The intrinsic value of gold: An exchange rate-free price index |
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| Institution: | 1. Xfi Centre for Finance and Investment, University of Exeter Business School, Rennes Drive, Exeter EX4 4ST, UK;2. Xfi Centre for Finance and Investment, University of Exeter Business School, Rennes Drive, Exeter EX4 4PU, UK;1. University of Wisconsin – Whitewater, Department of Economics, 809 W. Starin Road, Whitewater, WI 53190, USA;2. Department of Economics, Box 45A, College of the Holy Cross, One College Street, Worcester, MA 01610, USA;1. USEK Business School, Holy Spirit University of Kaslik (USEK), Lebanon;2. Management Development Institute Gurgaon, India;3. Montpellier Business School, Montpellier Research in Management, Montpellier, 2300 Avenue des Moulins, 34080 Montpellier, France;1. Department of Economics, Eastern Mediterranean University, Famagusta, via Mersin 10, Northern Cyprus, Turkey and Department of Economics, University of Pretoria, Pretoria, 0002, South Africa;2. Department of Economics, University of Pretoria, Pretoria, 0002, South Africa;3. Department of Economics, Helmut Schmidt University, Holstenhofweg 85, P.O.B. 700822, 22008 Hamburg, Germany;4. IPAG Business School, Paris, France |
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| Abstract: | In this paper, we propose a gold price index that enables market participants to separate the change in the ‘intrinsic’ value of gold from changes in global exchange rates. The index is a geometrically weighted average of the price of gold denominated in different currencies, with weights that are proportional to the market power of each country in the global gold market. Market power is defined as the impact that a change in a country’s exchange rate has on the price of gold expressed in other currencies. We use principal components analysis to reduce the set of global exchange rates to four currency ‘blocs’ representing the U.S. dollar, the euro, the commodity currencies and the Asian currencies, respectively. We estimate the weight of each currency bloc in the index in an error correction framework using a broad set of variables to control for the unobserved intrinsic value. We show that the resulting index is less volatile than the USD price of gold and, in contrast with the USD price of gold, has a strong negative relationship with global equities and a strong positive relationship with the VIX index, both of which underline the role of gold as a safe haven asset. |
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| Keywords: | Gold price index Commodities Exchange rates Cointegration Error correction mechanism G12 G15 C58 |
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