The Price of Gold

Abstract

Economists forecast the price of gold and annual output as if these were conventionally determined by the structure of market supplies and demands for newly produced commodity flows. Even when adjusted for changes in inventories, these models have been unable to explain the fluctuations experienced in actual gold markets. On the other hand, gold dealers have been equally unsuccessful in attempting to relate the changes in gold prices directly to movements in the traditional monetary variables thought to be important, such as the rates of change in the price level. This paper shows that neither approach can be successful without explicit consideration of the elasticities of supply and demand for gold stocks held outside those of producers or the central banking systems, estimated to exceed 1,000 million troy ounces. The fact that these holdings are orders of magnitude larger than annual production, given the important role of the dollar 's movements under flexible exchange-rales, suggests to us that the appropriate model for estimation is a stock exchange rather than the commodity model favored by economists or gold specialists.

This new approach considers gold as high powered money free of currency risk appropriately identified in a capital-assel-pricing model in which these stocks exchange with equities, bonds and other forms of money on the basis of asset-price expectations. Such a model, properly identified, reconciles the opposing economic market and monetary theory applications, and is described. It implies that during periods of monetary disturbance substantial premiums will be paid for gold, as evidenced by North American producers' shares trading in open markets free of unanalyzed risks other than fluctuations in domestic asset prices. Gold is the foreign asset in portfolios, free of currency risk. A simple test shows that such premiums have been paid equal to two or three times the value of the replacement capital of producers. This finding is consistent with the expectations of Tobin¹ for capital markets in general equilibrium. The movements of the premium are as predicted for movements in the other asset prices: viz., the interest rate, the rate of inflation and the dollar exchange rate for traded goods.

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Notes on contributors

KARL TSUJI

Richard Newcomb is Professor of Mineral Economics at the University of Arizona College of Engineering and Mines and Karl Tsuji is Research Associate, Department of Mining and Geological Engineering.