However, gold and the US dollar are commonly viewed as having an inverse price relationship - that their prices move in opposite directions - an intuitive concept since gold is priced in US dollars.
In January and February of 2020, gold and the US dollar actually had a positive correlation, both rising in price. The positive correlation reversed during the darkest moments of the selloff in stocks in March and we saw a negative correlation take over - gold sold off along with stocks while the US dollar rallied. Then, as stocks rebounded in late March, gold followed higher while the US dollar fell in value.
Part of the reason for the long term inverse relationship between gold and the US dollar is as follows. When the value of the US dollar increases versus other global currencies, the price of gold usually weakens in dollar terms. This is because gold demand softens as it becomes more expensive in other currencies. Conversely, a falling dollar increases the value of other currencies, boosting the demand for commodities such as gold.
Another factor behind the inverse relationship is that gold normally benefits from a low interest rate or declining interest rate environment, while currencies such as the dollar are pressured by it. If interest rates are falling, non-yielding assets such as gold become more appealing to investors in comparison to currencies. On the other hand, if interest rates are rising, gold loses some of its shine, as investors are lured by the promise of interest yield offered by currencies. For these reasons, the days when central banks announce their target base interest rate and monetary policy are extremely important in the market.
As we noted, it’s possible for the US dollar and gold prices to increase at the same time. The Coronavirus pandemic caused investors to buy both the US dollar and gold for their safe haven appeal early in the year. However, in the heat of the crisis, investors favored the US dollar over gold. The dollar rallied and gold sold off as investors scrambled to cover margin calls and sought the liquidity and stability of US dollars - the world’s reserve currency.
The notion that an economic recovery in the United States must precede a global recovery also underpins the dollar, despite the shockingly bad recent US economic data. As ‘risk on’ sentiment came back and stocks bounced, gold resumed its uptrend.
It’s interesting to look back at the last major financial crisis in 2008. History appears to be repeating itself (or at least rhyming). Gold prices began to fall in March 2008 along with stocks, while the US dollar rallied. Gold bottomed in October of 2008 and then rallied along with stocks as markets recovered in March of 2009, at which point the US dollar initially sold off. If prices follow the same pattern as 2008/2009 we might expect gold to make new record highs as markets recover and see a temporary pullback in the US dollar.
Mario van den Hurk is werkzaam voor Transsurance, een Nederlandse boutique die professionele beleggers adviseeert op het terrein van valutaproducten en -beleggingen.