Relationship Between Select Commodity Prices and Macroeconomics Variables in India : A VAR Analysis

Abstract

Focusing on the recent increase in gold prices, the basic objective of the paper is to predict changes in the price of gold and to examine the relationship that exists between commodity prices and macroeconomic variables in the Indian context. The variables considered are: commodity prices as represented by gold, silver and oil; and macroeconomic variables represented by interest rates, exchange rates and stock market indices. Vector Autoregressive (VAR) Modeling has been adopted and standard VAR summary statistics such as Granger causality tests, impulse response functions, and variance decompositions are analyzed to study comovements between the variables. Monthly data from April 2005 to December 2013 forms the sample period of our study. Primarily, the following conclusions emerge: First, the largest share of shock to price of gold is significantly explained by its own variance. Shocks in other variables explain only 10 per cent of the variation in gold prices. Interestingly, innovations in silver prices explain variations in gold prices more than it explains variations in its own price. Analysis of the impulse response functions reveals that a positive shock to oil and silver price has a favourable effect on gold price initially, though its response becomes adverse later. Further, the impact of a positive shock to Nifty on gold prices, though positive initially, dissipates thereafter. Additionally, innovations in exchange rate initially have an adverse impact on gold price, though later gold prices begin to respond favourably. Johansen’s Cointegration test suggests that there is a weak long term relationship that exists among the variables analyzed in the study