Does gold offer a better protection against losses in sovereign debt bonds than other metals

TLDR: This article showed that industrial metals, especially copper, tend to outperform gold and other precious metals as hedging vehicles and safe haven assets against losses in sovereign bonds and that copper is the best performing metal in the period immediately after negative bond price shocks.

Abstract: It is a commonly held view that gold protects investors’ wealth in the event of negative economic conditions. In this study, we test whether other metals offer similar or better investment opportunities in periods of market turmoil. Using a sample of 13 sovereign bonds, we show that other precious metals, palladium in particular, offer investors greater compensation for their bond market losses than gold. We also find that industrial metals, especially copper, tend to outperform gold and other precious metals as hedging vehicles and safe haven assets against losses in sovereign bonds. However, the outcome of the hedge and safe haven properties is not always consistent across the different bonds. Finally, our analysis suggests that copper is the best performing metal in the period immediately after negative bond price shocks.

Figures

Figure 3: Post-shock performance of equally weighted portfolios consisting of the bond and dedicated industrial metals

Table 7: Hedge and safe haven characteristics of industrial metals – sub-period analysis This table reports estimation results for the models in Eqs(1a), (1b) and (1c) for the three sub-periods, with individual industrial metals as the dependent variables in Eq(1a). SH1 tests the hypothesis 0 + 1 = 0, SH2 tests the hypothesis 0 + 1 + 2 = 0, SH3 tests the hypothesis 0 + 1 + 2 + 3 = 0. Panel A presents results for the period July 1993 to December 2000, Panel B presents results for the period January 2001 to December 2006 and Panel C presents results for the period January 2007 to June 2012. The asterisks ***, **, * represent significance of the estimates at the 1%, 5% and 10% level, respectively.

Figure 2: Post-shock performance of equally weighted portfolios consisting of the bond and dedicated precious metals

Table 4: Hedge and safe haven characteristics of industrial metals – Full sample period This table reports estimation results for the models in Eqs(1a), (1b) and (1c) for the full sample period, with individual industrial metals as the

Table 6: Hedge and safe haven characteristics of precious metals – sub period analysis This table reports estimation results for the models in Eqs(1a), (1b) and (1c) for the three sub-periods, with individual precious metals as the dependent variables in Eq(1a). SH1 tests the hypothesis 0 + 1 = 0, SH2 tests the hypothesis 0 + 1 + 2 = 0, SH3 tests the hypothesis 0 + 1 + 2 + 3 = 0. Panel A presents results for the period July 1993 to December 2000, Panel B presents results for the period January 2001 to December 2006 and Panel C presents results for the period January 2007 to June 2012. The asterisks ***, **, * represent significance of the estimates at the 1%, 5% and 10% level, respectively.

Table 3: Hedge and safe haven characteristics of precious metals – Full sample period This table reports estimation results for the models in Eqs(1a), (1b) and (1c) for the full sample period, with individual precious metals as the

