Gold And The U.S. Dollar
Marc Chandler | May 26, 2016 03:50PM ET
Many investors view gold as if it were money. Economists identify three functions of money: store of value, means of exchange and a unit of account.
It can be a store of value, but the price fluctuates compared with other forms of money, or other commodities, like oil or silver. Some argue that it is a store of value because of the limited supply, but that argument applies to many other goods, including commodities and real estate.
Others see gold as a store of value because our ancestors said so. For those who bought gold over the past 4.5 years, it has not been anything but. It has lost more than a third of its value in U.S. dollar terms and, of course, nearly the same in Chinese yuan. It has lost more than a fifth of its value in the past 3.5 years in euro terms. In the past three years, gold lost nearly 16% in yen terms.
Gold can be a means of exchange but is rarely as such. If I tried to pay my rent in gold nuggets, my landlord would likely tell me to give her real money. Even in the absence of acceptable paper money, as in occupied Germany after WWII, soldiers and other people did not resort to gold, but instead bartered in cigarettes.
Gold is not a unit of account. Even some critics of the U.S., like Venezuela or Russia, do not report their trade balances or economic data in terms of gold.
Most observers know that gold and the dollar generally move in opposite directions. But what does that really mean? How do we know what the dollar is doing? We have to measure it against another currency or basket of currencies.
Many observers use the Dollar Index. The daily correlation since March 2009 is shown in this first Great Graphic created on Bloomberg.
However, the Dollar Index is not the U.S. dollar. It's the dollar measured against a basket of currencies that are heavily weighted toward the euro. In fact, over the past 60 days, the absolute value of the correlation between the Dollar Index and gold (on a percent change basis ) and the correlation between the euro and gold is nearly identical (0.59 and 0.58).
Instead of the Dollar Index, using a broad, trade-weighted measure of the dollar may be a more rigorous approach. While both measures are inversely correlated to gold, there are significant discrepancies.
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For example, the inverse (60-day percent change) correlation between the Dollar Index and gold hit a new extreme Thursday since the end of 2014 (-0.59). The correlation between a trade-weighted dollar and gold is at -0.28, which is near the highest (least negative) reading this year. That's depicted in the lower Great Graphic.
Interestingly, gold's peak this year was on May 2, a day before the U.S. dollar staged a key reversal against several currencies, including the euro, yen, sterling and the Canadian dollar. Since then, It has fallen about 6.7%. Despite the softer dollar against other major currencies -- and many emerging-market currencies -- gold had a rough day on Thursday. It peaked in Asia near $1235 and trended lower to almost $1218. It is sitting in the trough now. It appears to be carving out some sort of distributional top.
A trend line of the mid-February low and hitting the March and April lows was violated on May 24. Thursday's high tested the trend line from underneath -- and it held. A top may not be confirmed, however, unless the $1190-$1210 is convincingly violated.
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