The (Asymmetric) effect of El Niño and La Niña on gold and silver prices in a GVAR model

Abstract

Recent studies show that El Niño episodes are generally inflationary because they tend to increase the prices of agricultural commodities and crude oil. Given this, in this paper 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., El Niño shock. 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 to capture the transmission of global climate-related shocks while simultaneously accounting for individual country peculiarities. The results show that both gold and silver serve as good hedges in periods of inflation and rare disaster risks resulting from El Niño negative shocks. Interestingly, silver is a better hedge than gold, as implied by bigger positive real returns in response to El Niño shock. At the same time, La Niña 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 stemming from El Niño events by investing not only in gold, but more so in silver.