Thursday, November 20th 04:25 PM IST

When Gold-US dollar become directly correlated

# gold  # US dollar  # currencies  # investment  

Changes in gold are sometimes driven upward not by relative weakness in the U.S. dollar to other fiat currencies, but, instead, by flight from all paper currencies.


NEW YORK (Bullion Street): Conventional wisdom is that US dollar and gold are inversely related which means when US dollar is moving up gold will decline.

However there are times when the opposite happens- a positive correlation between gold and US dollar. It has happened in May through December 1993, from May to Novmember 2005 and further in 2008 and 2009, according to Arkadiusz Sieron, Sunshine Profits Market Overview Editor.

However, positive correlation between gold and US dollar does not last long. What are the possible causes for such temporary aberrations? Capie, Mills and Wood’s in their paper “Gold as a hedge against the dollar” claim there may be some supply shocks or central bank’s (optionally government’s) intervention in the market. The other possible reasons are expectations among foreign investors that the U.S. dollar exchange-rate changes are only temporary. Such opinion could make them endure fluctuations rather than change their portfolios in favor of gold (think about transactions costs).   Arkadiusz Sieron further writes: However, medium or long-term trends were also affected: the traditional inverse relationship broke down during the two year period of 1978-1980. Such a long period calls for a more detailed analysis of the reasons behind disruptions in the negative correlation between gold and U.S. dollar in the medium or long term (but also in the short ones).

First, changes in gold are sometimes driven upward not by relative weakness in the U.S. dollar to other fiat currencies, but, instead, by flight from all paper currencies. This was probably the case of 1978-1980, when investors feared global recession following the oil crises or the collapse of the world’s monetary system (plus, gold was in the speculative buying mania stage at that time). Eventually they switched from all paper currencies to gold – the traditional store of wealth, historically chosen by the market to play the role of money. It should be clear now why the U.S. dollar was traded sideways to other currencies (all currencies were depreciating), while gold skyrocketed from $200 per ounce to $800 per ounce. It would be difficult to find a better argument why gold should be considered more like an international traded currency than just a simple commodity whose price is expressed in dollars. 

The second reason even further strengthens the role of gold as the global currency. Gold can be an insurance policy against financial crashes or even collapse of the monetary system. However, the U.S. dollar exhibits similar tail risk properties. Greenbacks are also seen as the world’s safe haven currency. The U.S. dollar is still the main reserve currency- over half of the total amount of greenbacks stock is held outside the USA and U.S. Treasuries are eagerly bought during crises. It should be clear now why the U.S. dollar and gold can move up or down together. Investors may choose both as safe havens: greenback and gold during global catastrophes or crises in another currency. The best example may be the period from November 2008 to February 2009, when both gold and the U.S. dollar were generally rising due to the financial crisis. Such a co-movement proved that gold behaves sometimes as a hedge against a dollar-denominated-system rather than the dollar itself. This is why gold is not only a hedge against stocks on average, but also a safe haven in extreme stock market conditions. Similar movement occurred in November 2010, when gold and the U.S. dollar rose together due to growing concerns about Ireland and the Euro zone’s situation. 

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