One thing largely ignored by U.S. investors when examining commodity returns is how different they can look in other base currencies. Intellectually, this is true for any return stream, but it always seems particularly strange for commodities because we think of their prices as being rooted in something more real. These varying return streams can prove confusing, however, when explanations for why prices changed in one currency lack credibility when viewed through the lens of another currency.
What affects gold prices? USD bias can skew the story
Gold, in particular, has suffered from this home-country bias as the U.S. dollar (USD) has become its main trading currency. Often, after large price swings, gold investors put forward various narratives describing the catalyst for such events. However, when examining gold prices across various currencies, it becomes obvious that these stories cannot possibly be the only explanations.
For example, Figure 1 shows the price of gold through the end of February, with prices in USD.
Figure 1: Cumulative Value of 100 USD in Gold, 12/31/2017-02/28/2018
Source: S&P GSCI®, Bloomberg, Parametric
For illustration purposes. Not a recommendation to buy or sell any security. All investments are subject to risk of loss.
As can be seen, gold appreciated strongly in the first half of January, then saw a steep decline in the latter part of the month, and then somewhat repeated the cycle again in February. At the time, many commentators said that these rallies were associated with a “risk-off” attitude by investors, who were attracted to the safe-haven aspects of gold. Similarly, the declines were said to be due to investor worries that the U.S. Federal Reserve (Fed) was sending strong signals that it would continue to tighten aggressively in 2018. The typical explanation says that gold prices tend to underperform in times of rising interest rates, as investors move from a non-interest-bearing asset (gold) into the now higher-yielding asset (bonds).1
However, gold is a global commodity, bought and sold by many investors whose home currency is not the USD. If these narratives offered up by USD-based investors were sound, you would expect to see similar price patterns regardless of the currency. But, as the graph below shows, when we examine the price of gold in euros (EUR) and Japanese yen (JPY), we do not see similar patterns. If not for the labels on the graphs, it would be difficult to conclude that the below lines were even describing the same asset.
However, gold is a global commodity, bought and sold by many investors whose home currency is not the USD. If these narratives offered up by USD-based investors were sound, you would expect to see similar price patterns regardless of the currency. But, as the graph below shows, when we examine the price of gold in euros (EUR) and Japanese yen (JPY), we do not see similar patterns. If not for the labels on the graphs, it would be difficult to conclude that the below lines were even describing the same asset.
Figure 2: Cumulative Value of 100 USD vs 100 EUR vs 100 JPY, 12/31/2017 - 02/28/2018
Source: S&P GSCI®, Bloomberg, Parametric
For illustration purposes. Not a recommendation to buy or sell any security. All investments are subject to risk of loss.
Given this, if you believe that the spike in the USD value of gold was due to elevated risk adversity among investors, you would have to believe that this change in risk tolerance only impacted USD-based investors, as both EUR- and JPY-based investors experienced flat prices over the same period. Similarly, you would have to believe that only U.S. investors were concerned about an accelerated pace of interest-rate increases. Both of these assertions border on the nonsensical.
The above time period is not unique, as you rarely see the price of gold move in tandem across different currencies. Which is to say, most stories told in the U.S. marketplace about the pricing of commodities have an inherent home-country bias, and when examined in a global context, are shown to be just that—stories.
Bottom line
Commodity prices are very complex. They involve a global marketplace of consumers and producers transacting in a variety of currencies. When looking at only the USD-based return pattern for a commodity, it is easy to create explanations for price movements that are easily shown to be incorrect when put into a global context.
Tim Atwill, PhD, CFA, Head of Investment Strategy (emeritus)
Tim led the Investment Strategy Team at Parametric, which is responsible for all aspects of Parametric’s investment strategies, until his retirement in 2019. He also held investment responsibilities for Parametric’s Emerging Markets and International Equity strategies as well as shared responsibility for the firm’s Commodities Strategy.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss.
1For more information, read our paper "Interest Rates Do Not Influence Precious Metal Prices."
