The (Asymmetric) Effect of El Nino and La Nina on Gold and Silver Prices in a GVAR Model

Recent studies show that El Nino episodes are generally inflationary, due to increases in the prices of agricultural commodities and crude oil. Given this, we examine the inflation-hedging property of gold (along with silver) from a novel perspective by analysing the impact of a negative shock to the negative component of Southern Oscillation Index (SOI) anomalies, i.e., an El Nino effect. To this end, we apply a large-scale global vector autoregressive (GVAR) model to 33 countries covering both developed and emerging markets using quarterly data from 1980:Q2 to 2019:Q4. The GVAR methodology provides an appropriate framework as it allows us to capture the transmission of global climate-related shocks while simultaneously accounting for individual country peculiarities. We find that both gold and silver serve as good hedges in periods of inflation and rare disaster risks resulting from an El Nino negative shock. Interestingly, silver is a better hedge than gold, as implied by bigger positive real returns in response to the El Nino. At the same time, La Nina shocks, captured by a positive effect to the positive component of SOI anomalies, fail to have a statistically significant impact on either gold or silver real returns. Overall, our results confirm the inflation-hedging benefits offered by the two precious metals, suggesting that investors can offset losses resulting from inflation-related risks resulting from El Nino events by investing not only in gold, but more so in silver.