Gold objects have existed for thousands of years but for many investors gold has only recently become a tradable investment opportunity. Gold has been described as an inflation hedge, a “golden constant”, with a long run real return of zero. Yet over 1, 5, 10, 15 and 20 year investment horizons the variation in the nominal and real returns of gold has not been driven by realized inflation. 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. Given this situation is it time to explore “this time is different” rationalizations? We show that new mined supply is surprisingly unresponsive to prices. In addition, authoritative estimates suggest that about three quarters of the achievable world supply of gold has already been mined. 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. As a result investors in gold face a daunting dilemma: 1) embrace a view that “those who cannot remember the past are condemned to repeat it”, there is a “golden constant” and the purchasing power of gold is likely to fall or 2) embrace a view that “this time is different” and the “golden constant” is dead.
Currently, the real, or inflation-adjusted, price of gold is almost as high as it was in January 1980 and August 2011. Since 1975, periods of high real gold prices have occurred during periods of elevated concern about high future price inflation. Five years after the real price peaks in January 1980 and August 2011, the nominal (real) prices of gold fell 55% (67%) and 28% (33%), respectively. Today's high real price of gold suggests that gold is an expensive inflation hedge with a low prospective real return. The financialization of gold ownership by exchange-traded funds, however, may introduce a period of irrational exuberance.
Contagion is usually defined as correlation between markets in excess of what would be implied by economic fundamentals; however, there is considerable disagreement regarding the definitions of the fundamentals, how the fundamentals might differ across countries, and the mechanisms that link the fundamentals to asset returns.Our research takes, as a starting point, a twofactor model with time-varying betas that accommodates various degrees of market integration between different markets.We apply this model to stock returns in three different regions: Europe, South-East Asia, and Latin America.In addition to providing new insights on contagion during crisis periods, we document patterns through time in world and regional market integration and measure the proportion of volatility driven by global, regional, and local factors.
We study the interrelationship between capital flows, returns, dividend yields and world interest rates in 20 emerging markets. We use a structural VAR framework to examine the impact of shocks in interest rates and net capital flows on asset returns and the cost of capital. In contrast to previous research, we explicitly take into account a fundamental nonstationarity in the data - structural breaks induced by liberalizations. We estimate our VARs in both the full sample, pre-break and the post-break sample, with the breaks endogenously determined. We find significant differences, in particular, between the pre-break analysis and the post-break analysis. We revisit a number of important hypotheses within the VAR framework. First, the "push effect" from world interest rates to capital flows appears consistently when we cumulate impulse responses whereas contemporaneously interest rates and capital flows show no consistent correlation pattern. Second, unexpected shocks to equity flows have a strongly positive contemporaneous effect on returns, in line with the findings of Clark and Berko (1997), and Froot et al. (1998). The effect immediately dies out but there is only incomplete reversal suggesting some of the effect is permanent. This is consistent with our finding that positive shocks in net equity capital flows lead to lower dividend yields -- our proxy for expected returns. Following Bekaert and Harvey's (1999) argument that dividend yield changes reveal information about the cost of equity capital, the equity capital flow shocks lead to lower cost of capital in many countries. We find that this relation is dramatically strengthened if we estimate our VARs on the post break sample. Although part of the initial effect may be due to "price pressure", our results suggest part of the response is near permanent and beneficial. Third, we revisit the Bohn and Tesar (1996) argument that capital flows are more likely driven by "return chasing" than portfolio rebalancing. We find evidence that positive returns shocks are followed by increased short-term equity capital flows. Finally, we provide interesting new results on the transition from pre-break to post-break systems. In almost all the countries we examine, our transition analysis of equity flows suggests that when capital leaves it leaves faster than it came. These intriguing results may shed light on the recent crises in Latin America and Asia and the role of capital flight.
The emergence of new equity markets in Europe, Latin America, Asia, the Mideast and Africa provides a new menu of opportunities for investors.These markets exhibit high expected returns as well as high volatility.Importantly, the low correlations with developed countries' equity markets significantly reduces the unconditional portfolio risk of a world investor.However, standard global asset pricing models, which assume complete integration of capital markets, fail to explain the cross-section of average returns in emerging countries.An analysis of the predictability of the returns reveals that emerging market returns are more likely than developed countries to be influenced by local information.
This is the transcription of the American Finance Association's Presidential Address of January 7, 2017. The address is based on the paper "The Scientific Outlook in Financial Economics".
