Copenhagen Business School Department of Finance 15th May 2019 Gold Price Dynamics Around the Clock Authors: Francesco Donati (115765) Johannes A. Jung (115540) Supervisor: Paul Whelan Pages: 98 Characters: 183,273 Thesis submitted in partial fulfilment of the requirements for the degree of Master of Science in Advanced Economics and Finance (Cand.Oecon) Acknowledgements We want to thank Copenhagen Business School for the splendid learning opportunity. We express our deep gratitude to the thesis supervisor, Paul Whelan, for his guidance. We want to thank our friends and families for their precious support during this exciting last period of our student life. A special mention goes to our parents, of course. We want to thank the amazing people met in the program, their energy, drive and diversity inspired and improved us. We will be missing all the ups and downs of student's life. Further, we want to thank Beyza and Emanuela, for the laughs and joy they brought us every day. Lastly, Johannes wants to mention that his girl Ploy is more precious than gold to him. Francesco & Johannes Abstract In this thesis we examine intraday behaviour of gold prices in the 24 hours day. We make a distinction between eastern world (China, India) and western world (US, Europe). We suspect that the intraday pattern may be affected by two factors: (i) large gold imports by eastern countries and (ii) manipulation of the London Gold Fix. We find a hat-shaped intraday seasonality, with gold appreciating during eastern trading hours in a robust way and depreciating for the rest of the day. Additionally, in the years of alleged manipulation gold prices drop around the London fixing times. In a multivariate regression analysis we find that East and West returns respond differently to the same shock, which means that eastern and western clienteles react asymmetrically in their gold consumption choices. Lastly, we backtest trading strategies trying to exploit the pattern. When transaction costs are not taken into account they outperform the market, with Sharpe ratios as high as 1.61. When taken into account, trading strategies underperform the market, but still show some profitability. Contents 1 Introduction 1 1.1 Motivation . .1 1.2 Literature Review . .2 1.3 Research Questions and Methods . .4 1.4 Main Findings . .5 1.5 Structure of The Thesis . .5 2 Gold - An Overview 7 2.1 Why do People Trade Gold? . .7 2.2 The Global Gold Market . 12 2.2.1 Supply . 13 2.2.2 Demand . 15 2.2.3 Trading venues . 17 2.3 The London Bullion Market . 18 2.3.1 Unallocated and Allocated Gold . 18 2.3.2 The Fixing Process . 19 2.3.3 Manipulation of the Fixing . 21 2.4 The COMEX Gold Market . 23 2.4.1 Gold Options . 23 2.4.2 Gold Futures . 24 2.4.3 The Delivery Process of Futures . 24 3 Data 27 3.1 Gold Data . 27 3.1.1 Why COMEX Gold Futures . 28 3.1.2 Reducing Frequency . 28 i 3.1.3 Cleaning Quotes . 30 3.1.4 Cleaning Volumes . 32 3.1.5 Data Properties . 32 3.2 Macro Data . 33 4 Market Microstructure 35 4.1 Returns . 35 4.2 Volatility . 38 4.3 Liquidity . 40 4.4 Trading Volume . 40 4.5 Interrelations . 42 4.6 Summary of Results . 43 5 Robustness Checks 45 5.1 Daylight Savings . 46 5.2 Different Sample Periods . 49 5.2.1 Three Sub Periods . 49 5.2.2 Year by Year . 52 5.3 Calendar Effects . 55 5.3.1 Month of the Year . 56 5.3.2 Day of the Week . 58 5.4 Summary of Results . 60 6 Macroeconomic Relationships 63 6.1 Established Relationships . 63 6.1.1 Gold, Inflation and Interest Rates . 63 6.1.2 Gold and Currencies . 66 6.1.3 Gold and Other Commodities . 67 6.2 Contemporaneous Correlations . 67 6.3 Contemporaneous Regressions . 69 6.3.1 Econometric Method . 69 6.3.2 Empirical Results . 71 ii 6.4 Summary of Results . 75 7 Trading Strategies 77 7.1 Active and Passive Strategies . 77 7.2 Performance Measures . 78 7.3 Without Transaction Costs . 80 7.3.1 Profitability . 81 7.3.2 Performance . 83 7.3.3 Portfolios . 84 7.4 With Transaction Costs . 85 7.4.1 Profitability . 86 7.4.2 Performance . 88 7.4.3 Portfolios . 88 7.5 The Efficient Market Hypothesis . 89 7.6 Future Profitability of Active Strategies . 91 7.7 Summary of Results . 91 8 Conclusion 93 A Additional Tables 95 B Additional Figures 109 iii iv List of Tables 6.1 Correlations between Macro Variables and Returns . 68 6.2 Estimation Results Ideal Specification . 71 6.3 Estimation Results . 72 7.1 Yearly Returns, without Transaction Costs . 82 7.2 Yearly Returns, with Transaction Costs . 87 A.1 Global Gold Stock . 95 A.2 Global Gold Demand by Sector . 95 A.3 Global Gold Supply . 96 A.4 Global Gold Reserve by Country . 96 A.5 Global Gold Mining Supply by Region . 97 A.6 Global Gold Mining Supply by Country . 97 A.7 Gold Trading volumes, Average Daily . 98 A.8 Gold Trading Volumes, Yearly (Exchange Only) . 98 A.9 Macro Variables . 99 A.10 Year by Year Average Returns . 100 A.11 Month of the Year Average Returns . 101 A.12 Day of the Week Average Returns . 102 A.13 Correlation Matrix . 103 A.14 Sharpe Ratios, without Transaction Costs . 104 A.15 Sortino Ratios, without Transaction Costs . 105 A.16 Sharpe Ratios, with Transaction Costs . 106 A.17 Sortino Ratios, with Transaction Costs . 107 v vi List of Figures 2.1 Barclays Manipulation Case . 22 3.1 Volumes and Spreads, Year by Year . ..