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How Changes in Expected Inflation Affect Gold Prices

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How Changes in Expected Inflation

Affect Gold Prices

By

Laurence E. Blose*

September 2005

JEL Code: G0, G1

*Associate Professor of Finance

Grand Valley State University
436 DeVos Center
Grand Rapids, MI 49504-6431
Work (616) 331-7436
Home (616) 977-5033
FAX (616) 331-7445

blosel @gvsu.edu
 How Changes in Expected Inflation
Affect Gold Prices

Abstract

How do interest rates and gold prices react to changes in expected inflation? This
paper uses surprises in the consumer price index as a measure of changes in inflation
expectations. It shows that surprises in the CPI affect interest rates but do not affect gold
prices. The paper concludes that speculation strategies based on changes of expectations
regarding inflation can be successful in the bond markets but not the gold markets.
Further, investors cannot determine market inflation expectations by examining the spot
price of gold.

2
 How Changes in Expected Inflation
Affect Gold Prices

1. Introduction

This paper examines how changes in inflation expectations affect the spot price of

gold. It is widely reported in the financial press that the price of gold is influenced by

changes in inflation expectations. This paper examines and empirically tests the theory

underlying the hypothesized relationship. It will show that the theoretical basis for the

relationship is murky. Proponents of the inflation expectations effect argue that upward

revisions in expected inflation will cause some investors to purchase gold to either hedge

against the decline in money or speculate in the associated increase in the price of gold.

Either way the buying pressure will cause an immediate increase in the price of gold.

This explanation overlooks the impact of inflation on interest rates and the cost of

holding gold. An increase in inflationary expectations will cause the expected future

price of gold to be higher then otherwise, but it will also increase interest rates and

thereby increase the cost of holding gold. Any speculative profit in holding gold during

inflationary periods will be offset by the higher cost of holding gold (i.e. higher interest

costs). Accordingly there will be no incentive for buying gold and gold will not react to

changes in inflation expectations.

This paper is comprised of four parts. First, the empirical evidence explaining the

relation between gold and inflation expectations is examined. Previous work presents

mixed results regarding the impact of inflation expectations on gold prices. The second

section discusses how inflation affects interest rates and the price of gold. The third

section tests the hypothesis that interest rates and therefore the cost of carrying gold are

3
affected by changes in inflation expectations. Over the seventeen year period examined,

there is a strong and significant relationship between changes in the term structure and

unexpected changes in the consumer price index. The fourth section examines the

relation between gold prices and changes in inflation expectations. Results presented

show that unlike interest rates, the price of gold is unaffected by unexpected changes in

the consumer price index.

2. Background

Numerous articles in both the academic literature and the financial press have

examined the efficiency of the gold market1 and the extent to which gold and gold related

assets offers diversification opportunities superior to equity investments.2 One way that

investors invest in gold is to attempt to project changes in inflationary expectations and

then buy gold in anticipation of upward revisions in inflationary expectations and sell

gold in anticipation of downward revisions in expectations.

The financial press contains substantial evidence indicating a prevalent conviction

that there is a strong relationship between inflation expectations and gold prices. Market

analysts in the financial press routinely attribute substantial changes in the price of gold

to changes in inflation expectations. Recent articles in the financial press have attributed

the current strength in gold price to higher inflationary expectations.3 When there are

unexpected changes in inflation indicators that occur on the same day as changes in the

price of gold, the change in gold price is routinely attributed to the changes in the

1
See for example Aggarwal and Soenen (1988); Salant and Henderson (1978); Blose and Shieh (1996),
McDonald and Solnick (1977); Frank and Stengos (1989), Solt and Swanson (1981), and Booth, Kaen and
Koveos (1982);.
2
See for example Carter, Affleck-Graves, and Money (1982), Jaffe (1989), Shisko (1977), Kolluri (1981),
Chua and Woodward (1990), and Chua, Sick, and Woodward (1990).
3
For recent examples in the financial press see Tatge (2005), Platt’s Metals Week (2005), Stern (2005),
International Money Marketing (2004), and Sivy(2004).

