Economists assume that the price of gold, although uncertain, is estimable. They come close to the estimate like any other commodity with increasing production costs.
Gold traders and specialists, by contrast, follow an older economic convention that emphasizes the monetary functions of existing gold stocks, which exceed the annual production of new metals by two orders of magnitude. The price of gold is believed to be largely based on expectations of changes in international macroeconomic variables and world trade.
Neither approach has produced good price predictions. The basic problem is that investment demands cannot be treated simply as changes to producers’ inventories for preventive or speculative purposes. as with other commodities. So if we claim that manufactured claims should increase proportionally with world gross national product (GNP), with Leontief et al., We get forecasts of annual world gold consumption in the year 2000 that are ridiculously high. that is, two or three times the 1980 outputs. If we were to supply such increases in new gold production, it would require increases in real gold prices to $ 600 or $ 1,000 per ounce in constant dollar terms.
Clearly, these estimates are inconsistent with past patterns of change in supply and demand for manufactured gold, which give evidence of considerable sensitivity to changes in price (price elasticity). This suggests to market experts that they are re-examining the role of gold as the main store of value whose price responds less to movements in manufactured products and the costs of new gold production than to changes in previously mined gold stocks. Such asset holdings largely respond to changes in asset prices, that is, interest rates, inflation, and the exchange rate. Because prices are influenced by changes in macroeconomic variables, this second approach attempts to correlate gold prices directly with monetary variables, but has been no more successful than the commodity approach.
One of the reasons for the failure is that changes in gold stocks complicate international capital movements. Capital movements are driven by expectations of changes in asset prices, and these are sensitive to uncertainty about monetary policies. These complications discourage and confuse attempts to use statistical analysis directly to explain movements in the price of gold.
We suggest treating gold as the share price of foreign assets in the portfolios of foreign exchange risk-averse investors. The own price of gold, the exchange rate, the price level and the interest rate are shown as prices of substitute assets that enter with other exogenous variables and wealth in the demands of private and public investors here and abroad. These investors maximize utility subject to monetary policy restrictions and balance of payments disequilibrium. As investors seek to maintain desired levels of different asset holdings, foreign and domestic, the markets for bullion or gold producing stocks respond in accordance with conditional expectations of changes in key rates and uncertainties affecting the value of the currency of the country of origin. The challenge with this hypothesis is to find a way to test it empirically.
One way to get around the difficulty is given by trading in mining stocks. Since bullion and gold mining company stocks are gross substitutes, the use of capital asset price theory allows us a simple test of this alternative model as applied to North American gold producers whose stocks they are listed on the stock exchange.
Our results show that trends in new gold production and price movements are not simple functions of commodity forecasts using conventional gold market analysis. Gold is best forecast as a stock price determined by the stock market. This implies a much more volatile market when monetary expectations become dominant. These periods are demonstrated by the size of the premium that prevails for gold above its price of production. This can be two to three times higher than normal, enough to discourage manufactured growth significantly. Around this premium level, irregular price cycles arise from movements in equity positions among investors during periods of adjustment to the global monetary imbalance. The variation in price is related to the sensitivity of the manufactured demands to price. We demonstrate that investors monitoring macroeconomic variables in a fully identified model can successfully hedge against currency devaluations and player capital gains periodically through a strategy that includes gold values in their investment portfolios.
