The hedging effectiveness of industrial metals against different oil shocks: Evidence from the four newly developed oil shocks datasets

Abstract

Against the failure of precious metals, particularly gold, in hedging oil market risks, this study attempts to determine if industrial metals would prove otherwise. On this note, we undertake a robust analysis of the effectiveness of seven commonly traded industrial metals in providing cover for investors against oil market risks. To measure oil market risks, we use four different oil shocks data newly computed by Baumeister and Hamilton (2019) which presently serve as the most comprehensive datasets on oil shocks. Using a robust estimation technique, we observe that analyses using the multivariate framework produce more significant results than the conventional bivariate model. Additional assessment of structural breaks and exchange rate seems provide robustness to the main multivariate results. Summarizing our results, we find out that the nature of shocks, whether demand- or supply-based, determines the hedging ability of the industrial metals. Except for the oil supply shocks that are unable to be hedged by the metals regardless of the estimation model, all the other three demand-based oil shocks can be effectively hedged by virtually all the metals. While the metals can hedge economic activity shocks in a superior manner, they only offer partial hedge for oil consumption demand shocks. The hedging potentials of the metals can either be partial, full or superior against oil inventory demand shocks. Potential investors can rely on these findings to note that they can find succour in trading in industrial metals in the presence of market risks that result from different oil demand shocks. Also, it is safe to include industrial metals in their investment portfolio since it is stable even when oil price exhibit significant instabilities.