4
inflation indicators. Alan Greenspan, the chairman of the Federal Reserve, has

commented that the price of gold is ”a very good indicator” of inflation and is useful in

the battle against inflation.4

Despite this widespread acceptance of the relationship between changes in

inflation expectations and the price of gold, there is no compelling empirical evidence to

support it. Garner (1995) examines the performance of an index of five leading

indicators of inflation, one of which is gold. He found only qualified (or weak) support

for the predictive power of the indicators. Mahdavi and Zhou (1997) examine the extent

to which gold and other commodity prices are leading indicators of inflation. They

conclude gold’s contribution to inflationary predictions is not statistically significant.

Cecchetti, Chu, and Steindel (2000) find that when gold is included in a leading indicator

of inflation it enters the model with a negative coefficient. This means that higher gold

prices are associated with lower inflation – the exact opposite of what would be expected.

Ex post tests of the relationship between long run gold price behavior and

inflation are sometimes cited as evidence that gold price and inflationary expectations are

related. For example, using monthly data, Sherman (1982) regressed gold price against

independent variables representing the money supply and growth in the money supply for

the period 1968 through 1980. Both variables had significantly positive coefficients

indicating a positive relationship between the price of gold and the supply of money. In

another study, Young and Khoury (in Khoury (1984) pp. 355-358) using monthly data,

regress gold prices against the consumer price index and find a significant relationship.

Haubrich (1998) using annual data, finds a relationship between CPI changes and gold

4
See Burns (1994), Wall Street Journal (2/23/1994), Wall Street Journal (2/28/1994), and Wall Street
Journal (06/29/1999).

5
prices in the previous period. He concluded that gold prices are a leading indicator of

inflation.

All of these studies examine the relationship between actual inflation and the

change in gold price over time. None of these studies attempt to identify changes in

inflation expectations. Since inflation by definition is a relative decline in the value of a

currency, a strong positive relationship between ex post gold prices and ex post measures

of inflation is not surprising. It simply documents the decline in the value of the currency

as expressed by inflation. The evidence illustrates the corrosive effect of inflation on the

value of the currency but does not indicate how the price of gold responds to changes in

inflation expectations.

3. Inflation expectations, the cost of carrying gold, and the price of gold

3.1 The consumer price index and inflationary expectations

This paper uses unexpected changes in the consumer price index (CPI ) as a proxy

for unexpected changes in inflation expectations.5 Whenever there is an unexpected

change in the CPI, the financial press often reports that analysts revise their predicted

future inflation to account for the unexpected change. For example, a large unexpected

increase in the CPI is typically interpreted as indicating higher inflation in the future.

When announced unexpected changes in the CPI are coincident with changes in bond

prices, stock prices, or commodity prices, the price changes are often attributed to a

change in inflation expectations arising from the CPI announcement.

The CPI figures are released approximately two or three weeks into each month.

The index reports the Bureau of Labor Statistic’s price survey conducted the previous

6
month. Thus, the CPI is a lagging indicator that reports price levels that were measured

as much as 50 days earlier. How is it that a clearly lagging indicator can be so widely

viewed as a leading indicator? One explanation is that inflation is viewed not as a pure

random walk, but as a chronic malady that over time has a tendency to spiral either up or

down. Given time, price increases in one industry will cascade over into other industries

affecting future inflation. Also, there is a feedback mechanism that allows price

increases in industry X to spill into other industries and thereby affect the prices in

industry X at a later time. This manifestation of inflation over time can be signaled by

changes in the recent past.

3.2 The term structure and the cost of carrying gold

Investment in gold requires that funds be diverted from other investments.

Accordingly the cost of holding gold is the opportunity cost of investing those funds in

assets with similar risks. Prior empirical research has shown that gold and gold related

assets (mining companies and mutual funds) are either uncorrelated or weakly negatively

correlated with market indices.6 Since these studies show that gold has a beta of zero (or

slightly negative), the riskfree rate is a reasonable approximation for the cost of holding

gold. This paper examines the impact of changes in inflationary expectations on the

interest cost of carrying gold by measuring the impact of unexpected changes in the CPI

on yields of US government debt maturing in one, two, three, five, seven and ten years. A

significant positive relationship will indicate that the cost of carrying gold increases with

increases in expected inflation.

