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A house divided against itself cannot stand

Explaining the composition effect in housing prices

Our recent post on women in the workforce included a lyric from Dolly Parton and an explanation of the composition effect. Here’s the formal definition: “The part of the observed between-group difference in the distribution of some economic outcome that can be explained by differences in the distribution of covariates.”

That’s a doozy of a definition, so let’s use a picture that’s worth 1,000 words to explain it… The graph shows the year-to-year growth rate of average home prices in the United States (blue bars) and in its 20 largest metropolitan areas (red bars). The blue bars and red bars generally extend in the same direction, although by different magnitudes. Because these top 20 metropolitan areas are part of the United States, it’s not surprising both sets of average prices move in the same direction.

But look what happened in 2010: Average home prices overall decreased while average home prices in the 20 largest metropolitan areas increased. Why? Because average home prices in smaller metropolitan areas and rural areas decreased more than average home prices in large metropolitan areas increased. That’s the composition effect: Looking at the big picture sometimes masks what’s going on with the individual parts.

Want to learn more about the composition effect in housing prices? Read “A Guide to Aggregate House Price Measures” by Jordan Rappaport of the Kansas City Fed.

How this graph was created: Search for “S&P home prices” and select the “U.S. National” series (FRED series ID CSUSHPISA). From the “Edit Graph” panel, use the “Add Line” feature to search for and select the “S&P 20-City” series (FRED series ID SPCS20RSA). From the “Format” tab, select “Bar” for graph type. From the “Edit Bar 1” tab, select “Percent Change from Year Ago” for units and “Annual” under “Modify frequency.” Do the same from the “Edit Bar 2” tab. Adjust the time period shown with the slider beneath the graph or with the start and end date boxes above the graph.

Suggested by Diego Mendez-Carbajo.

View on FRED, series used in this post: CSUSHPISA, SPCS20RSA

Currency arbitrage in the precious metals market: A gold rush?

FRED’s as good as gold, and the FRED Blog has used London Bullion Market Association data to prove it. In fact, our previous post tracks gold prices and appraises the new gold bar at the St. Louis Fed. Now these gold prices are quoted in three different currencies—U.S. dollars, British pounds, and euros—which is a golden opportunity to discuss arbitrage.

Arbitrage is the risk-free purchase and sale of an asset to profit from a difference in price across markets. Because the gold fixing price is quoted in three different currencies at once, it’s possible that one could make a profit by buying and selling gold in different currencies and then selling the currencies. For example: buy gold in U.S. dollars, sell the gold right away in British pounds, and then convert the pounds back to dollars in the foreign exchange market.

FRED can help us visualize this shiny concept: In the graph above, we show the ratio of the gold fixing price in U.S. dollars to the gold fixing price in British pounds. Then we graph the exchange rate between the U.S. dollar and the British pound. The two lines seem identical, so there’s no obvious arbitrage opportunity here.

But let’s dig deeper by building another FRED graph to show the difference between the U.S. dollar/British pound gold fixing price ratio and the exchange rate between the two currencies. If there really is no arbitrage opportunity, the graph should show a flat horizontal line at the zero mark.

This doesn’t look like a flat line, so did we find treasure?! Sadly, no. The graph shows differences in gold fixing prices between currencies, but they are extremely small and volatile. So small they’d likely be wiped out by transaction costs, such as brokerage fees in the precious metals and/or foreign currency markets. Rather than a gold mine, we seem to have found just some gold dust.

How these graphs were created: Search for “gold price” and take the 3pm gold fixing price in U.S. dollars (series ID GOLDPMGBD228NLBM). From the “Edit Graph” panel, add a series by searching for and selecting the gold price in British pounds (series ID GOLDPMGBD229NLBM). Apply formula a/b. Use the “Add Line” tab to search for and select the U.S./U.K. exchange rate (series ID DEXUSUK). For the second graph, take the first, delete the second line, add the series “U.S./U.K. exchange rate” to the first line, and apply formula a/b-c.

Suggested by Diego Mendez-Carbajo.

View on FRED, series used in this post: DEXUSUK, GOLDPMGBD228NLBM, GOLDPMGBD229NLBM

The price and weight of a bar of gold

Raise the bar at the St. Louis Fed's Economy Museum

The U.S. Mint is missing one gold bar.

No. This isn’t the plot of a National Treasure sequel. It’s the latest addition to the St. Louis Fed’s Economy Museum: a 9.75” long, 1.5” tall bar of gold on loan from the Mint. Because the bar is 99.999% pure gold, it weighs 28 pounds! So, how much does a 28-pound gold bar cost?

Let’s use FRED data to figure out the price of this bar, which is on display, coincidentally, right across from the museum’s FRED exhibit.

Although some people see gold as a hedge against inflation, the graph above shows just how volatile the price of gold can be. Here, we have the “fixing price” of a troy ounce of gold in U.S. dollars in the London bullion market. London is the largest trading center for precious metals, and gold prices are reported daily at two different times (10:30 AM and 3:00 PM London time) to account for these intra-day variations.

Sorry, but now we have to do some math. There are 14.5833 troy ounces in a pound, and the museum’s gold bar weighs 28 pounds. That’s 408.3324 troy ounces. Much like gold, FRED is very malleable; so we can customize the data to reveal the price of the entire bar. In the graph below, we’ve applied the formula a * 408.3324. Clearly, changes in global supply and demand affect the price. And, between January 1 and February 10, 2020, the price of the bar has ranged from $623,564.41 to $646,880.19.

If you visit the Economy Museum, you’ll have the chance to try to lift this  bar yourself. Before you visit, though, you may want to eat your spinach: 28 pounds is no small weight. Speaking of, the bar is literally worth its weight in gold, but what about its weight in cash? At its highest, the price of the gold bar would be a little more than 14 pounds of (mostly) $100 bills. If, you’re interested, the formula $646,880.19 / $100 * 1 gram/bill * 0.00220462 pound/gram gets you there.

By the way, FRED fans: The Economy Museum also sells FRED t-shirts! Unfortunately, we have no price or weight data for those…

How these graphs were created: For the first graph, search for “gold price” and select the 3:00 PM fixing price in U.S. dollars. From the “Edit Graph” panel, use the “Add Line” tab to search for and add the 10:30 AM fixing price. For the second graph, start with the 3:00 PM graph. From the “Edit Graph” panel, apply the formula from the post. Use the “Format” tab to add the golden touches.

Suggested by Maria Arias and Diego Mendez-Carbajo.

View on FRED, series used in this post: GOLDAMGBD228NLBM, GOLDPMGBD228NLBM

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