balance of gold and dollar

Gold Is the True Measure of Exchange

March 28th, 2016 by

balance of gold and dollarIt is fairly commonly known investing insight that gold performs well when the dollar falls. This inverse dynamic is also true with any other fiat currency; it’s just most apparent with the dollar, which makes up such a huge part of the global monetary order.

However, it should be noted that gold’s unique monetary properties (even though it’s a commodity) really make it the best measure of any currency’s value against another.

In a sense, this makes gold the ideal objective measure of the strength of currencies in terms of foreign exchange, often shortened to forex. Some might call this a sort of “gold standard,” if you will.

Gold and the Yen

One of the interesting gold-and-currency dynamics worth considering has been the recent correlation between the Japanese yen and the gold price. Over the last 5 years, changes in the gold price have shared a fairly strong correlation (0.5) with movements in the yen. During this year’s rally for gold, for instance, the yen also surged from 121¥ per dollar to nearly 111¥ to the dollar. The chart below (which uses the ETF, GLD, as a proxy) demonstrates.

Source: Seeking Alpha

Source: Seeking Alpha

The first thing to note is that the price of gold has remained the better performer of the two the entire way through. But why this general connection? Well, the most likely explanation is that the Japanese yen—much like the Swiss franc or U.S. Treasurys—is often chosen as a safe haven. This is obviously true of gold, as well, though precious metals are often recognized as the superior hedge.

yenDue to widespread currency devaluation (especially in Japan and China) and the emergence of negative interest rates, this correlation between the yen and gold is bound to break. Japan has long been an important economy in the global system (the third-largest, but long the second-largest). It is known as a trend-setter and a large exporter of capital—but negative interest-rate policy (NIRP) is sure to detail that eventually. It’s worth watching when this decoupling of gold and the yen happens, because unlike the USD/JPY exchange rate, pricing currencies in terms of gold can give you a objective sense of which of them are weakening. Comparing two currencies only gives you a relative idea.

The Dollar and the Fed

When it comes to currencies, however, the dollar holds the most sway in the global economy. It’s essentially ubiquitous. This is why the gold market seems so attuned to the monetary policies of the U.S. Federal Reserve.

gold-nugget-dollarWhile the conventional wisdom is that tighter monetary conditions (higher interest rates) cause the dollar to rise and makes the opportunity cost of holding gold higher (since the metal has no yield), there are two reasons this may not necessarily apply in 2016. First, gold actually performs well during the initial phase of a rate-hike cycle, judging by history. We often hear of a new president’s “first 100 days” in office as an important period that takes on different significance; this is also true for gold prices during a period of rate increases.

Second, the catch is that the higher rates in the U.S. are balanced by negative rates in Europe and Japan (and perhaps elsewhere as the year progresses). In a NIRP environment, the opposite about the opportunity cost of holding gold is true: with depositors actually losing on negative rates (negative interest), gold’s zero yield is comparatively positive.


The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.