key: cord-0845780-oubcob0c
authors: Salisu, Afees A.; Vo, Xuan Vinh; Lawal, Adedoyin
title: Hedging oil price risk with gold during COVID-19 pandemic
date: 2020-10-10
journal: Resources policy
DOI: 10.1016/j.resourpol.2020.101897
sha: 2a3b03ba9c88271b868b03e837c0fad203e0a46c
doc_id: 845780
cord_uid: oubcob0c

This paper assesses the role of gold as a safe haven or hedge against crude oil price risks. We employ the asymmetric VARMA-GARCH model, using daily data from January 2016 to August 2020. To account for the impact of COVID-19 pandemic, we partitioned the data into two to reflect the periods before and during the pandemic. Our empirical results find gold as a significant safe haven against oil price risks. The optimal portfolio and hedging analyses conducted also validate the hedging effectiveness of gold against risk associated with oil. The robustness of our results is further confirmed using three other prominent precious metals - silver, platinum, and palladium. In sum, our results are useful for investors and portfolio managers that are desirous of using gold and other precious metals as portfolio rebalancing tools to minimize or circumvent risks associated with volatile oil returns.

We the undersigned declare that this manuscript is original, has not been published before and is not currently being considered for publication elsewhere.

We wish to confirm that there are no known conflicts of interest associated with this publication and there has been no significant financial support for this work that could have influenced its outcome.

We confirm that the manuscript has been read and approved by all named authors and that there are no other persons who satisfied the criteria for authorship but are not listed. We further confirm that the order of authors listed in the manuscript has been approved by all of us.

We confirm that we have given due consideration to the protection of intellectual property associated with this work and that there are no impediments to publication, including the timing of publication, with respect to intellectual property. In so doing we confirm that we have followed the regulations of our institutions concerning intellectual property.

This paper investigates whether gold can continue to show its impressive run as a safety net for investors against oil market risks induced by the COVID-19 pandemic. The prospect of gold to provide cover for investors in the global crude oil market in the face of the pandemic has not been explored. 1 This research objective is significant, given that the financial markets, including the crude oil market are vulnerable to pandemics. With increased financialisation, the global financial and commodity markets have been empirically shown to be negatively impacted by SARS, EBOLA, & COVID-19 pandemics [see Chen et al., 2009; Ichev & Marinč, 2018; Akhtaruzzaman et al., 2020; Ji et al., 2020; Shehzad et al., 2020; Salisu et al., 2020] . Particularly, the COVID-19 pandemic has led to global economic slowdown, dropping

West Texas intermediate oil price below zero in April 2020, accompanied by a fall in the world industrial production index by about 4.5% in the first quarter of 2020 [see Gharib et al., 2020; Bakas & Triantafyllou, 2020] . Further, the crude oil market has witnessed some of its highest uncertainties partly due to the COVID-19 pandemic and partly due to political manoeuvres among oil producers during the period (see Ali et al., 2020) .

The scenario described as "crash in the global oil price due to the COVID-19 pandemic" justifies our search for a safe asset in the face of mounting global panic and increased risk aversion in the global financial markets [see also, Zhang et al., 2020; Salisu et al., 2020] . The first motivation for the choice of gold for this hedging purpose is consequent on its low variability, and its ability to preserve wealth during inflation and safeguard investment during financial crises/uncertainties [see Tully & Lucey, 2007; Shafiee and Topal, 2010; Narayan et al., 2010; Wang, 2013; Bildirici & Turkmen, 2015; Jebran et al., 2017; Uzo-Peters et al., 2018; Jin et al., 2019; Wei et al., 2019] . The second motivation to support our choice of gold rests on the inferences from Selmi et al. (2018) that gold is a worthy hedging asset when facing severe oil price movements. The third and strongest motivation for the study emanates from Ji et al. (2020) , who find strong hedging role for gold during COVID-19 pandemic when other potential asset classes are less effective. 2

The research objective to look at the efficacy of gold as a good hedge against oil price risk is not arbitrary. Theoretically, it develops from an established age-long relationship between crude oil and gold [see Soytas et al., 2009; Narayan et al., 2010; Zhang and Wei, 2010; Ewing and Malik, 2013; Gil-Alana et al., 2017; Bildirici & Sonustun, 2018; Bedoui et al., 2019; Chen and Xu, 2019] as the two biggest, commonly traded assets in the global financial/commodity markets. From the perspective of investors, when oil price risks increase financial markets' uncertainty as argued earlier during the pandemic, it is incumbent on investors to seek protection in gold as against other assets that contribute to spiral in financial contagions like oil, cryptocurrencies, and stocks [see Yaya et al. 2016; Corbet et al., 2020; . From a policy stance, the global linkage of gold and crude oil markets would indicate that the two prices be considered with an economic lens and within the spectrum of the energy & financial policies of net buying and selling economies [see Kanjilal and Ghosh, 2017; Seyyedi, 2017; Aguilera & Radetzki, 2017; Sephton & Mann, 2018] .

