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since the methodology in this
paper is very similar to a previous one, substantial portions of what
follows concerning methodology have been reproduced from my ‘‘The
price of gold and the exchange rates,’’ (with Fabio Scacciavillani), Journal
of International Money and Finance, December 1996; reprinted in Meher
Manzur (Ed.), 2002. Exchange Rates, Interest Rates and Commodity
Prices, Edward Elgar, and in MoonJoong Tcha (Ed.), 2003. Gold and the
Modern World Economy, Routledge. The layout of the paper is very
similar to that of the earlier one.In the first of the sections to follow, an international
pricing model is developed, which predicts that changes in
major currency exchange rates will impact on the prices of
commodities in all currencies––major and minor alike.
Section 2 is concerned with preliminary tests of the data
and Section 3––the core of the paper––reports the findings
of a study of the international market for gold. A short
summary section concludes the paper.
Gold is a prime candidate for a study of the effects on
commodity prices of fluctuations in major currency
exchange rates. A highly homogeneous commodity, gold
is traded almost continuously in well-organized spot and
future markets. Moreover, as annual production (and
consumption) of gold is minuscule compared with the
global stock, the gold-producing countries, not all of whose
currencies are traded in organized markets, are unlikely to
dominate the world gold market.
Exchange rates and commodity prices: the model
The model developed in this section focuses on the effect
of movements in exchange rates on the international price
of a homogeneous commodity that is traded in an
organized market; it is not the usual asset-pricing model,
as it is not concerned with the rate of return on holding
commodity in question.2 The model has two basic
elements: the law of one price and global market clearing
in a world of M countries or currency blocs. Ignoring all
barriers to trade and with all variables expressed in natural
logarithms, the law of one price for an internationally
traded commodity is simply:
P1 ¼ Pj þ E1j ; j ¼ 1; . . . ; M. (1)
Pj being the commodity price in currency j and E1j the price
of currency j in terms of the reference currency 1. Feedback
from the commodity market to exchange rates is assumed
to be negligible.
The excess demand (i.e., net imports), Qj, for that
commodity in currency bloc j is a function of its real price,
Pj
RPjPj*, where Pj* is the price level in that bloc, and a
1 by N vector Xj ¼ (Xj1,Xj2,y,XjN) of (yet to be specified)
market ‘‘fundamentals’’ specific to the commodity in
question and currency bloc j:
Qj ¼ QjðPR
j ;XjÞ; qQj=qPR
j 0; j ¼ 1; . . . ;M.
Global market clearing requires:
XM
j¼1
QjðPR
j ;XjÞ ¼ 0,
and hence a local log-linear approximation can be
written as:
XM
j¼1
ðqQj=qPR
j ÞðPR
j ¯P
R
j Þ
þ
XM
j¼1
XN
i¼1
ðqQj=qXjiÞðXji ¯X jiÞ
!
¼ 0; (2)
where ¯P
R
j and ¯X ji are means of the distributions of Pj
R
and Xji.
From Eq. (1), Pj
R ¼ P1E1jPj*. So Eq. (2) can be
rearranged into a fairly simple expression for P1:
P