Recent research has begun to cast some doubt upon the inflation Hedge capacity of gold. When you think of it, the inflation experience over the last 40 years, since gold began to float freely, has been very mixed. In the 1970s we were concerned in relation to inflation, perhaps even fears of hyperinflation; not the talk is of deflation or disinflation. So was gold a hedge against inflation? Is it now? Continue reading
Gold markets are under investigation by regulators, again. At one level nobody should be surprised that banks are constantly in the firing line for regulatory intervention. They brought it on themseleves. At another level ,one might wonder when investigations reach diminishing marginal returns. As ever Zerohedge, long on tinfoil millinery, is frothing and fretting. Continue reading
Here is some evidence…
We investigate which of the two main centers of gold trading – the London spot market and the New York futures market – plays a more important role in setting the price of gold. Using intraday data during a 17-year period we find that although both markets contribute to price discovery, the New York futures play a larger role on average. This is striking given the volume of gold traded in New York is less than a tenth of the London spot volume, and illustrates the importance of market structure on the process of price discovery. We find considerable variation in price discovery shares both intraday and across years. The variation is related to the structure and liquidity of the markets, daylight hours, and macroeconomic announcements that affect the price of gold. We find that a major upgrade in the New York trading platform reduces the relative amount of noise in New York futures prices, reduces the impact of daylight hours on the location of price discovery, but does not greatly increase the speed with which information is reflected in prices.
The full paper is here
Data via Fergal O’Connor
The chart shows the annual number of articles published in the Financial Times about gold between 2004 and 2014 from the FT Interactive Database. The total height represents all articles filed under the topic Gold by the Financial Times editors. The lower portion show the number filed under Topic: Gold as well as having gold in the title. So the number under the topic gold was 401 in 2009 and 212 of those (53%) also had gold in the title.
There has been a lot of media chatter over the last week regarding the possibility of the London gold price having been rigged, with Bloomberg leading the pack and with a lawsuit now having been filed. Shades of Auric Goldfinger haunt the trading desks. The way that this has been presented is that a set of researchers have found, using a tool that previously found manipulation in LIBOR, evidence of a fix in the gold fix. There may or may not be a market cartel rigging the gold market but my reading of what we have so far suggests that the evidence simply does not permit this determination to be made. Extraordinary claims require extraordinary evidence. What we have is …nothing much. Let me explain
The issue arose last week when Bloomberg published a piece that stated that evidence existed of a decade long price manipulation. But, the first problem we have is that they, and only they, have seen the paper. I understand that they are refusing, on the request of the authors, to release the paper until a draft is complete. This is shoddy academic practice of the first water. Publication by press release is not how good science is done. How good science is typically done is for a paper to be circulated in draft form to people knowledgeable of the area. They critique the paper and the authors incorporate these issues. Then a paper is perhaps presented to a conference, or placed on an open access repository of research papers such as SSRN.com. More comments, more critique, more iterations of the paper. Then it is sent to a journal or an edited book and yet more reviews are made and incorporated. If you have something really really exciting then when the paper is accepted you maybe release a press notice. Occasionally a paper that has gone through many rounds of review and rewrite will be press released or attract media attention when it hits a repository or a conference. It seems that the paper here is not even a complete draft. If the authors didn’t give it to Bloomberg then they have been remiss in noting loudly and constantly that they are not able to stand over the findings; if they did they are equally remiss in short-circuiting the usual process which is designed to catch errors and to spare all our blushes.
The paper that is alluded to as having “helped uncover the rigging of the London interbank offered rate” appears to be at the heart of this. In so far as we can tell, and remember we haven’t seen the paper, the methodology used is a variant of it. That paper is found in its 2008 draft form here and was published in Journal of Banking and Finance (of which I am an associate editor, but I had no involvement in the paper) in 2012. It takes about thirty seconds to read the abstracts. The 2008 paper abstract concludes “while there are some apparent anomalies within the individual quotes, the evidence found is inconsistent with an effective manipulation of the level of the Libor” and the 2012 final version states “We find some anomalous individual quotes, but the evidence is inconsistent with a material manipulation of the US dollar 1-month Libor rate.”. So, far from uncovering the LIBOR scandal they claimed there was none. There was. This doesn’t seem a very powerful test, with a Type 2 error returning a false negative . A more powerful and simpler test, but one that is not possible to be applied here as we do not have the quotes of the fix participants, was that of Snider and Youle, which DID suggest that there was a problem.