Following the introduction, the second section deals with theoretical construction for hedging oil price risks with gold. The methodology section describes the data, the estimable model and the estimation technique in Section 3. Section 4 discusses the results and Section 5 concludes the study.

The theoretical construction for linking the crude oil and gold markets has been argued to stem from the age-long connection between the crude oil and gold markets, and the gold and oil prices -both having global effects on the macroeconomic fundamentals of wide-ranging countries [see Soytas et al., 2009; Narayan et al., 2010; Zhang and Wei, 2010; Ewing and Malik, 2013; Gil-Alana et al., 2017; Bildirici & Sonustun, 2018; Bedoui et al., 2019; Chen and Xu, 2019] . Crude oil is a major source of energy globally and is therefore shown to significantly influence global macroeconomic dynamics, including economic growth, inflation, and stock market fundamentals of many countries [see Aguilera & Radetzki, 2017;

Ansari & Sensarma, 2019]. The gold market has also grown in size globally due to increase in its financial features especially post Bretton Woods, and therefore conveys price information across the global economy [see Zhang & Wei, 2010; Beckmann et al., 2018] .

With this connection, the theoretical linkage for the role of gold as a good hedge against oil price risk is straightforward. The nexus can be observed in two ways. First, oil price shock is associated with rising inflationary pressures [see for example, Hooker, 2002; Hunt, 2006; Zhang and Wei, 2010; Aguilera & Radetzki, 2017] . When this happens, it becomes a smart investment decision to look for a safe haven, given existing pieces of evidence that gold provides cover against inflation risks [see for example, Shafiee and Topal, 2010; Jain and Ghosh, 2013; Batten et al., 2014; Bildirici & Turkmen, 2015; Jin et al., 2019] .

Second, in periods of high financial markets uncertainties like the one brought about by the COVID-19 pandemic (see Bakas and Triantafyllou, 2020), risk aversion rises because investors are more concerned with cutting investment losses [see Tversky and Kahneman, 1991; Hwang and Satchell, 2010] ; the risk aversion motivates investors to look for alternatives to oil in their portfolio choices in the form of safe investment in gold [see Yaya et al. 2016; ]. This second view is based on the submission that gold market retains its low variability [see Qadan, 2019] in the face of high uncertainty in the mainstream financial markets during pandemics.

The ability of gold to serve as a hedge or safe haven can be viewed theoretically from the , gold seems to be the best investment alternatives (hedge or safe haven) in a period of crumbling economic outlook characterized by stock market crash, unfavorable exchange rates and weak commodities outlook. It is therefore expedient to note that return on gold (as determined by the demand for gold) is dependent on the returns on alternative investments like oil, bond etc. and the global risk factor. Therefore, risk-return (mean-variance) analysis in the global space is key to examining the expected returns and risk (variance) associated with gold and oil.

Following this study's objectives as earlier discussed, we collected data for the two main variables of interest, namely the global gold and crude oil prices. The gold price is measured using the London Bullion Market Association (LBMA) gold fixing Price in U.S.

Dollars per troy ounce. Crude oil price is proxied using the London Brent crude oil price.

Daily data on gold and oil prices were collected from the US Federal Reserve Bank of St.

Louis (fredstat) economic database, spanning January 2016 and August 2020. For robustness purposes, our empirical analyses are extended to evaluate the volatility spillovers and effectiveness of other prominent precious metals in hedging oil price risks. Specifically, we collected data on three other precious metals: silver, platinum, and palladium. Furthermore, J o u r n a l P r e -p r o o f we extend the analyses to account for the Covid-19 pandemic effects by extending the data sample to two additional sub-samples: (i) before COVID-19, which covers the period before the emergence of COVID-19 (ii) Covid-19 period-that is, since the first declaration of the emergence of the virus till date 3 .

