Is It Worth It

Executive Summary

This project aims to analyze various factors that affect the gold pricing, and that gold price does not only depend on supply and demand, as most commonly thought. Based on the results achieved, this project will develop a model to predict gold prices and infer if gold is a good investment. For the analysis, we took the monthly values of various macroeconomic factors like gold prices, oil prices, inflation, Dollar VS Euro exchange rate and production of world gold. We started with linear regression and changed it to non-linear model based on significance levels of the independent variables, and came up with an equation that can predict gold price. Based on the historical and ongoing trends, we concluded with the suggestion that Gold is still a good investment choice.

Introduction

Gold, one of the most precious metals known to man, was used by many economies as the currency standard due to its rarity, durability, easy divisibility, and the general ease of identification, often in conjunction with silver. Even after silver was no longer basis of currency, gold remained a base global currency until the collapse of the Bretton Woods System in 1971. gold has continued to play an important role in the global economy, and in the recent times, gold prices have been correlated with key factors impacting the economy like oil prices, inflation and exchange rates.

Through this study, we plan to analyse the influence of various factors on the price of gold, and try to answer questions like:

Does gold prices depend on the factors like oil, currency exchange rates, inflation or it only depends on supply and demand? Based on the model develop, we would try to predict gold prices, which in turn will interpret if gold investment is really a safe investment?

The conjectures:

1. Oil prices: Oil prices have been one of the most influencing factors in US and world economy. It is consumed and traded by virtually every economy in world.

2. USD to EURO exchange rate: Euro is one of the most important currencies in the world after USD. And since it represents a basket of multiple currencies, we are limiting our scope to Euro.

3. Inflation: gold prices are considered as barometer of inflation and historically it is claimed that inflation and gold prices have strong correlation.

Data Collection

We collected average monthly values of the above given factors since the inception of Euro in January 1999 from various financial websites like monex.com, kitco.com, bls.gov, inflationdata.com, ioga.com. We were unable to find data regarding supply and demand of gold in world, so for the purposes of this project, annual gold production was used, with the assumption that there is no gold supply deficit. The annual numbers were divided by 12 to come up with monthly averages.

The Analysis

Analysis of Scatter plots

Gold vs. Exchange Rate (Graph 1)

When comparing average monthly prices for gold and the Euro$/USD exchange rate for the past eight years, there is a strong negative relationship at -.80 slope. Therefore, we can conclude that as the dollar becomes weaker as gold prices increase. As you can see from the Graph (1), there are many more variations in gold prices when the dollar is weak than when the dollar is strong.

Gold vs. Inflation (Graph 2)

When evaluating the relationship between Gold and Inflation over the past 8 years one will see surprising results. There appear to be no real significant correlation between the two variables. One would think that when inflation was high Gold prices would be at their highest and when looking at the chart it appears that way. However, the results show that that the gold prices are at there highest levels when inflation is moderate.

Gold vs. Oil Prices (Graph 3)

The strongest relationship was found between Gold prices and Oil prices and both of these valuable commodities are trading at their highest levels. It appears that their value is in unison with a .91 slope over the past 8 years. Also, a lot more variation can be seen when Gold an Oil prices are high.

Gold vs. Monthly Production (Graph 4)

To create monthly production, we used annual production numbers to fit into our model. When looking a Gold Price versus monthly production, one can see that there are patterns at every price level but there is still variation in monthly production at these price levels. Furthermore, gold has a very low negative correlation with monthly production with a slope of -.19.

Gold vs. S&P 500 (Graph 5)

Average Monthly gold prices and the S & P 500 show an interesting pattern. At one point gold prices stay the same as the S & P rises and at the other point gold prices rise as the S & P rises. This is interesting because it appears that the market was rising without gold prices rising from January of 1999 to August 2000. Then, it looks like the market corrected itself by pulling back from a high of 1485 in August of 2000 to a low of 838 in February of 2003. The S & P then rose again and this time gold prices rose along with it until today.

Standard Residuals

Std. Residuals vs. Exchange Rate (Graph 1, 6, and 7)

As you can see from graph 1 there is a downward curving pattern between gold prices and exchange rates. Though the exchange rate in our linear model process is significant, we decided to take 1/exchange rate because of the pattern in graph one. Also, we have helped our Std. residuals pattern if you look at Graph 6 and 7. It appears that the pattern is less significant in our nonlinear model (Graph 7) which adds to the significance of 1/exchange rate. In our linear model (Graph 6), exchange rate has a lot more variation at the when inflation is low.

Std. Residuals vs. Inflation (Graph 2 and 8)

When looking at graph 2 & 8 there appears to be no patterns and because of this variables significance in both models we decided to leave this variable alone. Inflation appears to have a completely random distribution amongst gold prices and standard residuals.

Std. Residuals vs. Oil Prices (Graph 3, 9, and 10)

In graph 3, Gold vs. Oil, there is an upward sloping pattern; when oil increases gold increases.