Empirical Studies in Social Sciences

6th International Student Conference, Izmir University of Economics, Izmir Turkey

Effects of Oil Price, Interest Rate and Dollar Price of Euro on Gold Price
Hakan GNE Dokuz Eyll niversitesi letme Fakltesi/Senior 6114 sokak No:19 D:6 Karyaka ZMR Phone: ++ <05556458296> E-mail: <hgunes1987@hotmail.com> Fatma GLER Dokuz Eyll niversitesi letme Fakltesi/Senior Phone: ++ <05362204838> E-mail: <gulergoksel@hotmail.com> Merve A. ZKALAY Dokuz Eyll niversitesi letme Fakltesi/Senior Phone: ++ <05053368519> E-mail: <merwe_otesi@hotmail.com> Bolor LAAGANJAV Dokuz Eyll niversitesi letme Fakltesi/Senior Phone: ++ <05555566143> E-mail: <bolor_balt@yahoo.com>
Abstract We have witnessed sharp increase in gold prices in recent years. Since gold has many functions as directly used in jewellery, hedging against inflation and providing economic and physical safety etc, it is very important to know what the determinants of gold prices are. This paper, using the world gold price data for over 10-year period from 2000 to 2009, aims to explain the rise in gold price by considering the effect due to changes in oil price, eurodollar parity and interest rate. Thus we can understand the components of the gold price and advise policy. In our analysis, we applied Ordinary Least Squares method to estimate our regression model, cointegration test to find out if there is long run relationship between gold price and the other variable and made unit root test, specifically Augmented Dickey Fuller test, to investigate the stationarity. After that Granger- Causality test between gold price and each independent variable; except oil price, is examined. We omitted oil price from our model. This is because, just interest rate is not I(1) process, but it is I(0) . The result without oil price shows that there is no long-run relation between gold price, interest rate and eurodollar parity and Granger- Causality does not occur for both gold price-interest rate and interest rate-gold price, and for gold price-eurodollar parity and eurodollar parity-gold price.

Key words: Gold price, oil price, euro dollar parity, interest rate, stationarity, ADF, cointegration JEL Classification: C22, D40, F31

1.Introduction
In recent years gold has been controversial because of sharp increase in gold prices. Price of gold exceeded 1092$ per ounce in New York Stock Exchange in November 2009. 2008 Global Economic Crisis give rise to uncertainty in the global economy including developed and developing countries. Gold is not only used in jewellery but also used in industrial and medical applications. Moreover, gold is used for investment purposes by governments, households, institutional and private equity investors. If there is an economic uncertainty then gold become an insurance. In such cases, gold can protect us against the inflation and deflation. In addition, according to the World Gold Council (2006) Central Banks hold gold reserves because gold provides economic and physical safety, sustains world wide confidence and offers diversification benefits. Gold is a frequently investigated topic in literature. However each studies approaches our variables from very different point of view. Ghosh et al. (2002) divided demand for gold into two: one of them is use demand and the other one is asset demand. Use demand consists of production of jewelery, medals and coins. They matched asset demand with effective hedge. We have mentioned that gold had become an insurance policy, when there was an economic uncertainity. Capie et al. (2005) mention that even after money was invented, gold have remained to be hedge. They also explained that, if we have gold as money, this means we link currency to gold at a fixed price. In this case, price of gold can not determined by the government or central banks and automatic stabilizing mechanism occurs. Furthermore, Vaihekoski and Patari (2007), group the demand for gold into two categories. These are the demand for the physical gold and demand for investment purposes of institutional and private equity investors. Basically, in literature, most of the researches emphasized on hedge characteristics of gold. For instance; Aggarwal (1992) mentioned about golds failure of being short run hedge against inflation. According to him gold is an effective hedge against inflation and political uncertainity in the long run, not in the short and medium terms. An asset is an inflation hedge if it yields a return exceeding the inflation rate (Hsieh et al, 2002). Likewise, Gosh et al. (2004) have found the price elasticity of gold, compared to the US CPI, lead to a conclusion that gold is a long-run hedge against inflation. Capie et al. (2005) explained why gold has been a hedge. The reason behind this situation is gold is homogenous asset and it is easily traded in continious open market. Levin and Wright (2006) emphasized in their article that, gold is a long-term hedge against inflation. However, there are short-run deviations from the long-run relationship between the price of gold caused by short-run changes in the US inflation rate, inflation volatility, credit risk, the US dollar tradeweighted exchange rate and the gold lease rate, as well as there is a slow reversion towards the long-term relationship following a shock that causes a deviation from this long-term relationship. Kucukozmen et al. (2008) investigated whether gold or oil is a better indicator of the inflation and tried to find out which one provides a better hedge against the inflation in Turkey. Kucukozmen et al. (2008) reached a conclusion that gold is a better inflation indicator than oil, whereas inflation hedging abilities of both gold and oil depend on the existence of a stable long term relation with the inflation rate which is not existed.