The descriptive analysis of the returns 4 for gold and crude oil prices are summarized in Table 1 . The summary statistics considered include mean, maximum, minimum, standard deviation, skewness, and kurtosis. The mean of the summary statistics indicates positive average gold stock returns across the three sub-periods considered, while the average crude oil returns is positive before the emergence of COVID-19 but negative during the pandemic period. The positive average gold returns since the outbreak of COVID-19 and its effects on the global financial and commodities markets could be suggestive of a relatively average improved performance, same as for palladium and silver markets. On the other hand, the crude oil as well as platinum price returns experienced an overall average decline since the outbreak of COVID-19. The standard deviation which depicts a more volatile crude oil returns than gold and returns for the three other metals is considered. Lastly, all the series returns are negatively skewed for the full sample during the pandemic, while oil is positive before the outbreak. The high kurtosis values suggest that all the series are leptokurtic.

Furthermore, we extend the summary statistics to explore the co-movement between crude oil and the four commodities considered. The graphical illustration presented in Figure 1 suggests that there is co-movement between each commodity price series and crude oil prices, and this is stronger and more noticeable since the outbreak of COVID-19.

Following the descriptive statistics discussion, we evaluate the choice of appropriate GARCH model to be used for the empirical analyses. These formal pre-tests include serial 

The ARCH-LM tests indicate evidence of statistically significant conditional heteroscedasticity in both gold and oil price returns across the three estimation sub-samples.

By implication, estimators that account for such ARCH effects is preferred. In addition, the Ljung-Box serial correlation tests also support the evidence of statistically significant serial correlation. The additional formal pre-tests including the Engle-Ng sign and joint size bias tests indicate statistically significant estimates for both the full sample and pre-COVID periods. Hence, it supports evidence of significant asymmetric effects on gold and crude oil price returns. During the COVID-19 period however, the asymmetric effect is not evident.

Hence the estimation for the COVID-19 sample statistically supports the symmetric variant of the VARMA-GARCH model. Lastly, the Engle-Sheppard tests across the three data samples considered are not statistically significant, and these therefore provide statistical evidence of constant conditional correlations between the two commodity sectors. The summary of the preferred model for each data sample is summarised on the last row of Table   2 . I  II III IV I  II III IV I  II III IV I II III IV I  II III   2016 I  II III IV I  II III IV I  II III IV I II III IV I  II III   2016  2017  2018 2019 2020

Platinum (USD per ounce) Crude Oil (USD per barrel) spillovers between gold and oil price returns is specified respectively as:

where 

Finally, the conditional covariance is expressed as:

where GO ρ is the conditional constant correlations between gold and oil price returns. The estimation procedure as well as the statistical and structural properties of the model, which provides both the necessary and sufficient conditions, are provided in Ling and McAleer (2003) (see also Salisu and Mobolaji (2013) and Salisu and Oloko, (2015) . 

The results of the bivariate asymmetric and symmetric VARMA-CCC-GARCH models are summarised in Table 3 

The volatility spillovers between the two commodities price returns further confirm that there are significant volatility effects. The estimated coefficient of the variance equation is summarised in Table 3 and it shows that all the parameters of the ARCH and GARCH terms are statistically significant. The own shocks for the gold and crude oil returns is positive and statistically significant both before and during the pandemic period. The coefficients of the cross-returns spillovers between gold and crude oil returns ( 12

show that the current conditional volatility for each of the market significantly affects the immediate returns in the other market. However, while it is positive from oil to gold markets, the reverse is the case from gold to crude oil returns across the three samples. This finding is consistent with previous studies which established that crude oil firms are severely exposed to event-related risks such as the 9/11 attacks in the US and the global financial crisis of 2008 (see also (Kim et al., 2013; Lee & Jang, 2011; Li et al., 2020; Paraskevas & Quek, 2019; Park et al., 2017; Shrydeh et al., 2019) .

As expected, the own-volatility transmission for each of the market is positive and statistically significant for both returns before and during the pandemic. In addition, the cross-sector volatility spillover effects between gold and crude oil returns ( 

This section discusses the optimal portfolio weights and hedging effectiveness of gold for crude oil returns using the conditional variance and covariance estimates obtained from the main estimation. The significant of returns and volatility spillovers between the gold and crude oil returns is suggestive of volatility and risk susceptibilities to investors' assets in the global financial and commodity markets. The outbreak of COVID-19 pandemic further amplifies these associated volatilities and risks susceptibilities. It is therefore imperative for investors to mitigate such risks by engaging in portfolio rebalancing and hedging, through engagement in future contract and without jeopardising their expected returns.

