The Macroeconomic Determinants of Volatility in Precious Metals Markets



while Chow et al. (1999) suggest that commodities are in fact more attractive when the
general financial climate is negative. This evidence argues of a positive contribution from
the inclusion of key commodity contracts for trading and investment. Of particular
interest in recent years has been the market for precious metals, with large rises in gold
and silver prices and associated increases in other related metals.

Two recent studies provide detailed accounts of the potential risk-return tradeoff in
commodity markets. Gorton and Rouwenhorst (2006) focus on the behavior of the one of
the most commonly used indexes, namely the Goldman Sachs Commodity Index (GSCI).
These authors construct the equally-weighted monthly GSCI index for the period
between 1959 and 2004 and show that this index has the same risk premium as equities,
although the actual risk was less during the period. Importantly, they point to a negative
correlation of the GSCI index with stocks and bonds, indicating important financial
benefits to investors from including commodities in portfolio diversification strategies. In
addition, there is a useful hedging advantage linked to the importance of commodity
prices to underlying inflation. The conclusions of Gorton and Rouwenhorst (2006) imply
that commodities can be best viewed as a single asset class that have attractive risk-return
patterns and furthermore, are useful for portfolio diversification. This last point is of
considerable significance for hedge and investment fund managers who are limited in
their international investments due to the increasing integration of international stock and
bond markets.



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