Nonneutral short-run effects of derivatives on gold prices

Abstract

About 90% of the decline in gold prices over the decade of the 1990s – from $393 (per ounce) in the beginning of 1990 to $286 in early 2000 – occurred after early 1995. While gold prices were falling, the use of derivative instruments (forwards, options, futures and the like) by the gold mining industry increased rapidly. Traditionally, such activity would not be expected to affect gold prices. In this article we investigate the possible impact of derivatives on the gold market. The research findings suggest that the use of derivatives by gold producers, whether it was to hedge against the risk of declining gold prices, or for other purposes, probably pushed gold prices below what they would have been based upon historical relationships. Conversely, when gold producers reduced their net derivative positions over the April 1999:IV to January 2006:I period, this de-hedging appears to have helped boost gold prices back toward levels consistent with longer run fundamentals.