The bank interest rates shown are for annual Federal Reserve rates for 1-year periods. Consumption and production are shown in metric tons per year.
How these Factors Affect Gold Prices
The regression equation used in determining the relationship between these factors and gold prices is:
Price of Gold (in GPB) = - a*USD Value + b*CPI - c*Production of Gold + d* Consumption of Gold - e*Bank Interest Rates + E
Where:
- US Dollar Value is expected to have an inverse relationship between the US dollar and the price of gold. However, some studies have shown that the valuation of the dollar and the controls set by the US Monetary System have dampened the inverse relationship between gold prices and dollar value.
- The Consumer Price Index (CPI) is an approximation of inflation. As a general rule and because gold is a commodity, the level of inflation has a positive correlation with the price of gold. Some experts believe that the rate at which the price of gold changes is always better than the CPI rate thus an investment in gold will yield positive benefits for the investor.
- Production of gold is expected to have a negative relationship with price. As more gold is produced, the supply increases thereby pushing prices down.
- Consumption of gold is expected to have a positive relationship with price. As demand expands, gold prices increase.
- Bank interest rates are expected to have a negative correlation with gold prices. Gold is an alternative type of savings and with the price of gold rising faster than inflation; some investors believe that purchasing gold is better than keeping the money at the bank. Thus a high interest rate will reduce gold purchases and therefore the price of gold, while a low interest rate will result in the inverse.
- An error term ( E ) is added to capture movements in gold prices that are not predicted by these five factors.
The regression results are presented below.
GPB = 0.3813 USD + 1.2583 CPI – 0.0002 PRDN + 0.0903 CNSMPN – 14.9546 BINTRST – 71.64005
The regression equation is in summary, a good equation for determining the price of gold. The R-squared statistic is 0.9141 (adjusted R-squared is 0.9046). This means that 91% of the changes in the price of gold is correlated to the changes in the 51 separate observations for each explanatory variable as shown in the table below.
The regression results validate some of the expected correlation behaviour between the price of gold and the explanatory variables. The value of the dollar, initially assumed to have a negative correlation with gold price is shown to have a positive correlation. The price of gold changes by 1 British Pound for every 0.38 increase in US Dollar Value. This could be explained by the current economic situation of the US and the fact that the country consumes substantial volume of gold. As the US economy strengthens, its effects on consumption may be significant thus resulting in a positive correlation. The ANOVA results indicate that the t-statistic for USD is 7.91 which are interpreted as a significant statistic and a good explanatory variable for gold price changes.
Inflationary changes resulted as expected. As inflation increases by 1%, gold prices change by more than 1% (1.2583% to be exact). Gold prices increase at a faster rate than the basket of goods and services known as CPI. The t-statistic for CPI is 2.5303 which indicate that it too is a significant statistic and a good explanatory variable for gold price changes.
Production was found to have a very small effect on price of gold. A 1 MT increase in gold production period reduces gold prices by only 0.00002 UK Pounds. The t-statistic shows that it is a very poor explanatory variable, having a t-statistic value of only 0.003. The same is true for consumption. While an increase of 1 MT of gold consumed results in a 0.0903 UK Pound increase in price of gold, its significance as an explanatory variable is very poor (t-statistic of only 1.1024).
Lastly, interest rates have behaved as expected. A 1% increase in the bank rates results in a 14.95 UK pound reduction in prices. The t-statistic shows a very high -5.4475 indicating that the validity of bank interest rates as an indicator of gold prices.
The individual residual and projected values are shown in the succeeding charts.
There is no evidence of Heteroskedasticity for the US dollar rates, for consumption and for bank interest rates as seen in the graphs above. Heteroskedasticity can be visually seen as evident unequal distribution of variance. The graphs above do not present variances but the graphs for the CPI and Production indicate none. The test for Heteroskedasticity could be analysed using a statistical test for it and an evaluation using the standard chi-squared table but the output of the regression equation does not contain these tests and therefore could not be analysed using this method.
Conclusions
Gold will continue to be a significant commodity and a benchmark to which other currencies will be evaluated. The results of this research indicate that the price of gold is affected by the value of the US Dollar, the inflation rates and the bank interest rates that prevail and less on the fundamental supply-demand mechanisms (consumption and production). More research is recommended to pursue a more detailed approach to the determination of the factors influencing gold prices, which could be conducted with respect to the findings of this report.
References
Gold Fields Mineral Services Ltd., 1990–2000, Gold 1990–2000: Gold Fields Mineral Services Ltd. (London).
Ridgeway, R.H., 1929, Summarized data of gold production: U.S. Department of Commerce, Bureau of Mines, Economic Paper No. 6, 63 p.
U.S. Bureau of Mines, 1927–34, Mineral Resources of the United States, 1924–31.
U.S. Bureau of Mines, 1933–96, Minerals Yearbook, 1932–94.
U.S. Bureau of Mines, 1962–77, Commodity Data Summaries, 1962–77.
U.S. Bureau of Mines, 1978–95, Mineral Commodity Summaries, 1978–95.
U.S. Geological Survey, 1901–27, Mineral Resources of the United States, 1900–23.U.S. Geological Survey, 1997–2009, Mineral Commodity Summaries, 1997–2009.U.S. Geological Survey, 1997–2009, Minerals Yearbook, v. I, 1995–2008. U.S. Geological Survey, 1995–present, Minerals Yearbook, v. I. (Available via http://minerals.usgs.gov/minerals.)
U.S. Geological Survey, 1997–most recent, Mineral Commodity Summaries 1997–most recent. (Available via http://minerals.usgs.gov/minerals.)
U.S. Geological Survey, 1999, Metal Prices in the United States through 1998.U.S. Geological Survey and U.S. Bureau of Mines, 1996, Mineral Commodity Summaries, 1996. WiseGeek (2013). What is Gold. Retrieved from http://www.wisegeek.org/what-is-gold.htm
