88% Scientifically Accurate Predictor of Gold Value

Predicting the price of gold in the future has always been more art than science. Stocks, bonds, and other investments are generally valued based on their future cash flows, an attribute that gold simply doesn’t have. In fact, beyond taking note of macroeconomic principles and using historical trends as a guide there are few agreed upon techniques for understanding gold’s price movement.

In light of this, a research paper entitled, “The price of gold: a global required yield theory,” piqued the interest of Zero Hedge because it describes a scientifically accurate predictor of gold value. Below, we highlight several of the interesting concepts it chose to pull out.

This is an overview of the concept:

“In this paper, we offer a gold asset pricing theory that treats gold as a store of wealth. We demonstrate a theoretical and empirical link between gold price, inflation, and foreign exchange rates and the general valuation of the stock market.

“Our approach is based on a generalization of Required Yield Theory (Faugere-Van Erlach [2003]). Required Yield Theory explains the valuation of financial assets via investors’ general requirement to earn a minimum expected after-tax real return equal to long-term GDP/capita growth.

“We hold that since gold fulfills the unique function of a global store of value, its yield must vary inversely to the yield required by any financial asset class, thus providing a hedge in the case where such assets are losing value.

“Our theory explains about 88% of actual $USD gold prices and 92% of actual gold returns on a quarterly basis, including the peak prices of gold, over the 1979-2002 period.”

Here is an introduction to the Required Yield Theory:

“Hence, our theory postulates that movements in the global real price occur because of the precautionary demand for gold, which largely depends on changes in the inverse real P/E (or required yield) of other assets classes combined.

“A consequence of this postulate is that a decline in the value of the stock market index does not necessarily entail flight to gold when, for example, expected stock earnings are also falling to maintain a constant real P/E ratio.

“On the other hand, flight to gold will happen when stock market prices are dropping faster than expected earnings due to acceleration of inflation for example.”

The complete PDF of the recommended gold research report can be found here. For more details from Zero Hedge, including an excerpt on how well the theory applies to the gold market at the time the article was written, visit its coverage of a scientific theory on the fair value of gold.