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The Golden Dilemma

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  • Claude B. Erb
  • Campbell R. Harvey

Abstract

While gold objects have existed for thousands of years, gold’s role in diversified portfolios is not well understood. We critically examine popular stories such as ‘gold is an inflation hedge’. We show that gold may be an effective hedge if the investment horizon is measured in centuries. Over practical investment horizons, gold is an unreliable inflation hedge. We also explore valuation. The real price of gold is currently high compared to history. In the past, when the real price of gold was above average, subsequent real gold returns have been below average consistent with mean reversion. On the demand side, we focus on the official gold holdings of many countries. If prominent emerging markets increase their gold holdings to average per capita or per GDP holdings of developed countries, the real price of gold may rise even further from today’s elevated levels. In the end, investors face a golden dilemma: 1) embrace a view that ‘those who cannot remember the past are condemned to repeat it’ and the purchasing power of gold is likely to revert to its mean or 2) embrace a view that the emergence of new markets represent a structural change and ‘this time is different’.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18706.

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Date of creation: Jan 2013
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Handle: RePEc:nbr:nberwo:18706

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  1. Bordo Michael D. & Kydland Finn E., 1995. "The Gold Standard As a Rule: An Essay in Exploration," Explorations in Economic History, Elsevier, Elsevier, vol. 32(4), pages 423-464, October.
  2. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-run Stock Market Outlook: An Update," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 1295, Cowles Foundation for Research in Economics, Yale University.
  3. Dirk G. Baur & Brian M. Lucey, 2010. "Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold," The Financial Review, Eastern Finance Association, Eastern Finance Association, vol. 45(2), pages 217-229, 05.
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  6. Burton G. Malkiel, 2003. "The Efficient Market Hypothesis and Its Critics," Journal of Economic Perspectives, American Economic Association, American Economic Association, vol. 17(1), pages 59-82, Winter.
  7. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, Elsevier, vol. 4(2), pages 129-176, March.
  8. French, Kenneth R., 1983. "A comparison of futures and forward prices," Journal of Financial Economics, Elsevier, Elsevier, vol. 12(3), pages 311-342, November.
  9. Burton G. Malkiel, 2003. "The Efficient Market Hypothesis and Its Critics," Working Papers, Princeton University, Department of Economics, Center for Economic Policy Studies. 111, Princeton University, Department of Economics, Center for Economic Policy Studies..
  10. Geert Bekaert & Xiaozheng Wang, 2010. "Inflation risk and the inflation risk premium," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 25, pages 755-806, October.
  11. Pukthuanthong, Kuntara & Roll, Richard, 2011. "Gold and the Dollar (and the Euro, Pound, and Yen)," Journal of Banking & Finance, Elsevier, Elsevier, vol. 35(8), pages 2070-2083, August.
  12. Fama, Eugene F & French, Kenneth R, 1987. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums,and the Theory of Storage," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 60(1), pages 55-73, January.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Value of gold: is this time really different?
    by Economic Logician in Economic Logic on 2013-02-08 15:20:00
  2. Placer son argent dans l'or, un bon investissment ?
    by trenault@economiematin.fr (Captain Economics) in Economie Matin on 2013-07-18 16:10:11
  3. In gold we trust?
    by David Andolfatto in MacroMania on 2013-12-24 20:06:00

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