Gold's Decline Is No Coincidence

| About: Sprott Physical (PHYS)

Summary

The drop in the price of gold over recent weeks is no coincidence.

It has coincided with the appreciation of the U.S. dollar.

Your lesson is that when unsure as to what is driving the price of gold, the first place you should check is the dollar.

Gold's price slide of the last month is no coincidence. Rather it is the direct result of the sharp appreciation of the U.S. dollar. As the greenback has swiftly appreciated in its relative value, the price of gold has decreased in dollar terms.

In my view, the most important factor in determining the price of gold is the value of the U.S. dollar, at least for Americans if not for the world. Gold is a commodity, though a precious metal. It has value, like all commodities, based on supply and demand. And, like all commodities, its price also varies depending on the value of the currency used to purchase it. For Americans, that is the dollar, and given the importance of America to global economic and geopolitical stability, it's likely the dollar for everyone else too (many will want to debate this statement).

Many also see gold as a currency, and I regularly refer to gold (and silver) as mankind's default currency. As a currency, its value also changes relative to other currencies. So when the U.S. dollar loses value due to inflation, national insecurity or economic trouble, gold appreciates in value. Now, some will say gold is hard to trade because just a little of it is worth far too much or way more than a gallon of milk and a dozen eggs. However, I expect that problem would resolve itself quickly with the help of entrepreneurs and/or government if gold (and silver) were needed in tradable quantities in the event of severe devaluation of the dollar.

We can see how the price of gold varies with the changing relative value of the U.S. dollar.

Chart of GLD at Seeking Alpha here

Chart of UUP at Seeking Alpha

Heading into the September meeting of the U.S. Federal Reserve, expectations were confused as to exactly what the Fed might do. If it were to raise interest rates, it would likely serve as a support for the U.S. dollar. I say "likely" because if a rate hike is seen as premature by the consensus of economists and more importantly by financial market participants it could cause risky assets to be priced down in anticipation of an important detrimental economic impact of a higher cost of capital. If, however, the economy is seen as ready and even in need of higher interest rates for price stability, then a rate hike should do no or little harm to risky assets while serving dollar strength.

Today, the dollar is appreciating in relative value, not because of Fed action, but because of the problems of other nations. The dollar is benefiting significantly from the uncertainty and projections for the impact of Brexit, given the recent announcement of an effective date to start the process. Also, the dollar is gaining on uncertainty about the future of the European Union, given Italy's referendum on deck and the Deutsche Bank (NYSE: DB) situation threatening the European banking system. The British Pound has collapsed and the euro has been crushed against dollar strength over the last several weeks.

As a result of the dollar's relative gains, gold priced in dollar terms has declined in value. On Friday, that process was again in effect.

Precious Metal Securities

10-14-16

PowerShares DB USD Bull (NYSE: UUP)

+0.5%

SPDR Gold Trust (NYSE: GLD)

-0.6%

Sprott Physical Gold Trust (NYSE: PHYS)

-0.6%

iShares Silver Trust (NYSE: SLV)

-0.3%

Sprott Physical Silver Trust (NYSE: PSLV)

-0.5%

Direxion Daily Gold Miners Bull 3X (NYSE: NUGT)

-5.9%

Direxion Daily Gold Miners Bearish 3X (NYSE: DUST)

+5.9%

Market Vectors Gold Miners (NYSE: GDX)

-2.1%

Market Vectors Junior Gold Miners (NYSE: GDXJ)

-2.7%

Goldcorp (NYSE: GG)

-3.2%

Newmont Mining (NYSE: NEM)

-1.7%

Randgold Resources (NASDAQ: GOLD)

-3.4%

Barrick Resources (NYSE: ABX)

-1.9%

Yamana Gold (NYSE: AUY)

-2.9%

Gold Fields Ltd. (NYSE: GFI)

-5.0%

Silver Wheaton (NYSE: SLW)

-1.1%

Coeur Mining (NYSE: CDE)

-4.4%

Click to enlarge

However, on Thursday the importance of the dollar to gold also was shown in reverse. The U.S. dollar took a hit on Thursday due to a double-digit percentage decline in China's monthly exports in September.

So maybe you are wondering why the dollar didn't gain against another nation's weakness? In this case, the other nation was China, and the data was exports. China is closely related by investors to the United States because it is a key trading partner. The trade imbalance we have with China has been well-documented by presidential candidate Trump, and we have a deficit with China because we import a great deal of goods made in China. So if China's exports slow, that reflects on demand in America. If demand is softer in America, then the American economy is in question, and so the American dollar weakens. That is what happened on Thursday, and it is the reason gold had a one-day reprieve Thursday. Please note that I believe the data was anomalous and relative to August softness in sell-through, plus possibly due to commodity price weakness in September, as well as the problem with one major Chinese shipper impacting the deliver of goods. The takeaway here is the further evidence of the dollar's influence on the price of gold.

In conclusion, changes in the relative value of the U.S. dollar are important to gold and are behind the decline in gold prices over the past month. Tangible factors are at play in changes in gold and silver prices, and there are many. However, many of the factors are actually sub-factors that play on the value of the dollar, and so influence gold in that manner. Keep your eye on the dollar, and if you understand why it is acting in some manner, you can probably understand why gold is. I cover precious metals and the factors that move them closely and invite relative interests to follow my financial column here at Seeking Alpha.

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