What Gold Tells Us About Markets

June 15th, 2016 by

It’s often very difficult to get a firm handle on what markets are doing—and why. This has become especially true in this unprecedented age of negative interest rates.

Perhaps the largest and most important market of them all is the currency market—commonly called foreign exchange, or forex. An almost unimaginably huge sum of money changes hands every day through forex. The number is in the trillions, as demonstrated by the chart below.

Source: Casey Research

The Tricky Side of Currencies

world-gold-257x300One of the consequences of our free-floating currency valuations, untethered from any standard like gold, is that it’s awfully cumbersome and confusing. This has been the case since President Richard Nixon ended the dollar’s direct convertibility to gold in 1971. Although a step removed from a true gold standard, the Bretton Woods system that prevailed prior to Nixon closing the “gold window” still maintained the link between the dollar and the United States’ massive gold reserves. All other currencies were then measured against the dollar.

Now, every national currency floats freely against all others. (In some cases, a currency might be “pegged” to the dollar or euro as a main reference point, but this is becoming less and less common.) You can imagine it as a giant interconnected web of relationships that branch out in every single direction. When you tug at one strand of the web, all of the others are affected.

Yet, given the way that fiat currencies naturally lose purchasing power over time through inflation, it can be incredibly difficult to tell what’s actually going on. Moreover, almost limitless amounts of new currency can be “printed” (or issued) at central bankers’ whims. The main strategy adopted by most countries is to simply devalue their currencies in order to boost exports and economic activity—but how can you tell when everybody’s currency is falling?

balance of gold and dollarThe best answer is the same as it’s always been: measure their value relative to gold. Gold still serves as an excellent benchmark against which any currency’s value over time can be measured. The purchasing power of gold, so to speak, remains remarkably stable over time. It’s not so much that the price of gold fluctuates; it’s that (primarily) the dollar rises and falls in value over time, which is reflected by the gold price.

Other Factors Affecting Gold

Certainly, the situation described above speaks to the failure of central banks to maintain stability while encouraging growth. The more you hear that central bank policies have a profound impact on the gold market, the more it begins to make sense.

Another concern for gold traders and investors has been the anxiety generated by Britain flirting with an exit from the EU (a “Brexit”). This fear has not only been reflected in the surge in precious metal prices, but also in the ETF market. Even as the momentum from the beginning of the year begins to fade for gold and silver, gold is trading near a five-week high—and a three-year high when measured in the beleaguered British pound.

Gold funds are often touted as a convenient way of gaining exposure to the precious metals markets. While they are certainly a useful signal for what’s happening around the global markets, there’s no replacement for holding physical gold and silver.


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.