Interestingly enough, the U.S. dollar has a large effect on gold investments. Rick Rule of Sprott US Holdings says, “…my own view is that the gold price trades contra to confidence in the US dollar.” Unfortunately for investors, the US dollar has been “very strong, perhaps as a consequence of weakness in other instruments.”
Rule has not lost complete confidence in gold, however. There are a couple of elements that could factor into a gold increase. Rule has said in the past that the gold price could rise if the anticipated US interest rate rise fails, or if Federal Reserve Chair Janet Yellen isn’t able to follow through with a second interest rate increase. However, those comments raise the question of what a failed interest rate rise would look like — explaining, Rule laid out a couple of scenarios that could lead to such a failure, reiterating, “I think that would be extremely significant for gold.” It seems that until something happens to shake the dollar, gold prices will be in stagnation.
Remember, Gold Used to be a Currency
Historically speaking, gold and silver were used as currencies. The value of a unit of US dollar was originally tied to the value of a specific amount of gold or silver. However, during periods war and the Great Depression, this relationship was temporarily cut in order to protect the gold reserves. After ended the Bretton Woods system in the early 1970s, the US dollar became a true fiat currency allowing it to be freely traded and sold.
Gold and the Dollar: Both Global Currencies
Secondly, gold and the dollar are considered as global currencies. Many foreign banks hold dollars as a reserve currency, or invest more in gold to preserve their assets during volatile economic conditions. When the dollar weakens, banks as well as investors around the world buy more gold to protect their money and hedge against the U.S. dollar weakness; when the dollar strengthens, more and more investors and banks invest U.S. dollar to discard gold. Due to the fall in demand, the value of gold depreciates. This choosing of investors brings about negative relationship between gold and the US dollar.
In addition, the value of gold is commonly expressed as US dollars per ounce; therefore, any fluctuations of dollar are likely to affect the dollar price of gold. As the dollar rises, the gold price in dollar falls, and vice versa. It is worthwhile to note that the value of gold is unlikely to inversely fluctuate exactly in line with the value of US dollar. In fact, this reciprocal relationship is generally not obvious in a short period, but is almost obvious during periods of 12 months or longer.
Gold Investment and the Dollar
Now you may be thinking, then why should I invest in gold? Gold should be an important part of a diversified investment portfolio because its price increases in response to events that cause the value of paper investments, such as stocks and bonds, to decline. Although the price of gold can be volatile in the short term, it has always maintained its value over the long term. Through the years, it has served as a hedge against inflation and the erosion of major currencies, and thus is an investment well worth considering. If you have additional questions or concerns please refer to some of our other blogs or call us to talk to a professional.