How the Price of Gold Reflects the Value of the US

Dollar
Wednesday November 13, 2013 09:53
It is undeniably true that the price of gold is related to the value of the US dollar, so it is essential to
understand how this association has come about and exactly how the dollar influences the
commodities markets if you are considering making an investment in gold. Understanding how the
relationship between the US dollar and the price of gold works can help you to make the most
advantageous investment decisions


China is buying gold
The Gold Standard

It is worthwhile spending some time considering the history of the relationship between gold and the
US dollar in order to understand why they still hold such a pull over each other today. The
association developed from the use of gold and silver standards to set the values of currencies in the
past. In these monetary systems, the value of a unit of currency was tied to the value of a specific
amount of gold or silver. The US dollar was originally tied to a bimetallic standard, based on both
gold and silver, but it moved to a gold standard after 1900,which it remained on until 1971. The gold
stabilized the value of the currency, but it had to be abandoned whenever the currency faltered, in
order to protect the gold reserves. The ties were temporarily cut during the Civil War, the First World
War and the Great Depression. Once the separation was made permanent, a new kind of
relationship between the currency and the commodity arose, in which both were freed to play new
roles in the global economy. The US dollar became a true fiat currency, traded on foreign markets
and used as a reserve currency without risking the US gold reserves, while the price of gold was
freed from the restraints that had been imposed on it by financial policies designed to keep
currencies under control.


Will the US ever return to the gold standard?
An inverse relationship

The freeing of the US dollar from the gold standard has enabled it to fluctuate more widely, while the
value of the gold remains stable, making it a safe harbour for investors in times of uncertainty, as a
hedge against inflation and recession. The value of the gold remains stable in comparison to
currencies, but its price in any given currency can fluctuate as the perceived value of that currency
changes. The fluctuations in its price in US dollars reflects confidence in the currency, as the dollar
revalues itself in relation to gold. Thus, the price of gold tends to move in opposite directions to
the value of the US dollar. It is in understanding the subtleties of this relationship that an
appreciation of the history of the US dollars association with gold can be useful, in order to predict
when the inverse correlation is most likely to be triggered and how this can be used to ones own
advantage when investing.


The USD and Gold have historically traded as an inverse relationship
Confidence in Currencies and When It Fails

The historical association of the gold standard still holds a strong psychological sway over investors
today and shapes the policies of many global banks. When the US dollar is in trouble, investors and
global banks stocking their reserves tend to abandon it in favour of gold. Conversely, if the US dollar
is appreciating, banks can begin to shift their reserves from gold into currency, raising the value of
the dollar relative to gold. However, this inverse relationship is not as precise as the link between a
currency and a gold standard. Fluctuations in the US dollar do not always show a negative
correlation with the price of gold. For example, a crisis in another currency while the dollar remains
stable can drive yo the prices of both gold and the US dollar as foreign investors use both as a safe
harbour. The history of the currencys relationship with gold, and particularly the manner in which the
gold standard had to be temporarily abandoned during wars and depression in the past, can indicate
the types of situations that will trigger the instinct to turn to gold and bring the inverse relationship
into play, thus opening up investment opportunities.


When will the world see another currency crisis?
The Economic Crisis

One such opportunity arose with the onset of the global economic crisis in 2007-8, which triggered
renewed interest in gold as a safe harbour investment. The example of the Great Depression
enabled many investors and policymakers to predict this shift towards gold. Economic uncertainty
during the 1930s drove up demand for gold so much that the government was forced to suspend the
gold standard in order to prevent overseas banks from emptying the countrys reserves as they
abandoned their reserves of US dollars in favour of the more reliable option. Another important
factor that influenced the increase in the value of gold was the fact that it was at least in part, the
abandonment of the gold standard that had enabled the wild fluctuations in the markets that gave
rise to the crisis in the first place. Freeing the currency from the value of gold had destabilized the
dollar in a manner that allowed enormous economic growth, but which also allowed bubbles of an
unprecedented scale to swell and burst. Both the instinct to turn to gold in troubled times and the
influence of an unfettered dollar on the crisis caused the demand for gold to grow. The flocking of
investor the the safe harbours occurred early in the crisis, with money.co.uk noting increased
interest in the reliability of gold and fixed rate bonds, and reporting that 31% of investors were
predicting that gold prices would continue to rise even as record highs were reached in 2009. These
predictions proved true, as confidence in gold continued to grow, and new issues raised even
greater doubts about the security of the US dollar, to the extent that some commentators have called
for a return to the gold standard in order to protect the currency.



