Rising prices for gold have often followed a strengthening dollar, but that correlation has recently been broken. Gold prices have been going up in spite of the dollar’s relative stability.
What does this mean?
For starters, it means that investors are hedging themselves not just against inflation but also against riskier investments. It could also signify that we’re headed for a higher-inflation environment and stricter monetary policies.
But don’t get too excited – while gold is looking good at the moment. It’s unlikely to rise significantly over the long term without intense inflation or global crisis. Because central banks are reducing their purchases of bonds and raising interest rates.
Gold’s return has been relatively modest since the global financial crisis. But it’s finished 2014 on a high note. With a 6.7 percent rally in December and a 2.8 percent increase in January, according to Kitco.com’s Gold Index. While gold prices have generally moved in the same direction as the dollar index (a measure of the dollar’s value versus six major currencies), they haven’t always kept pace with the greenback.
The dollar-Gold correlation has been broken
From the policy side, the Federal Reserve is bringing interest rates back up, and it’s likely to raise them at least twice more this year. If so, it will signal a retreat from easy monetary policy that had begun in 2009. This could put upward pressure on interest rates and bond prices, which would hurt equity markets.
While gold prices have risen along with the dollar’s relative stability since October 2014, they’ve diverged from the trend in February and March – rising by about 6 percent even though the greenback has only gained about 1 percent. The Dollar Index hasn’t declined since its October rally either – it actually gained 2 percent.
A potential explanation for this incongruence is that gold commodities have been hedged against the U.S. dollar in the futures market, which may have caused its price to rise even though there’s little reason to do so.
As the dollar declines, gold prices hold steady: Why?
According to BullionVault, there’s been a strong inverse correlation between gold prices and the U.S. dollar over the past three decades – a weaker dollar meant higher gold prices, and vice versa. But lately this relationship has weakened, leading to questions about its longevity in the long term. One reason is that investors have increasingly defected from the dollar to other currencies – especially the Japanese yen and Chinese yuan – as global growth has shifted.
But it’s not just these two currencies:
Gold investors could be hedging against a variety of risks by increasing their demand for gold, such as international risks like geopolitical tensions in Ukraine or domestic events like increases in personal income taxes or health care expenses. While gold tends to rise more in times of political or economic uncertainty, it doesn’t always follow a trend.
Gold prices have slumped along with the dollar, but they can bounce back quickly: Why?
When gold prices go up, they tend to fall quickly afterward – around 15 percent on average in just two months – according to Kitco.com’s 24-hour historical gold chart . For example, last November the stock market suffered a 500-point drop and gold rose by about $52 an ounce. Then in January and February, the price fell by about 10 percent after starting 2014 with a 6.7 percent surge.
Is gold’s price high or low?
On the other hand, gold can easily rally with just a few days’ notice – it’s risen or fallen by nearly 10 percent in a week on average since 1980. But it is less volatile than other major asset classes like stocks, which are known to swing wildly. Gold’s volatility may be narrower because of its role as an inflation hedge; investors don’t want to be caught on the wrong side of a “gold bubble.”
Of course, some of this could be attributed to the breakdown in the correlation between gold and the dollar. But it’s also partly due to the fact that people have increasingly defected from gold as an investment since 2009 – even though central banks have been buying more of it. For example, Russia has increased its holdings of gold by 44 percent in five years.
Some investors are drawn to digital currencies like Bitcoins because they’re less regulated and aren’t subjected to government interference. Some could also be hedging against a potential currency crisis, which would hurt gold prices too.
