The Beginning of a US Dollar-Gold Alliance?

Way back in the day, when Cyclopip was still roaming around Pip Isle and Huck was just a baby barista, central banks around the world adhered to the “Gold Standard.” This meant that all currencies were pegged to the amount of gold reserves that countries had in their piggy banks. Gold, you could say, was a stable alternative to currencies since it held its intrinsic value wherever one would go!

Things changed when the US decided to kick the standard to the curb, with the dollar later assuming the role of the world’s reserve currency. Still, investors, traders, pirates, and leprechauns have had a yellow glimmer in their eyes whenever they got a hold of gold. This isn’t surprising – gold has always been a store of wealth and that probably won’t change any time soon.

Historically, dollar and gold prices have had an inverse relationship, primarily because of inflation. Remember that inflation causes a currency to devalue, causing it to lose its purchasing power. Because of gold’s inherent value, traders have normally jumped on the gold bandwagon whenever the prospect of inflation arises. That’s why whenever the dollar loses value, gold prices usually rise.

Now, this hasn’t held true all the time, as circumstances have sometimes led to a positive correlation in the prices of the dollar and gold. To better explain, take a look at this nifty chart I drew!

PoD Chart

As you can see, for the entire year of 2009, the inverse relationship between gold and the US dollar held. Gold soared above the 1,200 handle while the US dollar index sank under 72.00.

Come 2010, things started to change. Since January, both the US dollar and gold prices have been rising dramatically in unison, posting gains of 10% and 13% respectively!

It seems that risk aversion has been a very dominant theme in the markets. As investors worry about debt contagion all over the globe, they keep buying up the safe-haven US dollar. This doesn’t necessarily mean that they believe the US has a better economic footing compared to the euro zone. It’s just that the US dollar’s status as world reserve currency makes it relatively more stable.

But why is gold moving in lockstep with the rising dollar now? With rising government deficits and weak economic activity in some nations, most central banks don’t seem quite ready to pull the plug on their easing policies.

Most major economies are still in a wait-and-see mode, keeping interest rate hikes on hold until economic activity and inflation picks up. As a result, demand for gold has been soaring to high heavens, as investors considered it as a way to protect them from the prospect of high inflation.

On top of that, as more and more people doubt the stability of the global economy, stocking up on those shiny gold bars seems to be a better alternative than other assets. You can’t go wrong with gold, right? Until risk appetite gets back on its feet, this is as gold as it gets!

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