To properly analyze the fix in the manner which they analyzed the LIBOR fix they would need to have details on the positions and quotes taken in the fix by the fix members. This they do not have, and I am not aware that this is even collected. Thus they are (it seems) looking at the events around the period of the PM fix. Herein lies a problem. It is not clear what window they use, that is to say the frequency of the data they are analyzing. This is really important in the context of a market which may have upwards of 50% of its trading now coming from algorithmic trading positions. A tick-by-tick or better yet quote-by-quote analysis would be needed to see what was happening. A proper analysis would need to examine the timestamp of when the fix is released and the trades/bids immediately thereafter. It would need to see if the fix banks were able in fact to take consistent superior profits. To see how machines and people interact on information releases, which is what the fix is in essence, see here
The collusion test they use is in essence the following: where there is collusion there should be no real difference in average returns (as opposed to a non collusive market) but there should be lower variance. An immediate problem arises in that lower cross sectional variance is a hallmark not only of possible collusion but of herding. And we know that gold market participants herd (see McAleer , and a number of papers by Pierdzioch . Herding is a feature, at some stage, of nearly all markets. A test that can conflate herding with collusion might be one that would give us pause to think before we leap to a conclusion of one or the other being present.
Even leaving aside this, a further issue is how the authors calculate the intraday variance of trades. From their LIBOR paper they seem to use the coefficient of variation. This is very simplistic and when one is dealing with intraday variance it is really not at all clear that this is what one should do. Particularly when dealing with higher frequency data, and bear in mind we do not know what the data frequency they are using is in fact, there are microstructural issues to deal with in the estimation of volatility. Personally, I prefer to use range based estimators such as the Parkinson or Garman-Klass estimators of variance at intraday frequencies. Theres a very highly cited paper by Alizadhe (available in a working paper form here) on the superiority of these and other range based estimators. Some limited work on ultra high frequency gold suggests that volatility measurement needs to be taken very seriously
Even if we were to agree that the volatility measure used was adequate, if we know one thing it is that volatility is not constant. Engle even got a Nobel prize for a whole family of measures (ARCH and its many offshoots) to estimate and counter this. Looking over a 15 year period as they seem to do it is abundantly clear that volatility changes. Thus any statistical test that looks at the likelihood of a particular outcome as being within normal ranges (as the paper seems to do we are told) absolutely has to take into account the shifting nature of how likely likely is at any given time over any given window. Does it do this? We don’t know. Do the tests take account of the non normality of the data? Are they non parametric perhaps? We don’t know
A further issue is that we do not know what was going on on the days that this anomalous behavior was detected. Gold acts as a safe haven against extreme stock and bond movements (see here for the original paper and here for an extension to oil and currencies) A full investigation of how other markets were evolving on those days and why, whether it be in reaction to news or macro releases or whatever would be most useful. The PM fix is at 10am New York. Is the market in London reacting to New York market issues? We know that the locus of price determination shifts from London to New York and back again. See here. Is that what is happening? Models of the gold price routinely incorporate a range of real and financial variables, which themselves change and which have announcement dates. These need to be taken account of. We simply do not know if the detected changes were explicable by other , non collusive, market reaction.
The paper, we are told, because we don’t know what is in it, finds a break in the behavior of the fix in 2004. This again needs to be looked at. First 2004 represents the first real takeoff of gold from the doldrums of having been stuck in the $200-$400 for the previous 20 years. As markets accelerate the behavior of people changes. Second, we have in mid 2003 the first gold ETF. The market changed fundamentally in 2004-5 and merely finding a break in its behavior there doesn’t indicate anything other than that the market changed.
Bottom line – without seeing the paper its hard to tell what’s going on in it (duh…). However, I would be astonished if there were not a fairly reasonable set of explanations at least potentially available for anomalous (if they be so) changes around the fix in certain days. Extraordinary claims need extraordinary proof. We don’t have any, yet.
IRFA Special Issue on Gold
There has, in the last decade, been a remarkable resurgence in interest in gold as an asset class. The rise and fall of the gold price, questions of gold bubbles, the comparisons of the Euro to a new gold standard, the growth of China as a gold consumer, and the increased growth of gold related products have prompted significant numbers of academic papers on this metal. In this regard it seems timely to put together a set of papers that reflect the state of the art on the financial economics of Gold
Papers are therefore invited for a special issue on International Review of Financial Analysis on Gold. Papers should be submitted via the elsevier EES system by 1 September 2014. The Special Issue will be edited by Professor Brian Lucey, Editor in Chief, Professor Jonathan Batten, Special Issues Editor and Professor Dirk Baur, Associate Editor.
Papers should address the financial economics or econometrics of gold, gold derivatives, the gold market, the relationship of gold to other assets, the role of gold mining stocks, the microstructure of the gold market, forecasting of gold, the monetary role of gold and the role of gold as an investment asset. We welcome both theoretical and empirical approaches.
