A Gold Bubble (2012)
This paper examines whether bubbles occur in gold prices using the sup-ADF tests developed by Phillips, Wu and Yu (2011). The paper also proposes a model of the behavior of speculators in order to assess whether they have an impact on price, and therefore in bubbles forming.
They find evidence of bubble periods from the beginning of the new millennium using this method and argue that this is due to the increased importance of speculators in the demand for gold, as borne out by World Gold Council statistics. This finding is related to their earlier paper on gold’s safe haven status under threat, posing a risk to financial stability.
An unique feature of the paper is that it does not make any assumptions about the fundamental determinant of gold value, the role dividends would play for stock prices for instance. This allows them to ignore 2 issues. Firstly the contentious and unresolved issue of what is (are) the determinant(s) of gold’s value. And second a common issue in financial research, the joint hypothesis problem, where any misspecification of how the gold price is modeled is included in the bubble component so that it cannot be shown decisively if a bubble is present or the model used by the researcher needs correction.
Opinion: A weakness of this approach however is that a finding of explosiveness in the asset price, which is interpreted as a bubble having existed at some point, may not indicate a bubble but instead be due to explosiveness in the fundamental determinant(s) of gold’s value. Explosiveness implies that the numbers (price, dividends or some other measure) have jumped to a new level and have not come back to normal. For shares this could be interpreted as a permanently higher price due to a permanently higher profit level, giving permanently higher dividends, which would show as explosiveness but not imply a bubble.
Method: Recursive Right Tailed Augmented Dickey Fuller tests for price explosives from Phillips, Wu and Yu (2011)
Data:Gold price from 1970 to August 2012
Full Citation: Baur, Dirk, and Kristoffer Glover. “A Gold Bubble?” Available at SSRN 2166636 (2012).
Abstract: In this paper we use a test developed by Phillips et al. (2011) to identify a bubble in the gold market. We find that the price of gold followed an explosive price process between 2002 and 2012 interrupted only briefly by the subprime crisis in 2008. We also provide a theoretical foundation for such bubble tests based on a behavioural model of heterogeneous agents and demonstrate that periods of explosive price behaviour are consistent with increased chartist activity in the gold market. The identification strategy yields economically intuitive results and is a simple alternative to using more complex estimation techniques commonly used in the heterogenous agents literature.