Gold tracks the dollar
Update 1: According to Investment Update by world gold council, investors often use the direction of the US dollar as a bellwether for gold’s performance. However, over recent years, short-term movements in gold have been more heavily influenced by US interest rates and expectations of policy normalisation.
Our analysis shows that the correlation between gold and US rates is waning and that the US dollar is again a stronger indicator of the direction of price. And, in our view, this will continue over coming months – even while the dollar won’t explain gold’s movements entirely. Furthermore, the analysis shows that higher real rates have not always resulted in negative gold returns.
Linking gold, the US dollar and interest rates: There is no one single driver of the price of gold. Generally, gold’s price drivers can be grouped into four categories: 1) wealth and economic expansion; 2) market risk and uncertainty; 3) opportunity cost; and 4) momentum and positioning.
In the short and medium term, two variables attract investors’ attention most: the US dollar and interest rates.
Historically, gold has had a consistently negative correlation to the US dollar. Gold’s relationship with the dollar is determined by US-based gold supply and demand, as well as by the status of the dollar as the reserve currency globally. And while the US dollar is often a good bellwether of gold’s price performance, in recent years, gold has seemingly reacted more to the behaviour of US rates.
Yet, gold continues to trend higher – increasing by 8.5% since the Federal Reserve rate hike in December 2017 – despite interest rates rising at an accelerated pace. A key question for investors is therefore, what matters more – the direction of the US dollar or the direction of interest rates?
The answer is, generally, the US dollar. But there are exceptions to this rule. The increased negative correlation of US rates and gold between 2013 and 2017 was likely a result of the strong influence that US monetary policy was exerting across global markets. This period coincided with a shift in investor expectations of US monetary policy from being very accommodative to moving towards normalisation.
It also seems that, historically, periods when real rates had higher influence on gold coincided with shifts in monetary policy – either when it was very restrictive or very accommodative. This makes sense, as marginal changes to monetary policy during such periods would generally have larger effects on the global economy.
Higher rates are not always linked to falling gold prices: Intuitively, gold returns should be higher in periods of negative rates, given the low opportunity cost of holding. Conversely, higher real rates should push gold prices lower. But US interest rates do not necessarily influence the behaviour of global consumers of gold jewellery or of technology demand.
Nor do they affect the behaviour of investors outside the US for whom local interest rates matter more than US rates. A historical analysis of gold returns shows that: 1: when US real rates are negative, gold returns tend to be twice as high as the long-term average.
2: even if real rates are positive, so long as they are not significantly high (2.5% in our analysis and far higher than they are today), average gold returns remain positive & 3: falling rates are generally linked to higher gold prices; yet rising rates are not always linked to lower prices.
