The Macroeconomic Determinants of Volatility in Precious Metals Markets Jonathan A Batten Cetin Ciner and Brian M Lucey Jonathan A Batten Graduate School of Management Macquarie University CBD Campus Level 6 51 57 Pitt St Sydney NSW 2000 Australia Tel 61 2 8274 8344 Fax 61 2 8274 8370 Email jonathan batten mgsm edu au Department of Finance Hong Kong University of Science Technology Clear Water Bay Kowloon Hong Kong Tel 852 2358 8202 Fax 852 2358 1749 Email jabatten ust hk Cetin Ciner Cameron School of Business University of North Carolina Wilmington Wilmington NC USA Tel 1 910 962 7497 Fax 1 910 962 3922 E mail cinerc uncw edu Brian M Lucey Trinity College Dublin School of Business and Institute for International Integration Studies The Sutherland Centre Level 6 Arts Building Dublin 2 Ireland Tel 353 1 608 1552 Fax 353 1 679 9503 Email blucey tcd ie Date 1st June 2008 JEL C32 G10 Q40 Keywords Commodity prices Gold Macroeconomic factors Silver Volatility Abstract We investigate key macroeconomic factors that impact the price returns of precious metals markets The markets investigated were gold silver platinum and palladium whereas the macroeconomic factors accommodated business cycle monetary environment and financial market sentiment factors The key findings present limited evidence that the same macroeconomic factors jointly influence the volatility processes of the precious metal price series although there is some evidence of volatility feedback between the precious metals This finding lends weight to views that individual commodities are too distinct to be considered a single asset class or represented by a single index a finding of considerable importance for portfolio managers and investors 1 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 2 that existing theoretical and empirical relationships evident in key macreoeconomic factors that are known to drive stock markets Chen 1991 Kearney 2000 Racine 2001 Flannery and Protopapadakis 2002 should also be present and impact upon the volatility structure of this relatively homogeneous subset of commodities if one could speak of commodities as a single asset class We include in our empirical analysis macroeconomic factors that are known to be important for these metals considering their economic and industrial uses Abanomey and Mathur 2001 Ciner 2001 Erb and Harvey 2006 Fleming et al 2006 Our study also offers several additional contributions First although there is significant prior work on the macroeconomic determinants of volatility in equity markets little evidence exists from other non financial markets If similar factors are important in all or at least other asset markets it could be argued that they should figure in arbitrage based asset pricing models While to the best of our knowledge this is the first paper to provide empirical evidence on this issue in commodity markets it usefully extends Ross 1989 who argues that since volatility is a proxy for information flow focusing on the volatility structure rather than returns provides additional and valuable insights into portfolio and price dynamics Second our focus on precious metals permits us to analyze the nature of the arbitrage and price relationship between the gold and silver markets which have also been discussed in prior work For instance it is frequently argued especially by practitioners that since gold behaves like surrogate money it provides a hedge against inflation and hence should 3 be considered among the choices for investment by both households and institutions Since silver has significant industrial uses as mentioned by Erb and Harvey 2006 among several others its use for these purposes may not be so clear cut Thus our empirical study will also provide useful evidence on the substitutability of gold and silver as suggested by their historical use as coinage or whether they occupy separate markets with different uses and functions as has been suggested in the recent finance literature eg Ciner 2000 Erb and Harvey 2006 The remainder of the paper is organized as follows Next a brief review of the key literature is undertaken then the statistical method and data used in the analysis is discussed The key findings are then discussed in section 4 while the final section 5 provides some concluding remarks 2 Related Literature Commodities are important economically since fluctuations in their prices tend to impact on the viability of production and investment decisions made by firms In this sense they clearly impact upon the general level of economic activity Bernard et al 2006 as well as having a key role in the formation of inflationary expectations For financial researchers commodities are also of interest for their potential role in asset allocation decisions In this regard recent papers by Abanomey and Mathur