We estimate the optimal portfolio weights (OPW) to evaluate the optimal proportion of gold and crude oil assets that should form a rational investor's portfolio. Following Kroner and Ng (1998) and Arouri et al., (2011) , we construct the optimal portfolio weight of holding the two assets using the conditional variance and covariances defined as:

and, Consequently, the optimal weight of gold in the two asset classes considered can be evaluated as , 1 GO t ϖ − . Furthermore, we construct the optimal hedge ratio (OHR) to evaluate the hedging effectiveness of gold against crude oil returns. Following Kroner and Sultan (1993) the risk of a crude oil investment portfolio is minimised if a long position of one dollar in crude oil asset can be hedged by a short position of t α dollars in gold (see also Arouri et al., 2011; Salisu and Mobolaji, (2013) ; Salisu and Oloko, (2015) ). The formulation of the OHR between these two assets is defined as:

The results of the optimal portfolio weights and optimal hedge ratio computed for the sample partitions are summarized in 

We extend the empirical estimation by investigating the role of other prominent precious metals on the portfolio choice and their hedging effectiveness against crude oil risks, especially during the COVID-19 outbreak. Essentially, we consider three other prominent commodities: silver, platinum, and palladium. We commence estimating the appropriate bivariate VARMA-GARCH models for both the mean and variance equations between each J o u r n a l P r e -p r o o f metal and crude oil price returns 5 . The estimated results for the three metals -palladium, platinum and silver, show evidence of statistically significant bidirectional returns and volatility spillover transmission with crude oil prices; thus indicating that the trio, as also established for gold returns, could serve as safe havens for rising risks in the crude oil returns (see Table A1 and A2 in the appendix). In addition, the estimated OPW and OHR results as summarised in Table A3 of the Appendix section, indicate that optimal weight of each of the considered metals in a one-dollar investment portfolio is at 100, 0.96, and 1.01 for palladium, platinum and silver respectively. These results, as also established in the case of gold, are suggestive that each of the precious metals are optimal investment safe haven for crude oil investment risks since the outbreak of COVID-19. In addition, the computed hedge ratios further establish that risks associated with crude oil returns can be hedged by taking a short position in either of these assets (see also (Bhatia et al., 2020; Dutta et al., 2019; Hernandez et al., 2019; Yıldırım et al., 2020) .

The results from the study offers some significant implications. For instance, the results reveal that it is better off to calibrate gold in asset portfolio so as to maximize the expected utilities of risk-averse investors, especially when faced with significant upward shifts (or stability) in gold prices when compared with nose-diving oil prices. Furthermore, the ability of gold to hedge or serve as a safe haven suggests tilting towards gold in order to abate the growing concern about energy security and climate change related issues associated with oil. For policymakers, the findings suggest that policy should be tailored towards reducing the adverse effect of oil price volatility, which could be done by promoting the consumption of clean energy in place of fossil fuels.

This paper empirically evaluates the safe haven and hedging properties of gold during oil price crisis. To accommodate the statistical features of the series such as conditional heteroscedasticity and conditional correlations between gold and oil markets, we employ the VARMA-GARCH model and its asymmetric variants. This model allows us to evaluate the returns and volatility spillover transmission between gold and crude oil returns. The impact of the COVID-19 outbreak is further accounted for in the empirical exercise by partitioning the data sample into two to reflect the periods before and during the pandemic. The estimated results show statistically significant bidirectional returns and volatility spillovers between the 5 The results are summarized in the Appendix section.

gold and crude oil returns. The computed optimal weight and hedge ratios further validate the hedging effectiveness of gold against risks associated with crude oil, particularly during the pandemic period. We extend the estimation to investigate whether other precious metals such as palladium, platinum and silver will exhibit similar features as gold, and our results are in the affirmative, albeit with lower magnitudes. Summarily, we find that a diversified asset portfolio may improve the risk-adjusted return performance. Future studies that extend the safe haven and hedging properties of precious metals to risk associated with other financial assets such as stock market, foreign exchange market, bond market, and real estate, particularly during pandemics will further enrich the extant literature.

