Is Gold an Effective Hedge Against the Dollar?

With the recent crisis among financial institutions promising further economic weakness and an expansion of fiscal deficits, the decline in the U.S. dollar (blue line above) has gotten the attention of traders and investors. I've been hearing particular talk of hedging this dollar weakness through the purchase of gold as an alternative currency. But is gold an effective dollar hedge?

There's no denying its recent appeal. Over the last three trading sessions, volume in the gold ETF (GLD) has risen to over 20 million shares each day. That's easily twice the average volume over the last few months and the highest three-day total since the Bear Stearns crisis in March.

As the chart above indicates, since 2005 gold (pink line) and the U.S. Dollar Index (blue line) have been traversing opposite paths. The correlation of daily changes in gold and USDX was -.31 from January, 2005 through June, 2007. Since that time, it has soared to -.54. Over a quarter of the daily variance in the U.S. dollar and gold has been shared, suggesting that it has, indeed, been a kind of hedge.

When I went back to November, 1985--the first dates for which I have both U.S. Dollar Index and cash gold data--I found that the correlation of daily price changes between the two has been -.26. That led me to surmise that the current correlation might be historically high.

What I found was that the correlation of daily price changes in gold and the dollar from January, 1986 through December, 2002 was -.20. Since the start of 2003, that correlation has more than doubled to -.43. Interestingly, the period of the correlation's expansion has also been a period in which the U.S. dollar has fallen by more than 28% to modern lows.

The data suggest that, since the marked weakness in the U.S. dollar, gold has increased its role as an effective dollar hedge. Given the surge of interest in gold during March and now in the last few days, it wouldn't surprise me if participation in the gold market also emerges as a kind of sentiment indicator for the dollar.

Comments

[ozzy43]

This analysis seems to support the notion that, as the monetary system - make that 'manipulatory scheme' - engineered by the feds and the Fed becomes ever more unworkable, requiring ever more desperate and dangerous moves (e.g. opening discount window to all comers, raging inflation in nations with dollar peg, questions about petrodollars and dollar-as-reserve-curr... etc), gold continues to offer its traditional promise of succor to those fleeing the environment that has resulted from this scheme. Hard to see how that ends well for the dollar, or how this trend of the flight to gold could be reversed in the near to mid-term. Does a new global monetary arrangement - a new Bretton Woods - loom on the horizon?

[Dan Walker]

"French peasants have a long history of hoarding gold to ward off the vagaries of an elitist aristocracy. Yet they remain peasants. To me, that is where the argument breaks down."

I forgot where I read that, but it has stuck with me for 20 years.

That said, I have been accumulating silver for the last month, and now that gold has broken out, may include it in the scheme. With inflation rampaging across all continents, it certainly seems easier than staying on top of the currency crosses, and probably safer in the end.

[jt]

Dan...methinks you give way too much weight to a two-sentence philosophy with none of its labels defined.

"Elitist aristocracy" by definition will remain "elitist" generally b/c it has to do with heredity...family...an... that doesn't change with change of currency...they may become richer or poorer, but they remain the "elite."

And "peasant"--w... the heck is / was that? What's the definition? Perhaps it's any "poor" Frenchman/woman (how poor is that)? Perhaps it's simply someone not born "elite?" Perhaps it's someone of variable means who chooses to live a relatively "simple" life (as opposed to the lifestyle of the "elite")? Or perhaps the peasant remained a peasant b/c s/he had gold, and didn't end up in the poorhouse or a raggamuffin on the street.

Regardless...thru all ages...sooner or later gold and silver have been real money that can buy at the least the necessities of life...no worse. And BTW...I applaud your buying of silver...if I were you, I'd continue to collect silver rather than gold (though nothing wrong with having some gold, too)...and I can say that I would b/c I am...:) jt