5
The study uses the seasonally adjusted consumer price index for all urban consumers (CPI-U).
6
See Blose (1996), Aggarwal and Soenen (1988), Tschoegl (1980) and Carter, Affleck-Graves, and Money
(1982).

7
 There are two predominate explanations linking interest rates with

expected inflation. The Fisher hypothesis (Irving Fisher,1896) argues that higher future

inflation makes fixed income investment less desirable. Accordingly, bonds sell for less

and their associated yields are greater. The second explanation, the policy anticipation

hypothesis ( Smirlock, 1986), is based upon the Federal Reserve’s reaction to the higher

than expected interest rates. Since one of the Fed’s goals is low inflation, an indication

that inflation will be higher than expected may prompt the Fed to tighten the money

supply which will cause an increase in interest rates. The Fisher hypothesis and the

policy anticipation hypothesis both indicate that the term structure is directly proportional

to expected inflation. These two hypotheses are complementary in the sense that both

predict that higher expected inflation will cause higher interest rates.

Several researchers have tested the relationship between the Consumer Price

Index and interest rates or bond prices. Papers finding significant coefficients associated

with unexpected changes in the CPI are Balduzzi, Elton, and Green (2001), and Green

(2001). On the other hand, Urich and Wachtel (1984) and Dwyer and Hafer (1989) find

CPI coefficients are not significant. Smirlock (1986) finds the CPI coefficients not

significant prior to October 1979 but significant thereafter. This study uses a different

source of CPI expectations and examines a different time period than previous research.

By examining relationship between unexpected CPI and term structure this paper shows

that bond yields are affected by changes in inflation expectations. Since the cost of

carrying gold increases with bond yields, we conclude that the cost of carrying gold will

change with changes in inflation expectations.

8
3.3 Gold prices and the cost of carrying gold

Consider what happens when inflationary expectations change from an

expectation of zero inflation to an expectation of some positive number “I”. Because of

the change in expected inflation, the expected future price of gold will be greater by the

factor “I”. A popular hypothesis in the financial press is that speculators will purchase

gold to profit from the expected future increase in the value of the gold. Buying pressure

from this speculation will cause the demand curve for gold to shift to the right causing the

spot price of gold to increase. For convenience, I will call this the speculation

hypothesis of gold price. In this section, we will take a more detailed look at this

speculation hypothesis.

The following terms are used throughout the paper:

I = The rate of inflation. It is the additional amount of money (expressed as a

proportion of G1) that will be required to buy a good at the end of the
period over what would have been required if there were no inflation.

G0 = The spot price of gold at time zero.

G1 = The expected future spot price of gold if there is no inflation.

G1’ = The expected future spot price of gold if the expected inflation is I.

R = The real rate of return for gold, also the nominal return on gold when
inflation is zero.

R’ = The nominal rate of return for gold when inflation is I.

The subscript 0 and 1 indicates the point in time for all the variables. If the variable has

an apostrophe the expectation of inflation is I otherwise the expectation is zero.

Observe that by definition of I:

G1’ = G1 + G1 I (1)

9
 First consider the case in which there is no inflation. Let π1 be the expected profit

at time t=1 from holding gold if inflation is expected to be zero. Then π1 can be

expressed as follows:

π1 = G1 – G0 – G0 R (2)

Where G0 R is the risk adjusted opportunity cost of holding gold. The investment

in gold must be financed either by borrowing and pledging the gold as collateral or by

diverting owned capital from other investments. However the financing is accomplished

there will be a cost of G0 R.

