The Macroeconomic Determinants of Volatility in Precious Metals Markets

The Macroeconomic Determinants of Volatility in Precious Metals Markets

1. Introduction

Trading in commodities, in both cash and derivatives markets, as an alternative
investment class to traditional portfolios comprising stocks and bonds has grown
significantly in recent years. This reflects their use both as individual investments and as
part of the diversified portfolios of hedge and other investment funds (Edwards and
Caglayan, 2001), although individual investors have clearly been attracted to the
spectacular gains in prices made in recent years and especially following the collapse of
equity markets in March of 2000. Volumes now traded are significant. For example, as at
June 2007 commodity contracts outstanding, comprising agricultural commodities as well
as metals, oils and other resource commodities, were in excess of US$7.6 trillion
compared with equity related contracts of US9.2 trillion. Of these totals gold and trading
in other key precious metals (silver, platinum and palladium) comprised a significant
US$0.5trillion in outstandings (BIS, 2008: Table 19). Given the economic significance of
the precious metals market it is surprising the paucity of published research investigating
the price dynamics and linkages between these assets as well as between precious metals
and other asset classes.

Our primary goal in this article is add to the existing knowledge of these price
relationships as well as determining the precise nature and role of precious metals trading
both as individual assets and as a general asset class. To accomplish this task we
investigate the macroeconomic determinants of volatility in the precious metals market
defined by those financial contracts on gold, silver, platinum and palladium. We argue

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