Magoosh GRE

Recession and Gold Prices

| March 14, 2015

Introduction
The proposed topic of this dissertation is to explore the impact of the recession on the price of gold. The objectives of the study are to examine the recession and the impacts, positive and negative, it has had on the price of gold, reasons for these impacts, and how this has affected the overall economy.
Since the start of the recession in early 2008, equity markets have steadily declined across the board. Some markets have even experienced double-digit losses for several consecutive months. The recession has not only lead to decreases in the equity markets, but has also resulted in an overall sense of mistrust in the economy, banks, and the government. However, there have been some assets that seem to be immune to the economic turmoil being experienced in the major markets. Some of these assets, namely gold, have faired quite well through the recession and continue to do so. Whilst the majority of equity markets and assets have steadily declined through the recession, the price of gold has increased. It is important to understand why this is the case. It is essential to determine whether this is just an anomaly, or if there is something specific about gold that makes it immune or even incongruent to economic downturn. This dissertation study will endeavour to provide some insight regarding this topic.
The topic of gold prices in relation to recession presents a relevant study topic in that information can be ascertained as to what happens to the price of gold during a recession and why. It is also important to understand whether or not this occurrence is true for all commodities, or gold alone. Information can also be gathered regarding historical gold prices and the overall performance of the economy.
Three main research questions have been identified at this stage of the project:
1. What are the major impacts, both positive and negative, the recession has had on the price of gold?
2. What evidence is available regarding the degree of the impact the recession has had on the price of gold?
3. How will these impacts affect the future gold market?
Initial Literature Review
In order to conduct a dissertation study on the impact of the recession on the price of gold, it is first important to explore the economic theories regarding recession. It is also important to understand the literature regarding the price of gold relative to economic fluctuations. This study will also require a review into the literature regarding quantitative data available in relation to the price of gold and recession. Information will be gathered from a variety of sources including: textbooks, journal articles, periodicals, case studies, and index specific data.
Recession
In 1975, Shiskin described a recession as “two down quarters of GDP” (p. 222). Today, economists agree that a recession can be characterised by a collection of variables including: low or negative GDP, high unemployment, a decrease in investment, inflation, and household income, and an increase in bankruptcy (Knoop, 2010).
According to Lester (2009, p. 169), a recession is defined as “two successive quarters in a year when the economy shrinks rather than grows.” Some economists often refer to negative growth when describing a recession. This is due to the fact that during a recession several economic indicators can actually fall below zero.
In 2001 the National Bureau of Economic Research defined a recession as “a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade” (Arnold, 2008, 151). A recession not only affects GDP and employment, but also such things as government spending, consumption, and export activity. Whilst a recession affects the overall economy, various sectors may experience it differently. For instance, sectors such as manufacturing or production may be experiencing large declines, whilst at the same time other sectors such as information technology or research and development may actually be experiencing growth.
Gold Prices and Recession
Phillips (2006) suggests “the value of gold is that it is an instrument of value where no other one exists; it is not a promise to pay the bearer, which currencies are, but an asset that can be treated with value.” He postulates that it is this intrinsic value that attracts investors to gold during economic recessions. Whilst other asset categories are declining, gold as seen as a standard for safeguarding value.
Hamlin (2006) suggests that “because gold is a monetary asset, it will have a more direct correlation to inflation rates and currency fluctuations.” He also suggests that gold is a crisis hedge; meaning that in extreme times (recession) investors often turn to gold as a secure investment. Further to this, Wang et. al. (2010) state that “research has shown in the long-run that inflation tends to appropriately increase the price of gold, leading to gold’s popularity as an asset in portfolios to reduce the risk against sudden inflation.”
Whilst there have been studies conducted that prove gold to be an appropriate hedge against a recession, there is evidence that this is only the case in certain countries and regions of the world. Baur and McDermott (2010) conducted research into gold prices over a 30-year period that concluded that “gold is both a hedge and a safe haven for major European stock markets and the US but not for Australia, Canada, Japan, and large emerging markets such as the BRIC countries.”

Future Gold Market
Whilst historical gold prices are relatively easy to gain access to, the future of gold is more uncertain. However, given the steady increase in price of the commodity, several studies have been conducted into the future of the price of gold. Shaflee and Topal (2010) conducted one such study. The researchers used historical gold price data from 1968 to 2008 to predict gold prices for the next 10 years. The results suggested that “assuming the current price jump initiated in 2007 behaves in the same manner as that experienced in 1978, the gold price would stay abnormally high up to the end of 2014, after which the price would revert to the long-term trend until 2018.”
A March 2010 article in the Telegraph reported that gold and other precious metals have performed the highest in asset classes four out of the last five years. Stanczyk (2010) reported that future gold prices will “depend on the level of demand from emerging economies, particularly from China and India, which is likely to remain an important determinant of many asset prices as well as the pace at which the global economic recovery continues.” Whilst it is extremely difficult to predict the future of any investment instrument, the research available for gold suggests that the price will continue to increase.
Methodology
The methodology for this dissertation project will follow a qualitative approach based on secondary data. This methodology has been chosen in order to provide an investigation into the relationship of recession and the price of gold, based on already published empirical data. The published study would be chosen based on the methodology utilised, and data that has been gathered on gold prices, inflation, recession, and stock market indices. This data should ideally span the last 30 years and will be analysed using regression analysis techniques. Regression analysis is a process focusing on discovering relationships between a dependent variable and any number of independent variables. With regression analysis the researcher can understand how changes to an independent variable affect a dependent variable, thus the relationship between the two.
The study utilised in this secondary analysis, would have chosen the dependent variable as the price of gold, and the independent variables could include, recession, inflation, and various other commodity prices and indices. Through this analysis the researcher can determine what is known as the conditional expectation for the price of gold. The technique of regression analysis has been chosen in order to indentify any correlations between a recession and the price of gold. The research will then go on to review the findings and results from the study, and critically analyse the discussion and implications that ensue. The main aim would be to ascertain whether the study that has been conducted, and the results obtained, are reliable, valid, and generalisable, especially when considering the impact of recession on gold prices.
At this point in the research process it is suggested that there will be no ethical issues encountered during this research project. It is suggested that the research will add to previous studies in that it will either help to confirm or deny the theories available regarding recession and gold prices.

 

@31@#atacycles. Greenwood Publishing Group: Santa Barbara: CA.
Lester, A. (2009) Growth Management: Two Hats Are Better Than One. Palgrave Macmillan: Hampshire.
Phillips, J. (2006) ‘Where Does Gold go in a U.S. Recession.’ Financial Sense, September 2006.
Shaflee, S., and Topal, E. (2010) ‘An overview of global gold market and gold price forecasting.’ Resources Policy 35,3 178-189.
Shiskin, J (1975) ‘The Changing Business Cycle.’ New York Times.
Stanczyk, A. (2010) ‘Precious metals come in as top asset four out of five years, and the top asset of 2010 according to Lloyds TSB Assetwatch.’ Telegraph, March 2010.
Wang, K., Lee, Y., and Thi, T. (2010) ‘Time and place where gold acts as an inflation hedge: An application of long-run and short-run threshold model.’ Economic Modelling, December 2010.

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