Future Fed chair Janet Yellen got some attention earlier this month when she said that nobody "has a very good model" of what drives the price of gold. During her confirmation hearing before the Senate Banking Committee, Sen. Heller (R-NV) asked whether gold prices could serve as an economic indicator. Here's video of the exchange, at the 1:25 mark:
HELLER: "Do you follow gold prices?"
YELLEN: "To some extent."
HELLER: "Do you believe there's any economic indicator behind the rise and fall of gold prices?"
YELLEN: "Well, I don't think anybody has a very good model of what makes gold prices go up or down, but certainly it is an asset that people want to hold when they're very fearful about potential financial market catastrophe or economic troubles and tail risks. When there is financial market turbulence, often we see gold prices rise as people flee into them."
HELLER: "Well that was a better answer than I got from Chairman Bernanke last July. I asked him the same question and he said that "nobody really understands gold prices." And he went on to say, "and I don't really pretend to understand them either." Do you share that view or, clearly, with a few extra tidbits that you just shared with us."
YELLEN: "I think beyond what I shared, I don't have strong views on what drives
This kind of response is more significant than people might realize. First, notice that Yellen's remarks are of a piece with her predecessor's. There's no successful model, she doesn't have strong views, and oh, sometimes people buy things when they're stressed or afraid. Second, these remarks shut the door on any rational justification for owning precious metals.
- Inflation: The evidence is already clear that gold is not an effective inflation hedge, even at 15- and 20-year horizons. And as central banks around the world try to stoke demand, the primary risk in most economies is still the risk of deflation.
- Safety: as the Fed vice chair allows, sometimes people buy gold to hedge against tail risk. But notice that that's just a description of a behavior, not a justification. And to hedge financial claims, there are many less expensive and more effective hedges than metals.
- Future cash flows: Just kidding. You could buy some farm land, or horses, or dividend-paying stocks: all of those things are productive assets, unlike gold.
- Speculation: Here's where I think Yellen and Bernanke's "no predictive models" assessment is interesting. There are models that explain the behavior of most assets and that allow investors to price financial claims accordingly. The lack of a successful model for gold prices doesn't betray a secret new source of uncorrelated returns, it just confirms that fetishized commodities subject to swings of sentiment might not yield to sweet reason. If you want to trade momentum, or find a greater-fool locomotive and see whether you can get off in time, there are better things to trade than gold. There is some interesting research in options on gold futures, but even that work has everything to do with the features of options markets and not the value of the underlying asset.
Gold is down 31% in 13 months and the salesmen are having a much harder time now that their QE doomsday scenarios have proven false. But apparently the first question this Senator needed to ask the next Fed chair was whether she follows gold prices.
Izabella Kaminska, "Gold, the Rate of Reburying Trade"
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