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Gold and US Dollar Index Divergence....... “Mortal Kombat”

“Gold V/s U.S Dollar Index”
An investor rolling in & out funds investing in US$ gold price and the Dollar Index, would undeniably be aware of the fact that they are related in inverse proportion.
 
It is not possible for gold price and the value of dollar to follow the same trend throughout the course of time. Over the two decades, there have been few instances the pair has drifted from their inverse relationship.
 
Co-relation
 
The basic reason for gold and dollar being in complete opposition is that gold is more of a currency. Therefore, as the dollar’s exchange value decreases, more dollars are required to buy the yellow metal, increasing the value of the same. This shows that there is a strong correlation between the US dollar exchange rate and the gold price. The correlation between the US dollar price of gold and the U.S Dollar Index has seen the range from 0.68 to -0.96 between the years 1982 to 2010 (Fig.1). A negative correlation means that there is a strong relationship between two variables, but in the opposite direction. The correlation has strengthened a lot since 1982 as a -34.13% move in the US dollar index has increasingly resulted in a 202% move in the gold price, touching the lifetime high of $1383.9.

“The Break-Up”


This inversely proportional co-relationship is not guaranteed to hold for all periods and the strength of the relationship varies from being very strong (i.e. closer to -1) to very weak (i.e. closer to 0). In some periods we may observe a de-coupling of the two variables from its expected relationship. That is, instead of observing a negative relationship (Fig.2) we observed a positive one in years 1982, 1993, 2001, 2005 & 2008. In some cases, we might observe a fall in both the price of gold and the value of the US dollar, as we have witnessed in years like 1990 & 1994 respectively.
 
 
During recessionary periods the price of gold and the US dollar appreciate together, failing the inverse relationship in the short-run.
 
EURO........ “The major chunk”
USDX is so heavily influenced by the euro, that when dollar index is compared to the EUR/USD, the correlation is obvious; it is a converse relationship. One goes up as the other goes down.
 
The German Business Climate Index of the Information and Forschung (Ifo) which determines the business sentiment & business climate in the Euro-Zone shows that optimism is gradually returning, reflecting ever-increasing business confidence levels since early 2009. Manufacturing activity in the euro zone rose unexpectedly in October to 107.6 in October compared to 106.8 in September, rising to its highest level in 2 months. Moreover, the euro has been buoyed recently by expectations that the Federal Reserve will pump more money into the U.S. economy.
Some of the factors affecting EUR/USD are:
·         Interest Rates: The US Fed Funds rate is a good indicator for the EUR/USD. The greater the interest rate differential in favor of the euribor against the euro-dollar deposit, the more likely EUR/USD is to rise. However sometimes this doesn’t hold well due to the confluence of other factors.
·         Economic Data: The most important economic data is from Germany. The key data are usually GDP, inflation (CPI and HICP), Industrial Production, and Unemployment.
·         Cross Rate Effect: The EUR/$ exchange rate is sometimes impacted by movements in cross exchange rates (non-dollar exchange rates) such as EUR/JPY.
There are other reasons too like housing statistics data, employment & manufacturing growth, change in foreign reserves & many other reasons.
 
Roads Ahead
In the recent developments, the decisions taken in “Group of 20 finance” was that the chiefs vowed to avoid weakening currencies & are unlikely to mark an end to the dollar’s recent slide. Therefore, from the outcomes like these, gold may be the highest gain-taker & is likely to enjoy a relentless and rather one-sided rally.


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