A cost of carry arbitrage argument shows that in frictionless markets the

difference between the current price of the commodity and the future price of the

commodity will be the cost of carry. This is shown in equation (3):

G1 – G0 = G0 R (3)

Rearranging (3) gives (3a):

G1 = G0 (1+R) (3a)

An explanation of this cost of carry arbitrage result can be found in most introductory

financial futures textbooks (e.g. Kolb, 1994, pp. 82-90; and Chance, 2001, pp. 376-378).7

Now suppose that inflationary expectations change from zero to an inflation rate

I, but the spot price of gold does not change. According to the speculation hypothesis,

investors can profit by buying the gold now and holding it to it’s inflated value later. The

profit after the change in expectations will be:

π1’ = G1’ – G0 (1+R’) (4)

7
The derivation of the cost-of-carry model uses a "no arbitrage" argument that assumes that there is
unrestricted short selling. Unlike agricultural commodities in which shortages can constrain short selling,
there is an enormous worldwide supply of stored gold available for short selling. Short selling is
accomplished through dealers and producers.

10
 Substituting in from (1) and (3a) yields:

π1’ = G0 (1+I)(1+R) – G0 (1+R’) (5)

Where R’ is the cost of carrying gold after the change in expected inflation. The

impact of inflation upon borrowing and lending rates can be expressed by the following:8

1 + R’ = (1 + R) (1 + I) (6)

Substituting 6 into 5 gives:

π1’ = G0 (1+I)(1+R) – G0 (1+R)(1+I) = 0 (7)

In words, the cost of carrying gold increases by the exact amount as the expected

change in the value of gold; hence, there is no way to profit from the change in

inflationary expectations by buying gold. Any gain in the price of gold is exactly offset

by an increase in the cost of carrying gold. For convenience I will call this the carrying

cost hypothesis.

The above argument works in a cost of carry market where equation (3) holds. If

market imperfections disrupt the cost of carry arbitrage then (3) may be an inequality

rather then an equality. If (3) were an inequality, the above argument may not work

exactly as described. However, even when (3) is an inequality, the change in the cost of

carrying gold will offset (at least partially) any gain to be obtained by buying and holding

gold. Whether or not the cost exactly offsets the gain is an empirical question that is

addressed by this paper.

The above argument does not mean that an investor cannot profit from superior

information regarding future inflation. It is possible to make a speculative profit with

superior information. For example, suppose that an investor determines that inflation

8
This formula is traditionally known as the Fisher effect from Irving Fisher (1896).

11
will be higher than the market anticipates. The investor can borrow at R (rather than R’)

and invest in gold at a price of G0. Equation 5 becomes.

π1’ = G0 (1+I)(1+R) – G0 (1+R) = G0(1+R)I (8)

Observe, however, that the speculative profit does not come from investing in

gold but from borrowing at an interest rate R that does not reflect the superior inflation

information. A similar profit could be obtained without gold by simply borrowing at rate

R (no inflation) and holding cash or T-Bills. When market expectations are revised from

zero to an inflation rate of I, the yield on bonds will increase to R’. Then invest at the

higher rate to realize a speculative profit (the difference between the borrowing and

lending rates). Another procedure would involve short selling bonds and covering the

short position after market inflation expectations are revised upward. Observe that

neither strategy involves gold!

In the discussion, I have argued that there will not be any speculative profit to

investing in gold when inflationary expectation change from zero to I. To obtain this

same result when inflationary expectations change from any level I1 to another level I2,

simply obtain the result between zero and I1 and zero and I2 and the result follows for a

change from I1 to I2.

4. Test methods and results

4.1 The term structure and unexpected changes in the CPI

This paper examines the impact of unexpected changes in the consumer price

index on the cost of carrying gold (the term structure) and on the price of gold. The

consumer price index (CPI) is one of the most widely reported and used inflation

measures. The CPI is a measure of the change in retail prices. Each month the Wall

12
Street Journal reports both the actual and the expected level of the CPI index in the

“Tracking the Economy” column on the Monday of the week that the statistic is released.

The reported expected level is the consensus estimate obtained from a survey of

economists conducted by Wall Street Journal.9 In this paper, the unexpected changes in

the indices are estimated by subtracting the expected level of the CPI from the actual

reported level. This study uses monthly CPI announcements over the 17-year period

from March 1988 through February 2005.10

Insert Table 1 Here

Table 1 Panel A shows the frequency of reported changes in the CPI over the

examination period. The announced changes in the CPI range from a decline of .3 to an

increase of 1.1. Panel B shows the frequency of unexpected changes in the CPI. The

unexpected changes in the CPI range from an unexpected decline of .5 through an

unexpected increase of .5.

