Gold Prices and a Leading Index of Inflation. 1990.
Moore (1990) attempts to examine the idea that the link between gold returns and inflation lies in asset substitution, as discussed by Fortune (1988). He uses a leading index of inflation as a proxy for anticipated inflation compiled by the Colombia University Business School. Based on the model the investor would buy gold when the index pointed to a rise in inflation, selling holdings of either bonds or equities. When a fall was expected based on the index the investor would do the reverse moving their assets out of gold.
Their strategy leads to an annualised return of over 20% and 18% using stocks and bonds respectively between 1970 and 1988. Simply holding gold would have only yielded 14%, 11% and 8.7% stocks and bonds individually.
The successful use of a predictor of inflation to forecast gold prices seems to give further empirical back up to Fortune’s (1988) suggestion of an asset substitution channel existing driving gold and inflation into a long run equilibrium relationship. However the returns seem to be dominated by a long run appreciation in the gold price at the beginning of the sample, after the closure of the gold window up to the sharp fall in the early 1980’s. An update of this piece looking at more recent data would shed more light on the issue.