Do Gold and Oil Cointegrate?

I have written extensively here about cointegration between gold-miners and gold ETF's (GDX vs GLD), as well as between energy companies and oil ETF's (XLE vs USO). (See, for e.g., this article, or this article.) On another occasion, I also commented on an Economist magazine article about the possible cointegration between bond yield and oil prices. However, my fellow blogger Yaser recently pointed out an interesting link between gold and oil also. The reasons why gold and oil may be cointegrated are very similar to that of bond yield and oil: as oil price rise a) the oil revenue is invested heavily in gold, therefore pushing up gold price; b) there is an upward pressure on inflation, which increases the appeal of gold as an inflation hedge.

I did a cointegration analysis between gold and oil prices, and though their spread certainly looks somewhat mean-reverting since the 90's, it doesn't pass the cointegration test. The reason may simply be that this spread mean-reverts at a glacial pace: I estimate that the half-life (see my explanation of this term here) is over 14 months. Therefore, it may require historical data back to the 1970's to convince ourselves of their cointegration. (My own data on crude oil and gold prices only go as far back as the 1990's. If any reader knows of historical data source that goes back further, please let me know.) If, however, one is willing to take their cointegration by faith despite the inadequate data, then one may believe that gold is currently (as of Feb 12, 2007) just slightly undervalued relative to oil (the spread is about $8). I certainly don't recommend entering into a position on either side at this point!

Another article on political futures markets

A NYTimes article yesterday talked about the political futures market intrade.com in the context of the November election, particularly the Virginia Senate race, which I blogged about before. I urged my readers to curb their enthusiasm for using such markets for prediction in my article, while the NYTimes article is certainly much more enamored of them. However, I think we can all agree that such markets are very efficient in synthesizing all existing information and opinion in making a prediction, but it cannot reveal information that nobody can possibly know at this point, such as who is going to win the 2008 general election.

Use the right discount rate to avoid jail time

Here is a fascinating story about the former treasurer of Essex County, New Jersey, who was sentenced to seven and a half years in prison because the prosecutor used the wrong discount rate to value certain tax-exempt bonds.