All papers accepted will, prior to publication, be required to be accompanied by a video abstract or audioslide (see http://www.elsevier.com/about/content-innovation/audioslides-author-presentations-for-journal-articles / or http://www.elsevier.com/about/content-innovation/author-videos )
Papers should be submitted via http://ees.elsevier.com/finana/, selecting Gold Special Issue as article type. Please note that the standard submission fee remains in place for this special issue. We reserve the right to accept papers but to place them in regular issues of IRFA as opposed to the Special Issue.
Please feel free to contact any of the special issue authors if you wish to discuss the suitability of a paper for the special issue.
This is a version of a column published in the Irish Examiner 28 September 2013
Pensions are a time bomb that everybody knows is ticking away but few seem willing to defuse. Most politicians have over the years been happy to hope that when it does explode they will be long gone from the scene, and anyway maybe none of their constituents will be hurt. The recent proposals for mandatory provision are a good idea well grounded in best practice but are they enough?
Irish private pension funds have had a good year. This comes on the back of several horrible years. The year was good not just in terms of returns, 27% over the last four years or 6% per annum. It was also good in terms of inflows. This is important as the raid by the government on private pension assets has and had the potential to instill a lack of confidence. Yet we saw an inflow of 11%. Irish pension funds now stand at just over €80b.
This sounds a lot, but it is not really that much. Irish households have on deposit in excess of €90b. In a low interest rate environment where we are and will be for some time to come 80b will not yield much more than 4% pa. This amounts to, gross of tax, about €6400 per person. This is not enough to live on. Thus pension funds need to either up the rate of return they will get or they need to increase the amount of money under management, or both . The recent review of the Irish pension system by the OECD suggests that the private pension industry in Ireland, despite what many feel, is not overly expensive in terms of fees, measured internationally. What is problematic is that it is small. Smaller financial companies can find themselves at a disadvantage. While big is not always better, the efficiency of the pensions industry is probably best enhanced by it growing.
To get more returns is problematic. The strong 5-6% growth era of Ireland is over. We have not had that real growth since the mid 1990s and those conditions are not coming back. We have seen how problematic this can be when we chase that growth from credit pumping and / or property ponzi schemes. Thus pension funds that wish to increase growth in the longterm will need to consider thir asset allocation strategy very carefully.
If we examine Irish funds against European funds we find some significant differences. Irish funds tend to have the highest allocation to equities and amongst the lowest to property. This is strange. Although we have been burned by the property crash commercial property should form a solid part of a pension fund. The nature of this asset class is that it is longterm. To some extent this underweighting is a reflection of the cycle we are in but Irish pension investors should consider if 2% is appropriate for the long term. Second, within this heavy equity allocation Irish pension funds are grossly overweight in holdings of domestic equity. They hold 32% of all assets in the form of Irish company shares. The market capitalization of Irish shares is approx. 0.2% of world shares. This overweighting in essence is a gigantic bet on the health of the Irish stock exchange.
The domestic focus continues on the bond side, where only 5% of bond assets are non domestic government bonds. While Irish government bonds have performed very well over the last couple of years, falling yields being indicative of rising prices, pension fund investment is a longterm investment.
It is in the area of alternative investments that we see what is for me the starkest difference. The UK has shown a consistent drift to greater allocation of investments in alternative (to stock and bonds) assets over the past decade, with now 11% of all assets allocated. For Ireland this is 3%. The UK is leading a field in which we are lagging. 24% of all plans in europe are planning to increase their exposure to alternative investment classes such as gold and private equity.
Alternative investments are not an asset class – they are a series of asset classes ranging from emerging market debt to copper futures. The main elements tend to be commercial property, hedge funds, commodities, and classes of debt. Looked at over the last decade or so, certain kinds of alternative investment classes have performed spectacularly well. Amongst the top performers have been global infrastructure funds, commodities especially gold, and global private equity funds. Gold in particular has shown a remarkable sustained growth since 2000, even allowing for an element of froth. So also infrastructure, a trillion dollar market. And these are not especially volatile.
Irish pension funds will get increased levels of assets as the governments mandatory policies come on stream. This is good, in the long term. But it will only show the full benefit if the domestic equity focus is scrapped and a much more imaginative asset allocation policy is put in place. Irish pension funds having weathered the worst of the crisis should now look outwards.
My post on gold and the need to look at the recent falls in a longterm perspective have generated some heat and light on the twitterweb. One critique is : sure if you look at the original post it is an artefact of the timing.
So, here are a series of charts of gold v the S&P 500 rebased at 5y intervals.
As I pointed out this shows us that a) gold has had a remarkable run over the last while and b) stocks fluctuate a lot. A more serious issue is that this is unfair on the equity market : although declining as a percentage of stocks, dividend paying equities, in the long term, really perform.
Below is a slide from my first lecture set in the Applied Corporate finance course, given in the third year in TCD. Its from James Montier
and here is some information on dividend payers worldwide. Yes, its a mess….