Monday, January 14, 2008

Gold and "Summers-Barsky" theory

There was an excellent article on gold by John Dizard in the past weekend edition of the Financial Times.

Dizard's column piece, though brief, gave an informed overview of the metal's ongoing bull run, while assessing the possibility of a coming correction in the gold price.

In, "Gold is a bright prospect for the bold", Dizard draws on the opinion of one long-bullish portfolio manager and the ideas found in the "Summers-Barsky" theory to chart gold's future course.

"Mr Palmedo is one of the adherents of what gold people call “Summers-Barsky”, a theory of the relationship between gold and real returns on investment developed by two Harvard professors in 1985. One of them, Lawrence Summers, went on to become US Treasury secretary, president of Harvard University and, ultimately, an FT columnist.

Summers-Barsky, as described in their dense econometric paper, tracked and modelled the price of gold from 1730 to 1985 against interest rates, price indices and, for the latter years, equity returns.

Essentially, the professors found an inverse relationship between the price of gold and the real returns people can earn on their financial and industrial capital. As they put it: “The willingness to hold the stock of gold depends on the rate of return available on alternative assets.” Gold is a way to preserve capital, not increase it. If you can earn high rates or profits, you will be induced to sell gold and invest it in productive capital or interest-bearing paper."

Have a look at the full article at the link above.

Meanwhile, if there is a gold correction coming in the near future, it will likely have to wait another day.

Bloomberg reports that gold and platinum reached new record highs in earlier trading today, as a declining dollar fueled demand for precious metals and agricultural commodities.

Still, with speculative long positions increasing in gold, some analysts are becoming more cautious and increasingly expectant of an upcoming correction. We'll be watching.