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The Intrinsic Value of Gold: An Exchange Rate-Free Price Index

33 Pages Posted: 8 Mar 2017  

Richard D. F. Harris

University of Exeter - Business School; University of Exeter

Jian Shen

XFI Centre for Finance and Investment

Date Written: February 28, 2017

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, where 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. 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.

Keywords: Gold Price Index; Commodities; Exchange Rates; Cointegration; Error Correction Mechanism

JEL Classification: G12; G15; C58

Suggested Citation

Harris, Richard D. F. and Shen, Jian, The Intrinsic Value of Gold: An Exchange Rate-Free Price Index (February 28, 2017). Available at SSRN: https://ssrn.com/abstract=2926454

Richard D. F. Harris (Contact Author)

University of Exeter - Business School ( email )

Streatham Court
Xfi Building, Rennes Dr.
Exeter, EX4 4JH
United Kingdom

University of Exeter ( email )

Northcote House
The Queen's Drive
Exeter, Devon EX4 4QJ
United Kingdom

Jian Shen

XFI Centre for Finance and Investment ( email )

Northcote House
The Queen's Drive
Exeter, Devon EX4 4QJ
United Kingdom
+44 1392 722541 (Phone)

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