For much of 2013, gold and the dollar have had minimal correlation with each other, which each instrument having its own animal spirits. This is in sharp contrast to prior years, where in the wake of the US financial crisis and later the euro zone crisis, gold would move in inverse lockstep with the dollar, rising when the greenback declined and falling when the dollar rose.
Many theories have been put forward for why gold has fallen out of favour. The principal view is that there were just too many gold longs out there. Up until last fall, before the dollar began to fall against the euro and other currencies (apart from the yen) in the wake of the Federal Reserve’s QE3, gold maintained an element of safe-haven status also. Global investors at the time were overly long dollars, but could not yet stomach buying euros, given the problems in the peripheral countries and the economic sluggishness of the euro zone as a whole, and gold seemed to be a way to diversify. Retail accounts were active buyers of Gold Exchange Traded Funds (ETFs) and speculative accounts in general preferred a gold long position.
By early October, spot gold posted a high around $1796 and several analysts were calling for a move to $1900-$2000 sometime in 2013. Positions eventually became extended and larger fund selling prompted a sell-off into year-end, even though the dollar was falling against the euro and other currencies, which historically has often supported gold.
2013 has been a year of a generally rising dollar, especially versus the yen and emerging market currencies and gold has mostly been on the defensive. After larger dips, global investors attempted to buy gold repeatedly and each time have gotten their fingers burnt. This was more than evident in mid-April, when gold tumbled over $160 over the course of two days. A Securities and Exchange Commission filing on 15 May showed that Soros Fund Management had further reduced its investment in the SPDR Gold Trust, the largest bullion exchange traded product, by 12% to 530,900 shares (as per 31 March). This followed a 55% reduction in Q4, analysts said.
Since then, the market has shunned the precious metal and yet continues to watch it closely, just in case gold regains its luster. For much of June and part of July, gold tried unsuccessfully to vault $1300, even as the euro tested both sides of a rough $1.2750 to $1.3200 range and dollar-yen rose from Y98.25 to Y101.50. Finally, gold did break $1300 and rallied above a key pivot at $1322 (a low from earlier in 2013) to post a high around $1348.65, only to once again run out of steam and trade back below $1300.
In the current trading environment, with gold trading both sides of $1300, there are days where gold and the dollar appear to be highly correlated, evoking memories of the past, and then there are days where each instrument is marching to its own drummer.
Despite this, the latest forecasts for gold point to lower levels ($1100 or lower by the end of 2014) for the most part. However, these forecasts are based on the view that the dollar will benefit from US outperformance and rising US Treasury yields, which are expected to move higher at a faster clip than other developed markets. More recently, the dollar has been under pressure versus the euro, sterling, and select other currencies as economic data sets in other countries have been more upbeat and suggest that interest rate differentials may not favour the dollar as much as previously thought.
The World Gold Council weighed in recently on the possible effect on gold from the Federal Reserve winding down quantitative easing and eventually tightening monetary policy. The WGC said in a research paper (‘Gold and US interest rates: a reality check’) in its latest quarterly investment journal Gold Investor, released on 31 July, that investors should not overestimate the effect that a rise in US interest rates would have on gold in their portfolio.
“The paper analyses the impact on the gold market of higher interest rates, as financial markets factor in the impact any decision by the US Federal Reserve to wind down QE and tighten monetary policy might have,” the WGC said.
“Its conclusion is that, while negative interest rates support gold investment demand and rising rates increase the cost of investing in it, a normal rate environment – with real interest rates ranging between 0% and 4% or approximately 2.5% to 6.5% in nominal terms – is not automatically adverse to gold. In such a rate environment, gold’s inclusion in a portfolio has historically been beneficial to investors,” the report said.
The US economy and interest rate direction is no longer the key driver of gold prices, with emerging market countries “increasingly driving the long term view of gold.”
“US physical demand for gold (including ETFs) accounts for less than 10% of the market, while emerging markets make up close to 70% of annual demand,” the WGC said.
Juan Carlos Artigas, Head of Investment Research at the World Gold Council said:
“While headlines have focused on the recent price moves, the long term drivers of gold including emerging market growth and central bank demand hold firm, particularly when combined with a likely reduction in supply from both mine production and recycling. Even with the highest rate of interest, the core value of gold is to balance out a portfolio. Most investors are under allocated; optimal levels are identified as between 2% and 10%.”
At current levels (at the time of this writing $1323), gold has given up the lions’ share of the gains seen in the wake of the financial crisis and indeed recently traded at low levels last seen in the summer of 2010. Going forward, gold price direction may hinge more on whether emerging market economies can recover than if the dollar is going up or down.
Countries like China, India, Mexico, Russia and South Korea have been buyers of gold for reserve diversification reasons in the past few years. With the dollar rising, some of these countries have been forced to intervene to stem their currencies’ weakness, which depletes overall dollar reserves and thus creates less need to diversify into other currencies, such as the euro and or other instruments such as gold.
If there appears to be a correlation between gold and the dollar, it may not be long lived. As we mention in our book The Foreign Exchange Matrix (Harriman House, February 2013):
“risk appetite and risk aversion suffice to link any asset price to any other, but that is a short-term phenomenon and not a reliable trading guide over longer periods of time. In the end, the price of oil will always ultimately have something to do with the demand and supply of oil, in turn influenced by producer budgets and technological advances in alternative energy – and not the level of the dollar alone. The same holds true for gold or any other commodity or security.”