Full text

Does gold offer a better protection against sovereign debt
crisis than other metals?
Article (Accepted Version)
http://sro.sussex.ac.uk
Agyei-Ampomah, Sam, Gounopoulos, Dimitrios and Mazouz, Khelifa (2014) Does gold offer a
better protection against sovereign debt crisis than other metals? Journal of Banking and
Finance, 40. pp. 507-521. ISSN 0378-4266
This version is available from Sussex Research Online: http://sro.sussex.ac.uk/id/eprint/46962/
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1
Does gold offer a better protection against sovereign debt
crisis than other metals?
SAM AGYEI-AMPOMAH
a
, DIMITRIOS GOUNOPOULOS
b
, KHELIFA MAZOUZ
c1
Journal of Banking and Finance, forthcoming
ABSTRACT
It is a commonly held view that gold protects investors’ wealth in the event of negative
economic conditions. In this study, we test whether other metals offer similar or better
investment opportunities in periods of market turmoil. Using a sample of 13 sovereign bonds,
we show that other precious metals, palladium in particular, offer investors greater
compensation for their bond market losses than gold. We also find that industrial metals,
especially copper, tend to outperform gold and other precious metals as hedging vehicles and
safe haven assets against losses in sovereign bonds. However, the outcome of the hedge and
safe haven properties is not always consistent across the different bonds. Finally, our analysis
suggests that copper is the best performing metal in the period immediately after negative
bond price shocks.
JEL classification: G10; G11; G14;
Keywords: Gold; Precious Metals; Industrial Metals; Sovereign Bonds; Hedge; Safe Haven;
1
Sam Agyei-Ampomah is from Cranfield School of Management, Cranfield University, Cranfield, MK43 0AL,
UK., Dimitrios Gounopoulos is from School of Business Management and Economics, University of Sussex,
Falmer, Brighton, BN1 9SL, UK. Khelifa Mazouz is from Management School, University of Bradford,
Bradford, BD9 4JL, UK. We are grateful to the Co-Editors Carol Alexander and Ike Mathur, an Associate
Editor and two anonymous referee for their detailed and insightful comments. We would like to thank Dirk
Baur, Taufiq Choudhry, Theoharry Grammatikos, Alexander Kupfer, Shawkat Hammoudeh, M. Thenmozhi,
Dalu Zhang, seminar participants at the Southampton International Conference on the Global Financial Crises,
the European Financial Management Conference (EFM2013), the Multinational Finance Conference
(MFS2013), Cardiff Business School at University of Cardiff and School of Business, Management and
Economics at University of Sussex for useful comments and suggestions.

2
1. Introduction
The financial media normally regard gold as a safe haven asset. Its characteristics as a
financial asset have also been widely explored in the academic literature. Gold has been a
traditional investment vehicle since it serves as a hedge against inflation and a safe haven in
periods of market crises (see e.g., Baur and McDermott, 2010; Daskalaki and Skiadopoulos,
2011; Batten et al., 2013). It has also been widely documented that gold protects investors’
wealth against fluctuations in the foreign exchange value of the US dollar (Capie et al., 2005;
Pukthuanthong and Roll, 2011; Reboredo, 2013 and Ciner et al., 2013). The observed
increase in the value of gold during the recent financial crisis has motivated other researchers
to test explicitly its viability as a safe haven from losses in other financial markets. Baur and
McDermott (2010) show that gold protects investors against stock market shocks in major
European countries and the US, but does not serve as a safe haven for Australia, Canada,
Japan and emerging stock markets. Similarly, Baur and Lucey (2010) find that gold is a safe
haven for stocks, but not for bonds, in the US, the UK and Germany.
The main objective of this study is to investigate whether gold is a special investment
vehicle or if it has become relegated in status to the same standing as other metals, which are
primarily for industrial purposes and traded as commodities. There is no sound theoretical
model to explain why gold may act as a safe haven, but a major explanation often put forward
is that gold was among the first forms of money and has traditionally acted as an inflation
hedge (Baur and Lucey, 2010). However, since the collapse of Bretton Woods system and the
move to floating exchange rate regimes, the market for gold and silver have changed
dramatically (Hillier et al., 2006). The monetary element of these precious metals has
gradually been replaced and their industrial use has been extended. Furthermore, the
extensive use of gold as a hedging vehicle has also sparked the utilization of other precious
metals as risk management tools and diversifying commodity portfolios (see, e.g., Marshall et