Empirical Studies in Social Sciences

6th International Student Conference, Izmir University of Economics, Izmir Turkey

Several researches are made about effects of exchange rates on gold prices. Han et al. (2000) studied the long term and short term relationships between the exchange rate of AUS/USD and the gold price. They found out that there is a positive relationship between AUS/USD exchange rate and gold price. Vaihekoski and Patari (2007) used US/world exchange in their model which is statistically significant. Moreover they found out that the dollar depreciation would lower the price of gold to investors outside the USA and raise the demand for gold and raise US dollar price of gold. For a non US investor, dollar depreciation would lower the price of gold for them and make it more attractive. Furthermore, a research about gold was made by Ozturk and Acikalin (2008) comprising Turkey. They analyzed whether gold is an internal hedge or an external hedge against TL. This study found out that gold is an internal and external hedge which means gold is hedge against possible TL depreciation and rising inflation. Also authors concluded that gold can help for monetary policy decisions because gold price is a good indicator of expected inflation. The aim of this paper is to analyse the effects of oil prices, euro dollar parity and interest rate on gold prices. The results of this research can contribute to policymakers and analysts to understand determinants of gold price better. As well as the financial markets can be understood thoroughly by these actors. By this way they can take the most appropriate position. This papers contribution differs from the contributions of previous gold studies. First of all, we take into account the effect of interest rate. Also this study uses more frequent and the most recent data. The remaining sections of the study is as follows. Section II includes our data and the method of model, Sub-head under the Section II presents the estimated results, finally Section III is the conclusion part with short summary of our study.

2. Model
In this section, we will summarize our models data and present the methodology of our model. The data are monthly and cover the period from January 2000 to December 2009. There are 120 monthly observations, obtained from various sources. The data set is given in the Appendix of this paper. We obtained our dependent variable, gold price, from The London Bullion Market Association. As can be seen from Figure 1, there is an increasing trend in gold price and reached its the highest point, $1134,72, on December, 2009. During last 6 months gold prices tend to increase. One of our independent variable, oil price, is taken from Official Energy Statistics from the US Government. Oil prices increased rapidly during this period and the reasons behind this can be explained by the Iraq War, Asian growing demand for oil. However in last 2 quarters of 2008, oil prices decreased sharply because of Global Economic Crisis and reached to a minimum level, $31, that had not been reached since 2004. For last 6 months,
3

oil price started to increase again (See Figure 2). We expect a positive relationship between oil price and gold price. Another independent variable, euro dollar parity, is provided from Board of Governor of the Federal Reserve System. Euro dollar parity specifies how much one euro is worth in terms of dollar. Euro started to be in circulation from 2000 in EMU and thats why we collected our time series data from this date. We expect a positive relationship between eurodollar parity and gold price. This is because as dollar depreciates against euro, for nonUS citizens purchasing gold will be cheaper and demand and price of gold increases. The last independent variable is interest rate. It is obtained from Board of Governor of the Federal Reserve System. We took 3 month US Treasury Bills interest rate from secondary market into our model. We expect a negative relationship between interest rate and gold price. As interest rate decreases, opportunity cost of depositing money to the bank will decrease and people can start to invest in gold more. Figure 3 and 4 illustrates the data of interest rate and eurodollar parity, respectively.
Figure1. Gold Price, 2000-2009 Figure2. Oil Price, 2000-2009

Figure3. Interest Rate, 2000-2009

Figure4. Euro dollar parity, 2000-2009

Empirical Studies in Social Sciences

6th International Student Conference, Izmir University of Economics, Izmir Turkey

Our regression equation is;

Gold t = 1t + 2t Oil t + 3t Eurodollar
t

+ 4t Interest t + t

Where gold is our dependent variable and it shows gold prices. t is constant term and 1 we have 3 independent variables; oil price, eurodollar parity and interest rate respectively. In order to evaluate the effects of oil prices, eurodollar, interest rate on the gold prices we used Ordinary Least Squares method. Unit root test, -Augmented Dickey Fuller test- is applied to gold price, oil price and eurodollar parity, interest rate series to investigate the stationary properties of the relevant series. After that, we examined relationship between the nonstationary variables by using cointegration test which investigates the long term relationship between variables. To understand whether there is cointegration or not; firstly, we obtained residual series from OLS estimation and applied unit root test on it. In addition, we applied Granger- Causality test for each independent variables with dependent variable in pairs. 2.1. Emprical Results To observe the effects of oil prices, interest rates and euro dollar parity on gold prices, their regression is calculated by using OLS estimation procedure. Results are presented in Table 1.
Table 1. Determinants of gold price

Coefficient R 2 0,780 n=120

Constant Oil Price -421,195* 2,683* (108,412) (0,895) DW- stat 0,076

Euro/$ 729,823* (110,174)

Interest Rate -16,837* (6,701)

* Denotes significance at the %5 interval.