J o u r n a l P r e -p r o o f 

The effects of oil and gold prices on oil-exporting countries

The positive and negative impacts of the SARS outbreak: A case of the Taiwan industries

Forecasting volatility and correlation between oil and gold prices using a novel multivariate GAS model

Are cryptocurrencies a safe haven for equity markets? An international perspective from the COVID-19 pandemic Research in International Business and Finance

Safe Haven or Risky Hazard? Bitcoin during the COVID-19 Bear Market

The contagion effects of the COVID-19 pandemic: Evidence from gold and cryptocurrencies

Nonlinear relationships amongst the implied volatilities of crude oil and precious metals

Volatility transmission between gold and oil futures under structural breaks

The bubble contagion effect of COVID-19 outbreak: Evidence from crude oil and gold markets

Time series analysis of co-movements in the prices of gold and oil: Fractional cointegration approach

Can agricultural and precious metal commodities diversify and hedge extreme downside and upside oil market risk? An extreme quantile approach

Are oil shocks inflationary? Asymmetric and nonlinear specifications versus changes in regime

Oil price shocks and the U.S. stagflation of the 1970s: some Insights from GEM

How loss averse are investors in financial markets?

Stock prices and geographic proximity of information: Evidence from the Ebola outbreak

Dynamics of global oil prices, exchange rate and precious metal prices in India

Dynamics of oil price shocks and stock market behavior in Pakistan: evidence from the 2007 financial crisis period

Searching for safe-haven assets during the COVID-19 pandemic

Which one is more informative in determining price movements of hedging assets? Evidence from Bitcoin, gold and crude oil markets

Dynamics of Crude Oil and Gold Price Post 2008 Global Financial Crisis -New Evidence from Threshold Vector Error-Correction Model

Advertising and Firm Risk: A Study of the Restaurant Industry

Modeling Asymmetric Comovements of Asset Returns

Foreign exchange exposure of US tourism-related firms

Tourism companies' risk exposures on text disclosure

Asymptotic theory for a vector ARMA-GARCH model

What precious metals act as safe havens, and when? Some US evidence

Structure and asymptotic theory for multivariate asymmetric conditional volatility

Gold and oil futures markets: Are markets efficient?

When Castro seized the Hilton: Risk and crisis management lessons from the past

Corporate social responsibility and systematic risk of restaurant firms: The moderating role of geographical diversification

Risk appetite and the prices of precious metals

Modeling returns and volatility transmission between oil price and US-Nigeria exchange rate

Modelling spillovers between stock market and FX market: evidence for Nigeria

The COVID-19 global fear index and the predictability of commodity price returns

Is Bitcoin a hedge, a safe haven or a diversifier for oil price movements? A comparison with gold

Gold and Crude Oil Prices After the Great Moderation

Analysis of the Interactive Linkages Between Gold Prices, Oil Prices, and the Exchange Rate in India

An overview of global gold market and gold price forecasting

COVID-19's disasters are perilous than Global Financial Crisis: A rumor or fact? Finance Research Letters

The hedging effectiveness of gold against US stocks in a post-financial crisis era

World oil prices, precious metal prices and macroeconomy in Turkey

A power GARCH examination of the gold market

Loss aversion in riskless choice: a reference-dependent model

Brent prices and oil stock behaviors: evidence from Nigerian listed oil stocks, Financ

Can gold effectively hedge risks of exchange rate?

Oil price fluctuation, stock market and macroeconomic fundamentals: Evidence from China before and after the financial crisis

Volatility persistence and returns spillovers between oil and gold prices: Analysis before and after the global financial crisis

Time-varying volatility spillovers between oil prices and precious metal prices

Financial markets under the global pandemic of COVID-19

The crude oil market and the gold market: Evidence for cointegration, causality and price discovery

Note that AIC and SBC are not comparable for the different partitions

 (12) 18.893* (0.0911) 5.234 (0.950) 11.3248 (0.5013) Note: The Ljung-Box and McLeod tests provide the empirical statistics respectively for the serial correlation and remaining conditional heteroscedasticity of orders 6 and 12 for robustness purposes. Notes: The table reports average optimal weights and hedge ratios in a precious metal and crude oil asset portfolio using the variance and covariance estimates of the VARMA-CCC-GARCH models after accounting for exogenous factors including exchange rate and gold EMV volatilities.

Research Highlights:1. The safe haven potential of gold against oil price risk is examined.2. The analysis relies on the asymmetric VARMA-GARCH model with daily frequency.3. Gold is found to exhibit a significant safe haven against oil price risks 4. The optimal portfolio and hedging ratios support this evidence.5. Further analyses involving other precious metals reveal similar outcomes.J o u r n a l P r e -p r o o f