The interest rates for one, two, three, five, seven, and 10 year Treasury bonds and

notes were drawn from the Federal Reserve H.15 statistical release. The yields are based

on composite quotes reported by U.S. Government securities dealers to the Federal

Reserve Bank of New York.11 To obtain the constant maturity yields, personnel at

9
The survey typically includes 12 to 16 economists who work for Wall Street banks or consultants and
whose work includes forecasting the Consumer Price Index. The survey is taken the Friday prior to
appearing in the “Tracking the Economy” column.
10
The Wall Street Journal began publishing the “Tracking The Economy” forecasts in February 1988. The
period of this study covers exactly 17 years but only 203 monthly observations. One month is missing. A
US government shutdown because of budget problems combined with a paralyzing winter storm during the
second week in January 1996 caused a delay in the reporting of the CPI for December 1995. Accordingly,
the “Tracking the Economy” column did not estimate the expected CPI for that month.
11
The term structure is the set of annual yields on riskfree zero coupon bonds (sometimes called spot rates).
The H.15 release is calculated using coupon bonds. Accordingly, the yield curve in the H.15 release is only
an approximation of the true term structure.

13
Treasury construct a yield curve each business day and yield values are then read from

the curve at fixed maturities.12

Regression models (9) and (10) were estimated for each maturity strata.

∆R = α + γ ∆CPI + e (9)

∆R = α + γ U∆CPI + e (10)

In the above regressions, ∆R is the percentage change in the yield quote from the

previous day, ∆CPI is the actual change in the consumer price Index and U∆CPI is the

unexpected change in the CPI.

Insert Table 2 Here

Table 3 Panel A shows that the t-statistic for the γ coefficient for the actual change

in the Consumer Price Index is not significant for 2,3,5,7,10, and 30 year yields. The 1

year yield is significant at the 5% level.

Table 3 Panel B, shows that the γ coefficient for the unexpected change in the CPI

is significantly greater than zero at all maturities. The level of significance for all

maturities is in excess of .01. There is a strong and significantly positive relationship

between unexpected changes in the CPI and interest rates at all levels of maturity. Both

bond prices and yields respond to changes in the CPI as is predicted by the Fisher

equation. This finding indicates that interest rates and therefore the cost of carrying gold

change when there is an unexpected change in the CPI.

12
The H.15 release can be found at the federal reserve internet site:
Http://www.federalreserve.gov/releases/h15/data.htm

14
4.2 The relationship between unexpected changes in the CPI
and changes in gold prices and gold returns

To examine the reaction of gold prices to unexpected changes in the CPI, models

(11) and (12) were estimated.

RG = α + γ ∆CPI + e (11)

RG = α + γ U∆CPI + e (12)

Where RG is the % change in gold price from the previous day, ∆CPI is the actual

change in the consumer price index, and U∆CPI is the unexpected change in the CPI.13

The two competing hypotheses are listed below with a brief explanation.

Hypothesis Explanation Acceptance Criteria

1. Carrying Cost Carrying Costs offset speculative profits and In model (12), the failure to reject
Hypothesis there is no benefit to speculation. Unexpected the hypothesis γ = 0.
changes in CPI will have no impact on the price
of gold.
2. Speculation Speculative purchases associated with In model (12) rejection of the
Hypothesis unexpected changes in the CPI will cause gold hypothesis γ = 0 in favor of the
prices to increase. hypothesis γ > 0.

If the γ term in model (12) is positive and significant then the carrying cost hypothesis is

rejected otherwise the carrying cost hypothesis is accepted and the speculation hypothesis

is rejected.

Table 3 contains the results from the estimation of models (11) and (12). Panel B

shows the results of the regression of the return on gold against the unexpected change in

the CPI. The coefficient of the slope term γ has a t-statistic of 1.19 indicating that γ is not

significantly different from zero.

13
This study uses the price from the London Afternoon Gold Fix. The London afternoon price is fixed at exactly 3:00
PM London time which is 10:00 AM Eastern Standard Time. The CPI announcement is released and widely reported
at exactly 8:30 AM. Accordingly, the gold market has approximately one and one half hours to adjust the CPI news
before the London Price Fix is announced.