3
al., 2008; Belousova and Dorfleitner, 2012). Since gold has more characteristics in common
with other metals, particularly precious ones, than it does with any other commodities,
investors may treat metals as a separate asset class (Belousova and Dorfleitner, 2012). This,
in turn, would cause gold prices to comove more with metals than other commodities (see
Pindyck and Rotember, 1990; Pierdzioch et al., 2013 among others)
2, 3
Consistent with the comovement evidence, Daskalaki and Skiadopoulos (2011) show
that the returns on major precious metals, including gold, silver, platinum and palladium,
exhibit low correlations with stock returns. Morales and Andreosso-O'Callaghan (2011) find
that the precious metals markets are less affected by the recent global financial crisis than
other major financial markets around the world. Erb and Harvey (2006) and Roache and
Rossi (2010) also find that gold and silver prices are counter-cyclical, implying that precious
metals other than gold may also protect investors’ wealth in the events of negative stock
market conditions. Furthermore, observed marked data (see Figure 1 and Panel B of Table 2
below) suggests that industrial metals also comove with precious metals. Thus, industrial
metals may also serve as a place of safety in the events of negative economic conditions and
this leads to the following important questions: (i) to what extent does gold protect investors’
wealth against sovereign-debt crisis? (ii) does gold offer a better protection against sovereign-
debt crisis than other metals? and (iii) is the protection, if any, offered by gold and other
metals against sovereign credit deteriorations short- or long-lived?
While the hedge and safe haven properties of gold have explicitly been examined in
the context of both stock and bond markets (Baur and McDermott, 2010; and Baur and
2
Gold and precious metals can be reused or recycled for new fabrication, which provide an additional source of
supply. This is in stark contrast to energy, agricultural and livestock commodities which are spent, consumed, or
transformed but are rarely recoverable. Metals also tend to have longer shelf lives and are less susceptible to
adverse storage conditions than agricultural commodities. They can also be transported without the need for
specialised infrastructure such as in the case of oil or natural resources.
3
Indeed, our correlation analysis (see Table 2 below) indicates that metals tend to co-move and the comovement
is, in some cases, stronger during periods of crisis.

4
Lucey, 2010), the role of other precious and industrial metals as hedging vehicles and safe
haven assets has not yet been explicitly explored. This study investigates the relative abilities
of industrial and precious metals to protect investors’ losses in the sovereign debt markets.
Existing studies tend to focus on assets that provide protection against investors’ losses in
stock and foreign exchange markets, with government bonds typically seen as relatively safe
assets. However, recent evidence suggests that sovereign debt markets, particularly in the
Eurozone (except for Germany), have recently become more volatile due to the “flight to
safety” syndrome that has gripped financial markets (Schwarz, 2008). Furthermore, the
(unreported) finding that the correlation between the conditional volatility of government
bonds and that of the world index increases significantly during crisis periods suggests that
the extreme movements in sovereign bond markets may be representative of the crisis
episodes
4
. Thus, since government bond markets are affected by the economic downturns and
since sovereign debt crisis (e.g. the recent European sovereign debt crisis) and government
defaults (e.g. Russia in 1998 and Argentina in 2001) are not uncommon, it would be useful
for investors to identify asset classes that can protect their wealth against the sudden
deterioration in the government bonds.
While metals may not be the only place of safety
5
, we choose to focus on safe haven
properties of these assets for, at least, two reasons. First, metals are the closest related assets
to gold (a traditional “investment of last resort”). Second, metal prices are driven by the
global demand as opposed to domestic demand in the case of many domestic bonds and
stocks. In some cases, such as the recent European sovereign debt crisis, investors face losses
on both (domestic) stocks and bonds and may, therefore, seek refuge from other asset classes.
4
Further details on these tests are available upon request.
5
In unreported tests, we show that other commodities, including S&P GSCI agricultural index and S&P GSCI
Crude Oil Index and stocks, namely MSCI BRIC Equity Index and MSCI World Equity Index, can also be used
as a hedge and safe haven against losses in the sovereign bond market. Further details on these results can be
obtained from the authors.

Frequently asked questions

Q1. What are the contributions mentioned in the paper "Does gold offer a better protection against sovereign debt crisis than other metals?" ?

