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Gold and Dollar

The relationship between Gold and the US dollar has a long history. Before the current fiat money system, the value of dollar was tied to the specific amount of gold under the Gold standard. The gold standard was used from 1900 to 1971. It ended in 1971 when US President Nixon no longer allowed the Fed to redeem dollars with gold. Eventually, the US government decoupled the value of the dollar from gold altogether in 1976. Consequently, Gold moved to floating exchange and this made its price vulnerable to the dollar’s external value. The correlation between gold and dollar has been pretty much inverse since then with exceptions during certain periods. In correlation, a direct relationship means that value of two assets moves together while inverse means that they move in opposite direction. To simply explain the correlation, when the value of the dollar increases relative to other currencies around the world, the price of gold tends to fall in dollar terms. It is because gold becomes more expensive in other currencies. As the price of any commodity moves higher, demand recedes. Conversely, as the value of the US dollar moves lower, gold tends to appreciate as it becomes cheaper in other currencies. Demand tends to increase at lower prices. In 2008, the International Monetary Fund (IMF) estimated that nearly half of the moves in the gold prices since 2002 were due to dollar. A 1% change in the effective external value of the US dollar led to more than a 1% change in gold prices. The relationship between the value of the US dollar and gold is also impacted by Interest rates. Since Gold does not yield interest in itself, it must compete with interest bearing assets for demand. When interest rates move higher, the price of gold tends to fall as it costs more to carry the metal. Higher interest rates in the US would help the dollar to appreciate and hence lead to decline in gold prices. Similarly, lower interest rates would lead to a reduced opportunity cost for holding gold and help gold prices move higher. This was evident after the 2008 crisis when the Fed conducted a series of rate cuts and Fed Fund rates moved towards zero. Gold prices performed exceptionally well during that period and made a lifetime high of around $1900/oz. Now as Fed is moving towards increasing rates further and unwinding its balance sheet, the pressure on gold prices is evident as the dollar is gaining strength. There are of course exceptions to this relationship as there are periods when gold and dollar move together as both are considered as safe havens. Therefore during times of global crisis and panic, there may be times when both gold and dollar appreciate. Also, the dollar is not the only driving factor for gold prices. Gold’s fluctuating value will also reflect how strong or weak the economy is as well as global demand for precious metals.

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