Rationality in precious metals forward markets: Evidence of behavioural deviations in the gold markets

• We examine the forward–spot relationship in gold.
• We decompose the error into behavioural series, pessimism and optimism indicators.
• We correlate the behavioural factors with economic events and show over- and under-reaction to news.
• We provide evidence of gold behaviour in a behavioural sense.

We offer the first examination of whether the gold forward rate is an unbiased predictor of the future gold spot rate. We find strong evidence that it is not, particularly at longer maturities. Building on Aggarwal and Zong's (2008) approach to allow for investor risk aversion, we then examine if these deviations from rationality can be explained by behavioural factors such as market optimism and over-reaction to news. We find that forecast errors in the gold market generally suffer from over-reaction to observed spot price changes but underreact to outflows of gold from Exchange Traded Funds. Further, the forward premium is found to be a consistently optimistic estimate over the full sample. Finally, while the market mood is shown to vary greatly over time, swinging from pessimism in the 1990s to optimism after 2000, the forecast revision over-reaction is found to be consistently stable over the full sample. These are significant, important, and consistent indications of seemingly non-rational behavioural effects in the gold forward market.