MyValueResearch

Relationship between Gold and Dollar

Every person in the world is fascinated by the lure of the Yellow metal and it is the ripe time to invest in the Gold. But in order to precisely track the movement one has to analyse the movement in the Dollar.

In the current run up in the price of Gold, it is time to re-evaluate how Gold really relates to Dollar.

The reason that Gold and Dollar generally trend in opposite directions is that in one respect Gold is just another Currency. One has to pay more Dollars to buy Gold so the Gold price dominates Dollar. Conversely, when the Dollar’s exchange value rises, due to a bear-market rally or any reason, it takes fewer Dollars to buy Gold so Gold price falls. A short-term countertrend Dollar rally leads a short-term bearish trend for the price of Gold denominated in US Dollars.

The US Dollar was considered as the safe haven; but it was a story of long long ago. But at present many investors/central banks continue to hold Gold as their safe haven asset to protect themselves from worldwide economic shocks or tensions. The USD diversification is set to continue with the US having such a large foreign debt and weakening economic conditions. Gold is considered as safe heaven so Gold is used as a hedge against inflation, the ultimate “insurance policy” against geopolitical risk and protection during periods of turmoil in the financial markets. Due to the inverse relationship between Gold and with the outlook of Dollar looks dim bullish momentum in Gold is expected.

Gold is generally quoted in US Dollars per ounce of Gold; so any fluctuations in the strength of the Dollar are likely to be reflected in Dollar price of Gold: when the Dollar falls the Gold price rises… and when Dollar rises Gold falls. The relationship is not exactly inverse, however, and there are times when both Gold and Dollar rise or fall simultaneously

Countries like China, Russia, Japan hold vast amounts of reserves in foreign currencies and the USD is just one of the many they hold. It is estimated that countries (excluding the US) hold around $13 trillion in US currency. The major problem here is that if the US economy continues to show weakness and the USD continues to fall, then many nations who hold USD as foreign currency reserves might sell it and replace it with another nations currency, or even Gold.

Investors who are looking at buying Gold (like central banks) may have to sell their US Dollars to make this transaction. This ultimately drives the US Dollar lower as global investors seek to diversify out of the Dollar.

Weakening Dollar makes Gold cheaper for investors who hold other currencies. This results in greater demand from investors who hold currencies that have appreciated relative to the US Dollar. (If there is a fear of interest rate cut in any currency generally it depreciates the value of the currency. In that case investors prefer to invest in Gold as compared to Dollar. )

Conclusion:
There is endless discussion regarding officially re-linking Dollar to Gold in some manner, but in fact, Gold is de facto tied to Dollar, and has been since the birth of the nation. Each time that Gold is purchased, the price is different, and reflects the current perceived change in the relationship between Gold and Dollar. These two have always had an inversed relationship with each other, if one is up, the other is down. But in 2005, Dollar rallied while Gold remained firm; at times both were rallying together. So though there is inverse relation between the two one cannot say that it always happens. Gold is also considered as ideal currency is one whose value is stable and they hold that Gold is historically the most stable form of money. They believe an unstable currency such as “fiat money,” the value of which is determined by governments, is all too vulnerable to manipulation by corrupt politicians and increases the risk of inflation and deflation.

Following are the charts of US Dollar index and Gold. And it is evident that both have inverse correlation.