Price Dynamics of the World Gold Market: A Model Incorporating Inventories

Abstract

Gold is regarded as a strategic mineral in many countries and its price is a key indicator of global business confidence. Therefore, various studies, albeit static analyses, have been conducted on the world gold market. There is need for dynamic modelling of the market, which would enhance understanding of the world market conditions, especially the long-term tendency of world gold prices, and hence facilitate long-term planning. Production schedules in many producing countries, especially in the developing world, have reacted to short-term price fluctuations, making them unstable. This study incorporates an inventory equation into the world market model for gold. Simultaneous equation approaches are used to estimate the model. From this model are derived the time-path for the world market price of gold and its dynamic characteristics in terms of whether or not there is evidence of convergence (dynamic stability) and the nature of such convergence. All regression results are consistent with theory, except that the supply function has a positive and significant constant, which may be linked to expectations that are rife in the market. However, both supply and inventory functions have very low explanatory powers. The price time-path converges without oscillations, from below, towards an intertemporal equilibrium. This equilibrium is estimated at slightly over US$100,000.00 per kilogram, based on an average world income (including income projections) calculated over a century (1980-2079). If the assumption of average income is relaxed, the intertemporal equilibrium price becomes variable dependent on the actual values of world income at a given time, which however, does not alter its dynamic characteristics. The results, therefore, show that gold price is dynamically stable. Short-term fluctuations, which are sometimes extreme, have no long-term effect on gold attractiveness, which means that they should not affect long-term production plans, especially if they are price reductions. The study could be improved by incorporating technical progress and price expectations into the model. Generally, it would be expected that inclusion of technical progress, especially as a uniform trend over time, would result in a moving equilibrium without altering the conclusion on convergence.