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Gold and the Dollar Market Summary

Blog Oct 31, 2011

Gold and the Dollar Market Summary

It has often been said that gold and the U.S. dollar are polar opposites. This is somewhat of an exaggeration but the fact of the matter is that, over the long-term, gold does serve as a counterweight to the U.S. dollar.

This is largely because the U.S. dollar is the world’s reserve currency and when confidence in the dollar is high, demand for, and the perceived value of, gold is low. On the other hand, when confidence in the dollar is low, demand for gold is high and its value tends to increase.

Of course, there are exceptions to every rule and there have certainly been periods in which gold and the dollar have moved in the same direction. In other words, there have indeed been episodes during which the dollar has been weak, and, due to other unrelated factors, gold has been weak as well. Conversely, there have been episodes when the dollar has been strong at the same time that gold has been rising in value as well. (The period in the wake of the September 11th terrorist attacks would be a prime example of this rare phenomenon.)

Gold: The Ultimate Form of Real Money

Why does gold act as a counterweight to the world’s reserve currency of choice, in modern times, the US dollar?

The answer is simple. For centuries, gold was the basis for the world monetary system. In the 20th century, the world devolved into a fiat paper currency system and the US emerged as the primary economic, political, and military power in the second half of the century. As a result, the US dollar became regarded as a safe haven for investors and institutions around the world.

A 5,000 Year Track Record

But there is simply no way to erase 5,000 years of history and gold’s track record as a safe haven, store of value and trusted medium of exchange has never been forgotten. As the US embarked upon monetary and fiscal policies which eroded the value of the dollar over time, gold’s role as a safe haven came back into play. This was especially true during periods of extreme dollar weakness.

Interestingly, this happened even during periods which are not widely regarded as bull markets in gold.

Two prime examples came in the 1980s, well after gold had fallen from its then-all-time high of $850 per ounce in 1980.

Between June 1982 and February 1983, the US dollar declined sharply and the price of gold rose 75%.

During the 21 month period between February 1985 and November 1987, the price of gold rose nearly 80% due to a decline in the dollar that was touched off by the “Plaza Accords,” in which the US, Great Britain, France, Japan and West Germany intervened in the currency markets to purposely lower the value of the dollar so as to help US goods sell overseas. (A weak dollar makes US goods cheaper in overseas markets because those nations’ currencies are relatively more value in terms of the dollar.)

There is another very basic reason why gold serves as a counterweight to the dollar. Gold is priced in US dollars, so, when the value of the dollar declines, it makes perfect sense that the price of gold will rise. By the same token, when the value of the dollar increases, the price of gold will decline. This only accounts for a small portion of the action in the market everyday, the other portion comes from predominant buying and selling.

A declining dollar makes the entire country poorer over time and it does the same to any investor—individual, institutional, official—who is holding dollar assets. However, that same declining dollar tends to make holders of gold wealthier.

Thumbnail Photo We believe that everyone deserves a properly developed strategy for financial safety.

Lynette Zang

Chief Market Analyst, ITM Trading

Sources & References In This Article

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