Why Are Gold and the Dollar Running Together?

So far in 2009, gold and the US Dollar have both shot higher in tandem. Why...?

"A STRONGER DOLLAR typically weighs on gold," according to Reuters. But that's not what's been happening so far in 2009. Not by a long stretch.

The US Dollar has gained 6.0% against the rest of the world's major currencies since the end of December. Gold has, in the meantime, gained 7.5% versus the Dollar.

So versus the Dollar's No.1 paper-currency challenger – the Euro – gold just put in its best month-on-month since autumn 1999...up more than 13% inside 21 sessions.

How come?

"The market dynamic has shifted in the past couple of weeks and I don't think any commentators or analysts have really picked up on it yet," writes London currency trader Tom Tragett in an emailed note to us here at BullionVault Friday.

"Upon the release of weak US data," he says of the market's current nervousness, "do the following...

1. Sell EUR/USD, AUD, NZD and the Dow. Also sell EUR/CHF
2. Buy GBP, Yen and Gold."

Thursday's US housing and jobless data were almost as bad as today's GDP figures are likely to prove. But surely "Bullion typically moves in the opposite direction to the US currency," as Bloomberg keeps saying...time and again.

After all, gold is priced in Dollars. So Dollar up, gold down.

No?

Well, a perfect correlation between two prices – as judged by number-crunching data jockeys – will stand at 1.0 or near as damn it. If they display an absolute non-correlation, in contrast, then the number spat out by the PhDs' spread-sheets will read 0.0. And during the 20 years between 1982 and 2002, the average correlation linking weekly gains in the Gold Price to weekly falls in the US Dollar (and vice versa) and its trade-weighted exchange-rate index ran to just 0.31 – only a little better than hardly-worth-noting.

Gold then switched for a brief period to mirroring the Dollar's fast-fading fortunes on the world currency markets more closely, hitting a phenomenal correlation of 0.96 as the greenback's decline really got busy.

But come the spring of 2005, gold switched again, driving the correlation back down to 0.40 and returning to business as usual.

That's why, as BullionVault wrote back in its 5 Myths of the Gold Market report of May 2007, a US citizen looking to protect himself against the decline of the Dollar would have made three times as much profit holding gold rather than Euros so far this decade.

And right now, "the Euro in particular is reacting very negatively to heightened risk aversion," adds Tom Tragett, "as it is the most actively traded currency versus the US Dollar. Because the new dynamic in risk aversion now means that when the EUR/USD goes up then traders must sell their gold – since a higher Euro implies lower risk in the overall markets and hence less need to hoard the yellow stuff."

Got that? Look at Thursday's sharp drop in gold to $875 an ounce, for instance. Down 4.5% from Monday's 3-month high, it coincided precisely with the Euro rallying towards $1.3200.

The single currency's since dumped more than 3 cents (Friday AM in London). The Gold Price in Dollars has jumped 5.7% to a fresh 3-month high above $925.

"A lower EUR/USD now means you must pile back into gold," says Tom – merely observing, not advising, of course – "as it implies greater risk aversion...which completely flies in the face of what most analysts would have you believe in terms of a higher Gold Price running hand in hand with a higher EUR/USD."

Put another way – or so it seems to us here at BullionVault this Friday morning – the "Great Deflation" trade of buying Dollars to pay down debt and sit tight in cash now also includes Buying Gold as the ultimate depressionary back-stop.

Because the idea that gold is only ever an inflationary hedge is also a Myth of the Gold Market investors and traders would do well to dispel.

Stock position: None.

Comments

[Prudent Man...:]

If gold is a hedge against inflation it should be selling around $4,000.00 an ounce. Admittedly, I don't have a clue as to why people buy gold as an investment any more that Tulip Bulbs.

