The GIC’s Bahama Central Banking conference ended with a insightful talk on what’s affecting the price of gold.
Gold traders spend a lot of time arguing about the usual suspects.
- Inflation.
- Real rates.
- Central bank buying.
- Jewelry demand.
- Chinese retail flows.
David Kotok decided to ignore all of them.
Instead, he went looking for a market signal that might help explain the direction of gold prices.
What he found is unexpected.
The Variable That May Lead Gold
Kotok’s research focuses on credit default swaps (CDS) on U.S. Treasury debt.
A CDS is essentially insurance against a borrower defaulting. In this case, it’s insurance against the United States failing to pay its debt.
The market for U.S. CDS runs into the trillions of dollars and acts as a real-time gauge of how investors perceive sovereign credit risk.
Kotok asked a simple question.
Do changes in that market have any relationship with the price of gold?
To find out, he analyzed monthly data and compared gold prices with CDS spreads on U.S. sovereign debt.
Then he ran statistical tests to see whether movements in CDS spreads could forecast movements in gold.
The Result
The relationship was stronger than expected.
Kotok’s analysis shows that changes in CDS spreads often lead movements in gold prices, with lags ranging from roughly two months to nearly two years.
The test used is called Granger causality, a statistical method used to determine whether one variable historically helps predict another.
Important point.
Granger causality does not prove one variable causes the other. It simply shows that historically, one variable tends to move first.
And in this case, the CDS market often moved before gold.
Why That Might Happen
The logic is straightforward.
Gold functions as the ultimate monetary hedge.
If investors begin to perceive even a small increase in the risk of sovereign debt problems, they often move capital into assets that sit outside the credit system.
Gold fits that role.
So when the cost of insuring U.S. debt rises, demand for gold may rise as well.
Kotok’s work suggests that this relationship has been visible in the data for more than a decade.
A Market Signal, Not a Forecast
Kotok is careful about what this research does and does not say.
It does not predict the future price of gold.
It does not guarantee the relationship will continue. And it certainly does not imply that a U.S. default is imminent.
The United States has never defaulted on its sovereign debt.
What the research suggests is something simpler.
Markets may be embedding information about sovereign risk in CDS spreads before that information appears in the gold market.
For traders, that makes CDS spreads worth watching.
The Bigger Picture
Gold has always been tied to the credibility of governments.
When confidence in sovereign balance sheets rises, gold often stagnates.
When confidence weakens, gold tends to regain its monetary role.
Kotok’s work suggests that the CDS market may be one of the places where that shift shows up first.
Not in headlines.
Not in speeches.
In prices.
You can read more about Kotok’s gold research here:
https://open.substack.com/pub/dkotok/p/trying-to-forecast-the-price-of-gold?r=21mgy&utm_medium=ios