15
 Insert Table 3 Here

Based upon the results presented in Table 3 we cannot reject the carrying cost hypothesis.

Accordingly the carrying cost hypothesis is accepted and the speculative hypothesis is

rejected. The results indicate that gold prices do not change as a result of changes in

expectations regarding future inflation.

4.3 Additional issues

The conclusion that gold prices do not change as a result of changes in inflation

expectations would be incorrect if the results presented above come about as the result of

a type 2 error (failure to reject a false hypothesis). A type 2 error could occur if the

statistical tests were too weak to reject the null hypothesis or if the expected change in the

CPI as reported in the “Tracking the Economy” is biased or measured with too much

noise.

If these problems were in the gold tests (Table 3) then they should also be present

in the bond yield tests shown in Table 2. The bond yield test used the same independent

variables and identical methodology. However the bond yield test resulted in a rejection

of the null hypothesis with t statistics substantially greater than necessary to reject the

hypothesis at the 1% level. Accordingly, the rejection of the null hypothesis in the bond

yield tests shows that type 2 error was not a factor in those tests. The results in the bond

yield tests present an important validation of the methodology and independent variables

used in gold price tests.

There is also a possibility of errors in the dependent variable in the test of gold

price reaction to unexpected changes in the CPI. The gold price quote used in the study

was the London Afternoon Gold Price Fix. This occurs at exactly 3 p.m. in London

16
which is 10 a.m. in New York. The change in the CPI is released at 8:30 a.m. New York

time, So there is a period of one and one half hours for the price of gold to react to the

new information. The bond yields are estimated late in the same day so that there is in

excess of seven hours for the bond yields to adjust to the information. If the gold prices

do not completely react to the news by 10 a.m. then a portion of the reaction will be

missed by the study. To correct for this, model 12 was run using the two day returns

calculated from the day of the CPI release and the day after. The coefficient of the γ term

when the two day gold return is used is not significantly different from zero (t statistic =

.63). Accordingly, the two day returns test also fails to reject the null hypothesis.

5. Overview and Concluding Remarks

This paper examines how unexpected changes in the Consumer Price Index

affects gold prices. The paper presents two different theories that purport to explain the

relationship between expected inflation and gold prices. The speculation hypothesis

argues that changes in inflation expectations will cause immediate changes in gold prices.

The carrying cost hypothesis argues that higher inflation expectations will cause higher

interest rates (the Fisher effect). The higher interest rates will cause a higher cost of carry

for gold investment and will offset any speculative profit from investing in gold.

Accordingly, the cost of carry hypothesis predicts that the price of gold will not change

when inflationary expectations change. This relationship is tested using unexpected

changes in the consumer price index (CPI) as a measure of changes in inflationary

expectations. The paper finds that unexpected changes in the CPI have no impact on the

price of gold.

17
 This paper also examines the relationship between unexpected changes in the CPI

and changes in bond yields. The paper finds that there is a significant relationship

between changes in bond yields and unexpected changes in the CPI. The results indicate

that the cost of carrying gold changes with changes in inflationary expectations (i.e.

unexpected changes in the CPI). These results are consistent with the carrying cost

hypothesis.

The following conclusions may be drawn from the results presented in this paper:

1. Gold prices do not change as a result of changes in expectations regarding

future inflation. Articles in the financial press that tie changes in gold prices

to changes in expectations regarding inflation are mistaken.

2. Even if an investor has perfect foresight and knows that future inflation will

be substantially different than market expectations, the investor could not set

up a profitable speculation in the gold market to profit from that information.

The investor could, however, set up a speculation in the bond markets. In

other words investors should use the bond markets not the gold market to

speculate in changes in inflation expectations.

3. You cannot determine market inflation expectations by examining the spot

price of gold.

18
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Table 1.

Frequency for actual changes and unexpected changes in the consumer price index.

Monthly changes during the period March 1987 through March 2005.

Panel A: Frequency table for the reported changes in CPI.