Results indicate that all variables are statistically significant at %5 interval. The 77 percent of the variation in gold price can be explained by the model in %95 confidence interval. Durbin-Watson d statistic is 0.07 and as a rule of thumb, if R2 is greater than DurbinWatson d statistics we can suspect from spurious regression. Even, there are significant relationship between variables, this result may be caused by nonstationary time series used in our model. Therefore, Augmented- Dickey Fuller tests are applied at level to our time series variables. The unit root test results for all series are presented in the Table 2 below.

Table 2. Unit Root Test Results

Series Gold Price

Trend Present No Yes No Yes No Yes No Yes

Tau-statistics 1,653 -1,313 -2,668 -4,374 -1,025 -3,011 -1,438 -1,440

5% critical values -2,886 -3,448 -2,886 -3,449 -2,886 -3,448 -2,886 -3,448

Decision
D RH D RH

0 0

Oil Price Euro/$ Interest Rate

D RH 0 R 0 H D RH D RH D RH D RH
0 0

0 0

An intercept was included in the model and the test was performed in the absence of a trend term and with a trend term present. Test results indicate that all of the series are nonstationary, but the oil price with trend is stationary. Plots of variables strengthen our test results. The plots of variables as indicated above, already have a general appearance of nonstationary but, in the interest graph there is an uncertainity of nonstationary. After that, we applied the unit root test for the first differences of the nonstationary variables. Results are given in the below in Table 3.
Table 3. Unit Root Results- First Differences

Series Gold Price Interest Rate Euro/$

Trend Present No Yes No Yes No Yes

Tau-statistics -10,286 -10,698 -6,114 -6,088 -7,838 -7,796

5% critical values -2,892 -3,458 -2,886 -3,448 -2,886 -3,448

Decision
R H R H R H R H R H R H

0 0

0 0

0 0

Gold prices, interest rate, euro dollar parity became stationary in I(1) process. The plots of the first differences for gold price, interest rate and eurodollar parity are presented below. 6

Empirical Studies in Social Sciences

6th International Student Conference, Izmir University of Economics, Izmir Turkey

Consequently, according to test results, oil price is I(0) , and the other variables are I(1). Plots have a general appearance of stationary as you can see at figures below.
Figure 5. Stationary process of Gold Price Figure 6. Stationary process of Interest Rate

Figure 8. Stationary process of Eurodollar Parity

To utilize cointegration method, all series have to be simultaneously integrated of the same order. Since oil price is I(0) and the other variables are I(1), we dropped it from our regression model. Therefore, we re-run the regression by omitting the oil price. See table 4.
Table 4. Determinants of gold price

Coefficient R 2 0,762 n=120

Constant -662,474* (75,028) DW-stat 0,070

Interest Rate -8,146 (6.243)

Euro/$ 1016,282* (56,606)

* Denotes significance at %5 interval.

We obtained residual series from this model and applied unit root test to this residual series. Augmented Dickey Fuller test statistics is -0,3390 and critical value at %1 significance level is -3,9. Since critical value is less than test statistics, we do not reject null hypothesis. Hence, we reached that residual series has a unit root. If residuals has unit root there is no cointegration which means there is no long-term relationship between the independent variables and dependent variable. Lastly, we investigate causality, direction of influence of these time series. In order to investigate causality, we executed Pairwise Granger causality test procedure. Granger causality test assumes that, series used in test are stationary. Thats why we used first differences of time series. In addition, we should find optimum lag numbers to apply Granger causality test for each pairs; gold and interest rate, gold and eurodollar parity. To find optimum lag numbers, we estimated Vector Autoregression for each pairs in different lag numbers one by one. After that, we checked the Akaike Information Criteria and we picked the lag number in which VAR has minimum Akaike Information Criteria. Our data is monthly time series so we repeat it until the tenth lag. For gold and interest rate and for gold and eurodollar parity optimum lag number is 1. The results of Granger causality test are presented in Table 5.
Table 5. Pairwise Granger Causality Test Results

Null Hypothesis Gold price does not Granger cause Interest Rate. Interest Rate does not Granger cause gold price. Euro dollar does not Granger cause gold price. Gold does not Granger cause euro dollar.