In this study, the authors test whether other metals offer similar or better investment opportunities in periods of market turmoil. Using a sample of 13 sovereign bonds, the authors show that other precious metals, palladium in particular, offer investors greater compensation for their bond market losses than gold. The authors also find that industrial metals, especially copper, tend to outperform gold and other precious metals as hedging vehicles and safe haven assets against losses in sovereign bonds. Finally, their analysis suggests that copper is the best performing metal in the period immediately after negative bond price shocks. 

Q2. What do Baur and McDermott (2010) find that gold may act as a?

Baur and McDermott (2010) find that gold may act as a stabilizing force for the financial system by reducing losses in the face of extreme negative market shocks. 

Q3. How long after extreme shocks does a portfolio of palladium turn positive?

while the returns associated with a portfolio of palladium and UK sovereign bond begin to turn positive 8 days after extreme shocks, the portfolio that includes silver turns positive after 19 days. 

Q4. What is the safe haven for the bonds in the lower 1st percentile?

For shocks in the lower 1 st percentile, palladium offers a safe haven for the bonds in Finland, Germany, Italy, Netherlands, Portugal and the EMU benchmark bond and a weak safe haven for the rest of the sovereign bonds. 

Q5. what is the strategy for protecting investors’ wealth against sovereign crises?

as the hedge and safe haven properties of gold and other metals vary across bonds, a tactical allocation strategy that manages the bond-metal composition may be necessary to protect investors’ wealth against extreme losses in the government bond markets. 

Q6. What is the strongest safe haven for copper?

Their results also suggest that copper is the strongest hedging assets and investors are more likely to be protected from losses in the bond markets by holding industrial rather than precious metals. 

Q7. What is the main reason why industrial metals outperform gold?

The outperformance of industrial metals as risk management vehicles in the government bond markets is attributed to their increasing global demand as they are seen as key indicators of the health of the global economy. 

Q8. What do they show that precious metals have?

Draper et al. (2006) also show that precious metals have hedging capability and a potential for playing the role of safe havens, particularly during periods of abnormal stock market volatility. 

Q9. What is the effect of industrial metals on investors?

The ability of industrial metalsin protecting investors against losses in the US and European bonds may be attributed to increased demand for these metals from major emerging countries, including the BRIC, which have not been less strongly affected by the recent crisis. 

Q10. What is the way to protect against the negative returns of the US and European bonds?

The safe haven property of the portfolio of all metals is shown to be strong only for bonds in the Netherlands and the US for negative bond returns in the lower 5 th and 10 th percentiles, respectively. 

Q11. Why do they find that gold and silver have low correlations with stock index returns?

This is because a surprise improvement in economic growth may cause gold and silver prices to drop because of portfolio rebalancing effects, but result in higher industrial metal prices due to greater industrial demand. 

Q12. What is the hedging coefficient of silver?

Silver’s hedging coefficients are mainly negative, but not statistically different fromzero, indicating that this metal serves as a weak hedge against losses in the sovereign bond markets. 

Q13. What is the main regression model used to assess the return generating process of industrial and precious metal?

as in Baur and McDermott (2010), the authors model the return generating process of the metals as:(1a)(1b)(1c)where , D5 and D10 are dummy variables, which are used to capture extreme bond market movements, with values of one if the bond return on day t falls in the lower 1 st , 5 th and 10 th percentile, respectively, and zero otherwise. 

Q14. What is the performing industrial metal in the period immediately after extreme negative bond price changes?

the authors find that copper (palladium) is thebest performing industrial (precious) metal in the period immediately after extreme negative bond price changes. 

Q15. What does Baur and McDermott show that gold protects investors against stock market?

Baur and McDermott (2010) show that gold protects investors against stock market shocks in major European countries and the US, but does not serve as a safe haven for Australia, Canada, Japan and emerging stock markets. 

Q16. What are the correlations between industrial metals and the PMD?

With the exception of Zinc and Lead, the correlations between industrial metals and the Precious Metal Index (PMD) also increase during the times of crisis.