Gold and the US dollar – A Love Hate Relationship
Treesdale Partners, portfolio manager of the AdvisorShares Gartman Gold/Euro ETF (GEUR), AdvisorShares Gartman Gold/British Pound ETF (GGBP), AdvisorShares Gartman Gold/Yen ETF (GYEN) and AdvisorShares International Gold ETF (GLDE), share their thoughts about the gold space.
In previous commentaries we have discussed in detail our starting premise of gold essentially being a currency and the implications of this viewpoint on how to approach gold as an asset class. In this commentary we use the historical gold price in US dollars to demonstrate this inherent relationship between the value of gold versus the financing currency used to make purchases.
Any transaction to buy gold is analogous to a foreign exchange (FX) transaction. In a FX transaction an investor exchanges one currency for another, at an agreed exchange rate and on an agreed date. In a gold transaction, an investor exchanges a currency (in most cases the dollar) for gold at an agreed exchange rate, typically expressed in dollars per ounce. In this transaction, the exchange rate defines the relative relationship between the two currencies or in the case of the gold transaction between gold and the dollar – it is in effect the exchange rate at which the market values the two assets on a relative basis. While some gold investors may view gold as a physical asset to be held as an absolute store of value we view gold as asset to be held as a store of value relative to the financing currency. In the scenario of an investor buying gold financed in dollars this means explicitly that they are expressing a view on the future, relative value of gold versus the dollar.
Using gold financed in dollars (Gold/USD) as an example we can readily demonstrate this relative relationship between gold priced in US dollars and the dollar. In the chart below we chart a ten year history of the six month percentage change of the price of gold in dollars and the six month percentage change in the USDX US Dollar Index. We use the USDX as a measure of the international value of the USD against a basket of major currencies. Both series are standardized using the semi-annualized, standard deviation of daily price changes for each respective series. The data is normalized as the price of gold and the USDX USD Index have different volatilities with gold in general being the more volatile asset. So we must standardize both series to be able to meaningfully compare the percentage moves over each six month period.Source: Bloomberg, LP; Treesdale Partners calculations Past performance is not indicative of future results.
The key feature to highlight is the apparent inverse relationship between the price of gold in dollars and the USDX USD Index. This should not be surprising as it is somewhat of a definitional relationship. When the price of gold increases in dollar terms, this indicates the dollar is weak relative to gold and we would also, in general, expect the dollar to be weak on broader currency markets. And this relationship is born out in the chart where the value of the dollar as proxied by the USDX USD Index moves inversely against the price of gold in USD terms. In particular when the dollar and gold are at lows/highs the extremes of each almost always occur at mirror opposites – see the red circles on the chart above. In simple terms the price of gold in dollars tends to be at its highs when the value of the dollar is at its lows.
The key takeaway from this simple observation is the inherent relationship between the price of gold relative to the financing currency (in this example the US dollar). For investors buying gold in dollars, it is critical to understand the relationship between gold and the dollar as a long position in gold is explicitly expressing the view that the price of gold will increase relative to the dollar. Similarly investors buying gold in yen are explicitly expressing the view that they expect the price of gold to increase relative to the yen. In other words the choice of financing currency for gold purchases matters.
This consideration should be of particular note to gold investors in the current macro-economic environment where the Federal Reserve has indicated its resolve to end asset purchases in contrast to other central banks such as the Bank of Japan which are still focused on maintaining accommodative monetary policy. This has led many economists to forecast general strength in the dollar on currency markets and has at the same time created a conundrum for investors who might be both bullish gold and the dollar. The solution to this conundrum of course would be to choose an alternative funding currency other than the US dollar, such as the euro, yen or British pound, with which to finance gold.