% change in Frequency Cumulative Cumulative

CPI (# of months) Percent Frequency Percent

-0.3 4 1.97 4 1.97

-0.2 3 1.48 7 3.45
-0.1 4 1.97 11 5.42
0.0 14 6.90 25 12.32
0.1 37 17.73 61 30.05
0.2 50 24.63 111 54.68
0.3 44 21.67 155 76.35
0.4 20 9.85 175 86.21
0.5 14 6.90 189 93.10
0.6 8 3.94 197 97.04
0.7 3 1.48 200 98.52
0.8 2 .99 202 99.51
1.1 1 .49 203 100.00

Panel B: Frequency Table for unexpected changes in CPI.1

% change in Frequency Cumulative Cumulative

CPI (# of months) Percent Frequency Percent

-0.5 1 .49 1 .49

-0.4 1 .49 2 .99
-0.3 3 1.48 5 2.46
-0.2 14 6.90 19 9.36
-0.1 66 32.51 85 41.87
0.0 63 31.03 148 72.91
0.1 40 19.70 188 92.61
0.2 10 4.93 198 97.54
0.3 4 1.97 202 99.51
0.5 1 .49 203 100.00
Notes:
1. U∆CPI = ∆CPI - E∆CPI Where U∆CPI is the Unexpected change in the Consumer Price Index,
∆CPI is the (actual) reported % change in the Consumer Price Index and E∆CPI is the Expected % change
in the Consumer Price Index.

21
Table 2:

The relationship between government bond yields and changes in the CPI.

Using monthly data over the period March 1987 through February 2005, the following models were
estimated using OLS:

Panel A: ∆Rt = α + γ ∆CPIt + et

Panel B: ∆Rt = α + γ U∆CPIt + et

Where ∆Rt is the change in the bond yield from the previous day, ∆CPIt is the actual change in the CPI
and U∆CPIt is the unexpected change in the CPI calculated by subtracting the expected change from the
actual change.

Panel A: Impact of Actual Change in the Consumer Price Index on Bond Yield

Bond n α α γ γ Adj
Maturity t-stat t-stat R-sq2

1 year 203 -.004 -2.14* .011 2.06* .016

2 year 203 -.002 -1.05 .007 1.16 .002
3 year 203 -.002 -0.90 .005 0.91 .000
5 year 203 -.001 -0.77 .003 0.68 .000
7 year 203 -.001 -0.93 .003 0.70 .000
10 year 203 -.001 -0.93 .002 0.57 .000

Panel B: Impact of Unexpected Change in the Consumer Price Index on Bond Yield

Bond n α α γ γ Adj
Maturity t-stat t-stat R-sq2

1 year 203 -.000 -0.38 .030 3.67** .058

2 year 203 .000 0.12 .028 2.81** .033
3 year 203 .000 0.06 .025 2.79** .033
5 year 203 -.000 -0.03 .021 2.72** .031
7 year 203 -.000 -0.23 .019 2.78** .032
10 year 203 -.000 -0.43 .016 2.61** .035

** Significant at the .01 level

* Significant at the .05 level

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 Table 3

The relationship between gold prices and unexpected changes in the CPI

Using monthly data over the period March 1987 through February 2005, the following models were
estimated using OLS:

Panel A: RG = α + γ ∆CPI + e
Panel B: RG = α + γ U∆CPI + e

Where Rg is the % change in the price of gold, ∆CPI is the actual change in the CPI and
U∆CPI is the un expected change in the CPI calculated by subtracting the expected change from the actual
change.

Panel A: Model (1) RG = α + γ ∆CPI + e

Number of Observations 203

Adjusted R-Squared2 .000
F Value .12
p Value .726

Parameter Estimate t-statistic

Intercept α .000 .83
Slope γ -.001 -.35

Panel B: Model (2) RG = α + γ U∆CPI + e

Number of Observations 203

Adjusted R-Squared .002
F Value 1.42
p Value .234

Parameter Estimate t-statistic

Intercept α .001 1.03
Slope γ .005 1.19

** Significant at the .01 level (one sided)

* Significant at the .05 level (one sided)

23

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