Feb 01 03:34 PM

[ROLEX18K:]

Gold and USD are running together as there are too many investors who are short both, when USD started to appreciate greatly last year, in the beginning common sense prevailed and GC crashed to 700$ but later investors with billions ( think biggest investment banks, not some stinky hedge funds ) realized that there is too much money at stake on the GC short side and started to buy it.
USD is too big an animal for any bank except the Fed to sell it when it is in the rally mode, but GC which is mostly traded on COMEX and other futures venues is easy to manipulate.
Even 1-2 billion $ strategy buying GC constantly can shift a balance of positions to net long, the shorts who can't keep their shorts go out at loss and new shorts enter.
In general this is very bad for GC price when it will start to be dumped when some other banks will sell physical GC ( 100oz of physical sell equals 10,000oz in futures game ) and we are very near such change in direction as price moves are very fast in Gold, it looks as big players do all they can to prop up the price.But it will all stop when small physical sell order will enter the pit.
Remember, not investor who buys 1 American Eagle to hide all his wealth in the coin and then writes on SA that he is a gold bug, controls the supply/demand in gold, same as not some conspirator end of the world freak who bought gold stocks that are down 70% controls it.
The pit belongs to the banks and banks belong to the Fed, also it can be that Fed is happy that some investors are buying GC at this prices and sells it's GC slowly to this big manipulators but in the end THE BOSS will set up everybody and gold will crash.
I see the gold bug's face when they will face it, the total crash in gold.

Feb 01 06:27 PM

[Lonestar1:]

We have had this virtual economy for so long that runs the real risk of virtualizing our currency. The Fed actions have corrupted our sense of wealth. Getting into gold is to get back some sense of purity.


On Feb 01 03:34 PM PrudentMan, CFA wrote:

> If gold is a hedge against inflation it should be selling around
> $4,000.00 an ounce. Admittedly, I don't have a clue as to why people
> buy gold as an investment any more that Tulip Bulbs.

Feb 01 06:46 PM

[JudeJin:]

comparing gold to tulip bulbs? please, educate yourself about why gold is a reserve at all central banks while tulip bulbs are not.

Feb 01 09:53 PM

[jeerio:]

ok, a lot of reading here the past few days. seems to me that the reality with gold is will likely become a bubble of sorts due to the fact it has a strong "retail" presence around the world. typical non-investors will run to it just like 30 years ago, and half of them will get crushed. all we don't know is what the specific number is - will it get to 1200, 1500, 2500, etc.?

so many on SA are seeking linear and logical answers to the interplay of the dollar, gold, treasuries, oil and the like. these answers don't exist, at least not in advance. pick a couple short, and pick a couple of them long, and when you're up 15-25%, sell them and watch and wait for a few days or weeks.

at some point everyone here will be "right", at least for a week or a few months. unless you're willing to bet all you have on one idea (which would be very foolish) there will be plenty of being right to go around....

as for me, i'm going to play both sides of all these opportunities. simple macro-trend watching applied to a week or two at a time. i'm delighted with a 10% return for January. perhaps next month i'll guess wrong, and lose a few % before i hit the sidelines to watch and wait some more.

all this other grandstanding, post-bashing, etc. is a real waste of time.

Feb 02 12:58 AM

[kelm:]

You would all do well to Read Marc Chandler's piece this morning on the de-leveraging process. We are seeing continued de-leveraging by funds which is resulting in a repatriation of dollars to the US. We are also seeing an unwinding of a dollar carry trade. Flight to quality is a term that is thrown around every time the dollar rises. It is true in some circumstances but not in all.

Feb 02 12:19 PM

[OldLimey:]

"Upon the release of weak US data," he says of the market's current nervousness, "do the following...

1. Sell EUR/USD, AUD, NZD and the Dow. Also sell EUR/CHF
2. Buy GBP, Yen and Gold."

Indeed, that's pretty much how it is. Makes you proud to participate, doesn't it??

Feb 02 02:50 PM

[GMaximus:]

This one is pretty easy. The reason why gold and USD have both been "going up" recently is that all currencies have been falling against gold and the USD has just been falling less. In this case you see the dollar relatively stronger than other currencies like the Euro, etc... but still see gold prices rise because the dollar is still losing value vs gold

Feb 03 07:09 PM