Who will pay in the next economic crisis?
Trouble Economies Highlight Stability of Gold

Any looming economic trouble that is expected to affect the value of currencies such as the US
dollar will create a shift towards gold. The approach of the US debt ceiling is no exception to this
rule, and it has the potential to create another climb in the value of gold as confidence in the US
dollar is shaken once more. Even if a solution is reached in time, many investors will remain cautious
about the US dollar. Meanwhile, the price of gold has been demonstrating its inverse relationship to
confidence in the currency particularly clearly as opinions about the course of negotiations has
shifted between optimism and pessimism over the course of the crisis. Whenever optimism, that a
solution is near peaks, the price of gold drops a little. Gold futures fell to a three month low early on
October 15 as expectations of a solution appearing drew investors away from safe harbour options.
However, any indication that negotiations are stalling or that the deadline for a solution may be
missed, results in a move in the opposite direction. Indications that disagreements were arising once
again in the house, causing the effort to find a solution to the debt ceiling crisis to stall once more,
resulted in a rise in the price of gold during afternoon trading on the same day. Gold looks set to
remain an important safe haven in the near future, even if an agreement can be made to raise the
debt ceiling and shift this problem forwards into the future. The fluctuations that have occurred as a
result of the debt crisis only serve to emphasize the importance of gold as a safe haven from the
troubles that plague the economy.

Ran
k
Country Reserves of foreign exchange and gold (US$)
1 China
3,236,000,000,00
0

