At around $1200 at the time of writing, gold is sitting below its average price for the last 12 months, of $1246. However, the metal has held its own amongst the commodities cohort this year, as shown in the graph below.
Overall, gold has been a fairly flat story since early 2014, with volatility edging up slightly this year.
We have developed a fair value of the gold price based on a multiple regression analysis of its price on 22 driver variables including interest rates, stock indices, other commodities and exchange rates. The database is six years of daily prices.
The elasticity of the gold fair value to groups of driver variables is shown in the graph below.
As can be seen, gold is negatively correlated to the US dollar.
We have also developed a prediction model based on the lead given by the change in the Baltic Dry Index (BDI) of raw material shipping freight rates. This index is widely seen as a leading indicator of world economic growth, with increases viewed as bullish and conversely.
Based on the BDI lead, it is possible to develop price predictions for a range of commodities, interest rates, stock indices and currencies. These can be combined with the fair value model elasticities shown above to give a predicted movement in the gold price over the next month. We also backtest the prediction models to assess their value in a trading environment (taking a long position when the predicted price change is positive and a short position when negative).
The predicted price changes for the next month, and the return/volatility ratio over the last six years from trading the predictions, are shown in the following table:
Predicted price change | Backtest return/volatility | |||||
| US dollar | 1.7% | 83.2% | ||||
| VIX | 0.3% | 40.1% | ||||
| Interest rates | -3.1% | 83.9% | ||||
| S&P 500 | 1.8% | 88.1% | ||||
| Commodities | -2.9% | 97.6% | ||||
Total | 126.9% |
The 126.9% return/volatility from trading all the predictions combined compares with that applying to the S&P 500 over the same period, of 142.7%. We consider this to be reasonably robust given the period commences in mid-2009, around the start of the latest bull market in US stocks.
The predicted movement in the gold price for the next month is shown below. The contribution of each driver variable to the overall decrease is also shown. As can be seen, our view that the US dollar will strengthen is a significant driver of our predicted weakening in the gold price.
Impact of predicted price change on | |||||
gold fair value | |||||
| US dollar | -5.0% | ||||
| VIX | 0.0% | ||||
| Interest rates | 1.0% | ||||
| S&P 500 | -0.4% | ||||
| Commodities | -1.5% | ||||
Total | -5.8% |
We also used the BDI model to directly forecast the gold price movement for the next month. A change of -2.3% resulted, confirming the signal given above. The backtest return/volatility ratio from trading this model was 89.5%.
We commented on the volatility in the gold price and showed its negative correlation to the S&P 500, above. Not surprisingly, allocating a component of a US stock portfolio tracking the S&P 500 to gold traded using the BDI leading indicator as outlined in this article would have improved the return/volatility ratio of the portfolio. For a 5% allocation, the ratio would have improved from 142.7% to 146.7%.