Monday January 25, 2021 - 11:33:57 GMT
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Why gold and the US dollar have an inverse relationship
The relationship between gold and the USD dates back when the gold standard started getting used. In that period, the value unit of gold was tied to a particular value unit of dollars. It was used throughout the period from 1900 - 1971. With 1971 being the year when currency became separated from the gold standard. Both standards of payment (gold and USD) were freed. From then, their valuation was done based on demand and supply. The USD on the one hand became a fiat currency, which was a centralized currency that got its value from government control, yet is not backed by any physical product. It is traded on the foreign exchange markets. This made the USD a reserve currency.
On the other hand, after 1971, gold became a floating exchange and had a floating exchange rate. This made the price of the precious metal susceptible to the value of the USD. The International Monetary Fund in 2008 calculated that 40 to 50% of the movements in the price of gold since 2002 were related to the USD. If there is as little as a 1% move, in the external value of the USD, it will lead to a more than 1% shift in the prices of gold. Most traders and investors alike always need to be updated with regards to the value of the currency in order to make a decision whether or not to secure their wealth by rushing for a safe share like gold or not. They need up to date information to accurately measure the strength of the currency to know if it's falling or increasing, and using this currency strength meter guide will help any investor forecast the value of the currency before making their next move.
There is an inverse relationship between the price of gold and the trade-weighted USD. The price movements of the USD, whether it is losing or gaining trading power is shown by the trade-weighted value, compared to other currencies in trading. Nevertheless, this relationship between the two assets is not as accurate as it was during the gold standard era. Although it is gone now, most investors tend to drift to gold when there is a dip in the value of the USD. The reason why this inverse relationship stays is that:
The currencies of other countries increase when there is a decrease in the price of the U.S. Dollar. This further increases the demand for assets including gold, as the prices increase too as seen here.
Investors begin to look for other ways to store their wealth when the U.S dollar begins to lose its value. And the next best alternative has always been gold.
However, it is worth noting that both the value of gold and the U.S dollar can increase at the same time. The reason for such an occurrence could be in the event of a crisis in another region or country. This will result in investors rushing to safer assets, which are gold and the U.S dollar. There are many factors that drive the U.S dollar. They include inflation and monetary policy in the U.S as opposed to other countries. Another driving factor is economic prospects in the U.S, as opposed to other countries. All these factors have to carefully be considered by investors.
It is essential to know the direction that the prices of gold will take. Gold stocks like Barrick Gold Corp.(ABX), Goldcorp Inc. (GG), Gold Miners Index (GDX), and exchange-traded funds (ETFs) like SPDR Gold Trust (GLD) are connected to the prices of gold.
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