2 Japan
1,259,000,000,00
0

3 Saudi Arabia 541,100,000,000
4 Russia 498,600,000,000
5 Taiwan 390,600,000,000
6 Brazil 352,000,000,000
7 Switzerland 331,900,000,000
8 Korea, South 306,400,000,000
9 India 297,900,000,000
10 Hong Kong 285,400,000,000
11 Germany 238,900,000,000
12 Singapore 237,900,000,000
13 Algeria 183,100,000,000
14 Thailand 175,100,000,000
15 Italy 173,300,000,000
16 France 171,900,000,000
17 Mexico 149,300,000,000
18
United
States
148,000,000,000
19 Malaysia 133,600,000,000
20 Indonesia 110,100,000,000
21 Iran 109,700,000,000
22 Libya 100,300,000,000
23 Poland 97,870,000,000
24
United
Kingdom
94,540,000,000
25 Turkey 88,210,000,000
26 Denmark 85,050,000,000
27 Philippines 75,300,000,000
28 Israel 74,870,000,000
29 Canada 65,820,000,000
30 Iraq 58,960,000,000
31
United Arab
Emirates
53,590,000,000
32 Netherlands 51,270,000,000
33 Sweden 50,350,000,000
34 Norway 49,270,000,000
35 Peru 48,930,000,000
36 South Africa 48,870,000,000
37 Hungary 48,840,000,000
38 Lebanon 48,140,000,000
39 Romania 48,060,000,000
40 Spain 47,100,000,000
41 Australia 46,800,000,000
42 Argentina 46,350,000,000
43 Chile 41,940,000,000
44
Czech
Republic
40,290,000,000
45 Nigeria 35,210,000,000
46 Niger 35,210,000,000
47 Ukraine 31,790,000,000
48 Colombia 31,010,000,000
49 Belgium 29,430,000,000
50 Kazakhstan 29,320,000,000
51 Angola 28,350,000,000
52 Venezuela 26,910,000,000
53 Kuwait 25,930,000,000
54 Austria 25,170,000,000
55 Macau 23,730,000,000
56 Portugal 21,340,000,000
57 Morocco 20,650,000,000
58
Turkmenista
n
19,260,000,000
59 Pakistan 18,090,000,000
60 Vietnam 17,670,000,000
61 Egypt 17,660,000,000
62 Bulgaria 17,270,000,000
63
New
Zealand
17,010,000,000
64 Serbia 16,850,000,000
65 Qatar 16,820,000,000
66 Uzbekistan 15,000,000,000
67 Syria 14,830,000,000
68 Croatia 14,480,000,000
69 Oman 14,370,000,000
70 Jordan 12,110,000,000
71 Bolivia 12,020,000,000
72 Finland 10,350,000,000
73 Uruguay 10,300,000,000
74 Azerbaijan 10,270,000,000
75
Trinidad and
Tobago
10,210,000,000
76 Bangladesh 9,192,000,000
77 Botswana 8,674,000,000
78 Iceland 8,550,000,000
79 Lithuania 8,210,000,000
80 Sri Lanka 7,900,000,000
81 Tunisia 7,372,000,000
82 Greece 6,900,000,000
83 Latvia 6,383,000,000
84 Belarus 6,209,000,000
85 Guatemala 6,197,000,000
86
Congo,
Republic of
the
5,886,000,000
87 Kenya 5,298,000,000
88 Cuba 5,147,000,000
89 Paraguay 5,096,000,000
90 Ghana 4,810,000,000
91 Costa Rica 4,756,000,000
92
Papua New
Guinea
4,445,000,000
93 Yemen 4,370,000,000
94 Cote d'Ivoire 4,300,000,000
95 Bahrain 4,245,000,000
96
Bosnia and
Herzegovina
4,150,000,000
97 Cambodia 4,069,000,000
98 Burma 3,931,000,000
99 Tanzania 3,726,000,000
100 Cameroon 3,316,000,000
101
Equatorial
Guinea
3,055,000,000
102 Ecuador 2,958,000,000
103 Dominica 2,902,000,000
104
Dominican
Republic
2,902,000,000
105 Georgia 2,818,000,000
106 Honduras 2,785,000,000
107 Uganda 2,782,000,000
108 Mauritius 2,743,000,000
109 Ethiopia 2,665,000,000
110 Albania 2,665,000,000
111 Senegal 2,635,000,000
112 Macedonia 2,581,000,000
113 El Salvador 2,504,000,000
114 Mozambique 2,469,000,000
115 Slovakia 2,462,000,000
116 Zambia 2,324,000,000
117 Gabon 2,320,000,000
118 Panama 2,315,000,000
119 Jamaica 2,273,000,000
120 Moldova 1,965,000,000
121 Armenia 1,959,000,000
122 Nicaragua 1,892,000,000
123 Kyrgyzstan 1,835,000,000
124 Namibia 1,758,000,000
125 Ireland 1,703,000,000
126 Haiti 1,341,000,000
127 Madagascar 1,255,000,000
128 Lesotho 1,100,000,000
129 Luxembourg 1,000,000,000
130 Slovenia 991,300,000
131
Burkina
Faso
957,000,000
132 Rwanda 955,000,000
133 Chad 887,500,000
134 Benin 887,200,000
135 Fiji 833,500,000
136 Tajikistan 815,200,000
137 Guyana 807,800,000
138 Togo 786,200,000
139 Laos 773,500,000
140
Congo,
Democratic
Republic of
the
755,700,000
141 Barbados 745,100,000
142 Guinea 642,100,000
143 Swaziland 600,500,000
144 Malta 515,500,000
145 Zimbabwe 461,000,000
146 Estonia 409,000,000
147 Montenegro 400,000,000
148 Cape Verde 361,000,000
149 Burundi 295,500,000
150 Sudan 295,000,000
151 Suriname 263,300,000
152 Malawi 263,000,000
153 Seychelles 255,400,000
154 Belize 237,100,000
155 Gambia, The 223,200,000
156 Eritrea 184,500,000
157 Samoa 165,600,000
158 Vanuatu 161,400,000
159 Tonga 86,800,000
160
Sao Tome
and Principe
51,470,000