Gold and inflation: Expected inflation effect or carrying cost effect?

Abstract

This study examines whether the expected inflation effect hypothesis adequately explains the causal relationship between inflation expectations and gold returns. A bootstrap full‐sample Granger causality test shows that gold returns cause inflation expectations rather than the reverse. To account for possible structural changes, we apply bootstrap subsample Granger causality tests with 60‐month windows. The results suggest that both professional forecasters' and consumers' inflation expectations have negative effects on gold returns in some but not all sample periods, contradicting the expected inflation effect hypothesis. No causality is found in other periods, consistent with the carrying cost hypothesis that the expected gain from gold due to higher inflation is offset by its carrying cost. Holding gold will not necessarily hedge against inflation because gold returns do not necessarily correlate with inflation expectation. Therefore, the carrying cost hypothesis more accurately explains the relationship between gold returns and inflation expectation than the expected inflation effect hypothesis does.

Analysis of the Frequency-Based Relationship between Inflation Expectations and Gold Returns in Turkey

“…Figure 4, on the other hand, indicates the presence of anti-phase causal impacts from the inflation expectations on the annual gold returns at higher frequencies around 2012, indicating that the annual inflation expectations from the Granger-causality test negatively impact the annual gold returns in the short term. These results largely reinforce the findings of Xu et al (2019a), which document a negative, rather than positive, causality from the inflation expectations to the gold returns, contradicting the expected inflation effect hypothesis. The weak, but significant causality from the gold returns to the inflation expectations in the current study is in line with Xu et al (2019a), indicating that the hedging ability of gold is valid only during certain periods.…”

“…These results largely reinforce the findings of Xu et al (2019a), which document a negative, rather than positive, causality from the inflation expectations to the gold returns, contradicting the expected inflation effect hypothesis. The weak, but significant causality from the gold returns to the inflation expectations in the current study is in line with Xu et al (2019a), indicating that the hedging ability of gold is valid only during certain periods.…”

“…The CWT-based Granger-causality test provided limited evidence for out-of-phase and unidirectional causal linkage, from inflation expectations to gold returns, in the higher and medium frequency intervals. This was corroborated by Xu et al (2019a), which found that inflation expectations caused negative gold returns in the USA. These findings further suggested that a decrease in inflation expectations significantly leads to a decrease in gold prices in the short and intermediate terms in Turkey.…”

“…The author suggested investors to follow the changes in bond markets rather than the changes in gold prices for speculative purposes regarding inflation expectations. Xu et al (2019a), on the other hand, tested the validity of both the expected inflation effect and the carrying cost hypotheses using a bootstrap causality test with a rolling window size of 60 months in the USA. The test results confirmed that the expected relation between gold returns and inflation was more steadily explained with the carrying cost hypothesis but not with the expected inflation effect hypothesis due to the existence of a negative relationship, indicating the hedging ability of gold exists only for certain periods.…”

“…A few studies such as Tkacz (2007), Le Long, De Ceuster, Annaert, &Amonhaemanon (2013), andBampinas andPanagiotidis (2015), report a significantly positive association between the inflation expectations and gold prices, indicating the hedging ability of gold prices in the short term, the long term, or both. However, some studies also document insignificant results and report that gold prices are not useful in predicting future movements of inflation (Erb and Harvey, 2013;Tufail and Batool, 2013;Ghazali, Lean, & Bahari, 2015;Xu, Liu, Su, & Ortiz, 2019a). Among these studies, Blose (2010) has put forward two remarkable theories about the relationship between inflation expectations and gold.…”