Abstract:
We develop models for examining possible predictors of the return on gold that embrace six global
factors (business cycle, nominal, interest rate, commodity, exchange rate and stock price factors)
extracted from a recursive principal component analysis (PCA) and two uncertainty indices (the
Kansas City Fed’s financial stress index and the U.S. Economic uncertainty index). Specifically, by
comparing with other alternative models, we show that the dynamic model averaging (DMA) and
dynamic model selection (DMS) models outperform not only a linear model (such as random walk)
but also the Bayesian model averaging (BMA) model for examining possible predictors of the return
of gold. The DMS is the best overall across all forecast horizons. Our result is also robust to a version
of the PCA that uses all the 28 potential predictors instead of categorizing them, as well as, alternative
out-of-sample period. Generally, all the predictors show strong predictive power at one time or
another though at varying magnitudes, while the exchange rate factor and the Kansas City Fed’s
financial stress index appear to be strong at almost all horizons and sub-periods. However, the
forecasting prowess of the exchange rate is supreme.
