One of dozens on gold and inflation

MINING FINANCE AND

INVESTMENT

WHAT’S BAD FOR STOCKS, GOOD FOR GOLD

Economic research affirms gold and silver price/inflation link over long term

Recent university research has reaffirmed the old adage that what historically has been good for gold prices, isn’t good for stocks, and vice versa—if the period involves a longer timeframe.

Author: Dorothy Kosich
Posted: Monday , 22 Oct 2007

RENO, NV -

An Oklahoma City University study reinforces the belief that, when circumstances are bad for the stock market, the conditions are good for gold and silver prices.

Contrary to popular belief, however, the author of the report also claims that today's bull market is not based on investors' expectation of inflation heating up, but rather upon the growing wealth of developing nations where gold ownership is more culturally prevalent.

Associate Professor of Economics James Ross McCown and student John R. Zimmerman, both of the Meinders School of Business at Oklahoma City University, gathered data for the years 1970 to 2006, testing "for the correlation between each of the metals [gold and silver] and the U.S. CPI [Consumer Price Index] inflation rate," using time intervals ranging from one month to five years.

They concluded that the "correlation is very small at the one month horizon but become larger as the horizon is lengthened. These results confirm the findings of Jaffe (1989), and Levin, MacMillan, Wright, and Ghosh (2004) that metals prices are unrelated with inflation at short time horizons and positively correlated with inflation at long time horizons."

The researchers also examined a theory of former Federal Reserve Chairman Alan Greenspan that gold prices served as an indicator of expected future inflation. The two tested the ability of metals prices to track inflation as computed from the yield spread between nominal U.S. Treasury securities and the U.S. Treasury Inflation Protection Securities (TIPS). The discovered "the prices of both metals show a large positive correlation with the expected future inflation rate, and that the correlation is highest for the time horizon over ten years."

Nevertheless, they noted that large increase in metals prices beginning in September 2005 "were not matched by corresponding increases in expected inflation."

Among the methods of gold and silver investment considered by McCown and Zimmerman in their study were purchase of physical metals, mining stocks, and derivatives based on metals prices.

The data researched in the study found that spot prices of gold and silver between 1970 and 2006 actually produced lower returns than the MSCI U.S. Stock index, and had higher volatility. During that period gold had a return that was 2% lower than that of stocks, and about 2% higher than U.S. Treasury bills.

The researchers then divided their time periods into three subperiods. From January 1970 to January 1980, gold and silver had annualized returns of more than 29%, or "far in excess of stocks and inflation," they explained. During the second subperiod from February 1980 to August 1999, "both metals had negative returns as compared with the large positive returns enjoyed by stocks."

For the third subperiod from September 1999 to December 2006, gold and silver again had positive returns, "far in excess of inflation and the meager returns to stocks during the period," according to the researchers.

When viewed according to monthly increments, the study determined that "both gold and silver returns are virtually uncorrelated with inflation." As the time horizons are increased, "we see higher and higher correlations, culminating in a positive correlation between gold and inflation of 0.0711 and between silver and inflation of 0.530, for the five-year horizon."

"Both metals show strong evidence of an ability to hedge inflation risk over the long term," the researchers asserted.

Among the study's conclusions:

• Gold and silver show evidence of ability to hedge a stock portfolio.

• Both metals also show ability to hedge inflation, which increases in effectiveness at longer time horizons.

• Confirming Greenspan's (1993) claim that the price of gold is a useful indicator of expected inflation, "both gold and silver prices show high correlation with expected inflation as measured by the spread between nominal U.S. Treasury securities and TIPs yields."

In an interview with Mark Hulbert, Editor of the Hulbert Financial Digest, McCown attributed the current gold bull market to "the influence of newfound wealth in parts of the world where there is a strong predisposition to owning gold, like India and some countries in the Middle East."

To download the study, "Analysis of the Investment Potential and Inflation-Hedging Ability of Precious Metals," go to http://ssrn.com, the website of the Social Science Research Network. The study may be downloaded for free if the reader registers with the site.

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Heavy, eh??

Personally, I think tracking currencies versus the US dollar is a wise move - it will give you a REAL view of how inflation actually is, at least for those with more flexible, livable incomes. The people at the bottom just continue to get screwed .. it's just WORSE than ever now.