F statistics 0,010 0,484 0,052 0,041

The null hypothesis that gold price does not Granger cause interest rate, and also interest rate does not Granger cause gold price can not be rejected. Moreover, eurodollar parity does not Granger cause gold price and gold price does not Granger cause eurodollar parity in the short-run. There are not causality between gold-eurodollar parity and gold-interest rate.

3. Conclusion
In this paper, effects of oil price, euro dollar parity, interest rate on gold price are analysed. First, we run the regression by using OLS estimation process. Then we suspect from spurious regression and stationary properties of the gold price, interest, oil prices and eurodollar parity series. All variables must be the same order of integration, this is a precondition for cointegration. Interest rate has different order. Thats why we drop the interest rate from our model. We applied unit root test to this models residual series to examine cointegration relationships. As a result of this test, we conclude that there is no cointegration, no long-term relationship, between independent variables and dependent variable. Furthermore, in order to determine the casual relationships between /$ exchange rate and gold price and between oil price and gold price, Pairwise Granger causality test is used. The results indicate that gold does not Granger cause interest rate and interest rate does not Granger 8

Empirical Studies in Social Sciences

6th International Student Conference, Izmir University of Economics, Izmir Turkey

cause gold, similarly, gold does not Granger cause the eurodollar and eurodollar also does not Granger cause gold price. As a result there are no short term relationships between these variables either. During our research, we expect a relationship between our independent variables and dependent variable. We expected to explain variations in gold prices by variations in our regression model. However results do not support our expectations. We find out that there is no cointegration between our dependent variable; gold and independent variables; interest rate and eurodollar parity. Consequently, we face with a spurious regression. Advanced econometric methods and longer time series data can lead different results from ours. This research can be an example for the further papers.

References
Aggarwal, R. (1992). Gold Markets, In: Newman, P., Milgate, M. and Eatwell, J. (eds.) The New Palgrave Dictionary of Money and Finance, 2, Basingstoke, Macmillan, (pp. 257-258).
Capie, F., Mills, T.C., & Wood G., (2005). Gold as a Hedge against the Dollar. Journal of International Financial Markets, Institutions and Money, 15.

Ghosh, D.L., Macmillan, E.J., & Wright, R.E. (2002). Gold as an Inflation Hedge?. Studies in economics and finance, 22. (1). 1-25. Dooley, M. P., Isard, P. & Taylor, M. P. (1995). Exchange Rates, Country-Specific Shocks and Gold. Applied Financial Economics, 5, 1219. Han, A., Xu, S., & Wang, S. (2008). Australian Dollars Exchange Rate and Gold Prices: An Interval Method Analysis. 7th International Symposium on Operations Research and Its Applications, 46-52. Harmston, S. (1998). Gold as a Store of Value, World Gold Council, Research Study No.22, http://www.gold.org/value/reserve_asset/index.html. Accessed May 2007. Hiller, D., Draper, P., & Faff, R. (2006). Do Precious Metals Shine? An Investment Perspective. Financial Analysts Journal, 62(2), 98-106. Hsieh, C.T., Hamwi, I.S., & Hudson, T. (2002). An Inflation Hedging Portfolio Selection Model. IAER. Ivanova, K., & Ausloos, M. (1999). Low q-moment Multifractal Analysis of Gold Price, Dow Jones Industrial Average and BGL-USD Exchange Rate. The European Physical Journal B, 9, 665-669. Kucukozmen, C., Oguz, D., & Yanik, I. Which One is a Better Indicator and Hedge Against Inflation, Oil or Gold? Evidence from an Emerging Market. Levin, J. E., & Wright, E. R. (2006). Short-run and Long-run Determinants of the Price of Gold. World Gold Council , Research Study, 32, http://www.gold.org/value/reserve_ asset/index.html, Accessed May 2007. Lucey, B., & Tully, E. (2006). Seasonality, Risk and Return in Daily Comex Gold and Silver 1980 - 2002, Applied Financial Economics, 16. Ozturk, F., & Acikalin, S. (2008). Is Gold a Hedge Against the Turkish Lira. See Journal, 35-40.

10

Empirical Studies in Social Sciences

6th International Student Conference, Izmir University of Economics, Izmir Turkey

Ranson, D., & Wainright, H.C. (2005), Why Gold, not Oil, is the Superior Predictor of Infl ation. Gold Report, World Gold Council. Vaihekoski, M., & Patari, E. (2007). Gold Investments and Short- and Long-Run Price Determinants of the Price of Gold. Lappeenranta University of Technology,School of Business Finance, 1-77.

11