Many people wonder how US dollar or gold price movement can affect each other. Gold is traded and priced in US dollars, so they have a strong connection. A common perception about the gold and US dollar relationship is that they act inversely.
If the price of gold is going down, then it means that the dollar is gaining strength. Similarly, if the dollar starts to weaken, gold’s price will rise. Historically, we have seen this trend, but there are times when the dollar and gold prices have increased simultaneously.
The gold price has occasionally risen along with the US dollar due to global supply and demand. To understand the relationship between gold price and US dollars, we will discuss a few factors in this article. It will help you understand the factors that affect currencies and the changes in gold prices.
What Happens to Gold Price When The Economic Indicators Are Positive?
The positive economic indicators signify that the future outlook is good and investors are confident in cash-backed assets. If jobs reports, oil prices, real estate prices, and consumer confidence are all positive, then the economy is on the right track, which will strengthen the US dollar. As a result, you might see a decrease in gold prices. So, if the economic conditions are stable and have positive indicators, gold prices will likely decrease.
As an investor, keeping an eye on the economic conditions is vital since it can forecast possible movement of gold prices. Below are the major economic indicators that can help you know how gold prices might change.
Inflation
Many experts use inflation as a KPI (Key Performance Indicator) to know about the possible changes in gold price. A moderate inflation rate between 2% to 3% will keep gold prices low.
However, if inflation increases at a higher rate, gold prices will also rise. High inflation means the currency is losing value, and the cost of living is rising. In these conditions, investors focus on precious metals like gold.
Stock Market
The stock market is also an economic indicator that shows how well the economy performs. If the stock market is experiencing a bullish trend, investors will continue buying stocks and other intangible assets like bonds, ETFs, etc.
However, economic downturns, political instability, or market uncertainties contribute to negative market sentiments. Consequently, the demand and price for gold will rise.
Interest Rates
Similar to the US dollar, the interest rate also has an inverse relationship with gold’s value. Usually, the changes in interest rates are intended to improve the economy, meaning it will impact gold prices negatively.
When interest rates rise, the economies have a prosperous outlook as businesses expand and more jobs are available in the market. Therefore, the attraction of precious metals like gold and silver diminishes as people will focus on other investments.
Conversely, a fall in the interest rate would mean that economic growth stagnates and the currency loses its value. As a result, the popularity of haven investments increases, and gold prices will increase.
But What Happens when there’s Economic Uncertainty and the US Dollar Weakens?
On most occasions, negative economic situations or geopolitical tensions caused gold prices to increase. Most investors turned towards safe havens and started purchasing less-risky investments such as gold. As a result, the demand for tangible assets will increase.
However, this is not the only reason the gold price would increase. The role of central banks and governments can also significantly impact the value of gold. Many countries use gold to pay for foreign debts or use it as a hedge against the dollar. Therefore, if the central banks start purchasing more gold, it will increase the demand and price of gold.
Nevertheless, some specific patterns will emerge. If you look at the chart above, there is a standard pattern that you will see between the trend of currencies and gold prices. You can see the comparison shown by the DXY Currency Index that includes major currencies like:
- Euro
- Japanese yen
- British Pound
- Canadian Dollar
- Swedish Krona
- Swiss Franc
The DXY Currency Index measures the dollar's value against the basket of these currencies.
Sudden economic downturns can also cause the demand for gold to increase as investors lose their confidence in cash-backed assets. The Covid-19 pandemic and the financial crisis of 2008-09 are good examples of how a sudden change in economic conditions can drastically increase gold prices.
In both scenarios, investors lost their confidence in volatile markets and turned toward gold. Sudden economic downturns can weaken the US currency and increase the gold price.
History of Gold and US Dollar Relationship
A vital point to consider is that this inverse correlation between this precious metal and the US dollar didn't exist till 1933. The Federal government suspended the gold standard in 1933. Many economic experts believe this step was necessary to pull the economy out of the Great Depression.
Initially, the US dollar's value connected to gold under the gold standard. So, each dollar has a specific amount of gold attached to it. However, the US allowed other countries to exchange paper money for gold until 1971. Under the Nixon administration, this system became much less popular.
What are the Factors That Can Move Gold Prices?
The movement in the gold price is the result of a combination of supply/demand and market sentiments. While it might seem straightforward to understand, these can work together in different ways to push the price of gold up or down.
For example, a concern for a recession or rising inflation will make the demand for gold rise. Since investors lose confidence in paper money, they would often flock to tangible assets such as precious metals and real estate. So, what other factors can cause the gold price to change? Let's learn more about it.
Supply And Demand
Gold is unlike other commodities such as oil consumed over time. Most minted gold is still available, so why does a price decrease if the supply is not limited? The reason is that the demand continues to stay high as various industries use gold.
Also, countries like India and China continue to purchase gold in large quantities to hedge it against the US dollar. Investors also tend to buy gold during uncertain economic situations, driving the demand up. Thus, the high demand influences prices of gold.
ETFs
The exchange-traded funds (ETFs) also play a crucial role in moving gold prices up and down. The SPDR Gold Shares (GLD) is an excellent example of an ETF that allows individuals to invest in gold. These ETFs buy and sell gold, becoming more popular with every day, making them a significant player in the gold price movement.
Central Banks
We have already mentioned that central banks buy and sell gold to stabilize their economies and make foreign debt payments. If the country holds a lot of foreign reserves and has a stable economic outlook, it will decrease its holdings of gold. Since gold doesn't give any returns like bonds or stocks, central banks wouldn't hold on to it.
On the other hand, if the country's foreign reserves are falling and its currency is devaluing rapidly, it will increase its gold holdings. The problem with central banks is that they often find themselves on the wrong side of the trade.
Retaining Value
The most critical reason that makes gold a top pick for investors is that it retains its value. It is a fantastic hedging tool against inflation and protects your money from losing its purchasing power. Therefore, many investors who aim for long-term returns tend to purchase gold.
While it may not significantly impact gold’s price, it is a contributing factor. For instance, an economic downturn would discourage people from investing in volatile investments. They would look for safer alternatives such as gold, which would make its price go up.
Geopolitical Issues
Geopolitical issues play a significant role in the price movement for gold. We recently saw gold prices reach an all-time high after the Russia’s invasion of Ukraine. Investors turned towards this precious commodity since it was a safer investment option during uncertain times.
We saw similar cases in the past when a major geopolitical conflict caused the demand for gold to increase. Many countries also try to increase their gold holdings during a crisis if they have low foreign currency reserves. An example of this is Russia, which increased its gold reserves before the war.
Takeaway
The possibility of a gold-backed currency is unlikely in the near future. Therefore, the fluctuations in the gold prices are subject to the economic conditions and the dollar's position. Investors should also consider the global demand for this commodity to understand how the gold’s price will react.
Since gold acts as a hedge against inflation and the US dollar, investors will continue to invest in it. It will remain an optimal alternative investment opportunity when the economic situations are uncertain or if there is political instability. So, if you want to invest in gold, you need to stay updated about the economic conditions and the value of the US dollar.
