Gold shares an inverse dynamic with the dollar. When the dollar goes up, gold moves lower — and vice versa. In recent days, however, this dynamic has become stressed.
When the dollar moves lower, gold — which is denominated in the U.S. currency — has traditionally rallied as it becomes cheaper for non-U.S. investors to buy the precious metal in alternative currencies.
In early October, when the dollar index (DXY) hit an 11-month peak of 107, gold was languishing at $1,850 an ounce. By the end of November, the DXY had fallen 4.5% to 102 and gold had rallied 10% to $2,050. Tracking this movement in gold were exchange traded funds such as the SPDR Gold Trust GLD.
Low Trading Volumes
“Gold has had fits and starts all year because the dollar comes off and then it rallies again,” said Greg Weldon, CEO of Weldon Financial. “So people have become disappointed and left the gold market.”
Weldon explained that open interest in the gold futures market — that’s the total of all long and short positions, a measure of trading volume — has been very low since the recent push to $2,000. On Nov. 22, open interest fell to 154,000.
Then on Monday, something seemingly extraordinary — but not uncommon in low volumes of trade — happened to the price of gold. It opened at $2,075, then jumped 2.7% to a record high of $2,130, before crashing back down 5% to close at $2,024.
This was one of gold’s other key risk facets at work — geopolitics. When the world seems an unsafe place, there’s safety in gold. It is one of the most popular haven assets for investors to store their cash in times of turmoil.
The timing of gold’s rally on that day coincided with a Houthi drone attack on several ships in the Red Sea. The drone was later shot down by a U.S. warship, leaving investors to focus on a renewed rally for the dollar. The gold price slumped.
“This market’s wiped clean I think — people are not involved, they’ve liquidated ETFs, we have a monetary situation where the narrative has shifted, geopolitical risk… You have a lot of things going on here with China pulling the puppet strings,” said Weldon.
“And I think the time to own gold is now, because if you get above $2,060 this thing could take off.”
Dollar Dynamic To Fuel Gold Rally
He explained that the narrative behind gold’s dollar dynamic will return as he expects the dollar to move lower again, despite a rally over the past week.
“Everyone wants gold to break out because of what we have in the background, but what you need is that dynamic with the dollar depreciating.
“I think we’ll see that because the Fed’s having to acquiesce to higher inflation — we have a 40-year downtrend in interest rates and inflation that has reversed, and there are a lot of factors that now suggest a longer-term secular shift to higher highs and higher lows in inflation.”
Another Correlation: Real Interest Rates
Similar to gold’s inverse relationship with the dollar, it shares a negative correlation with the real interest rate — which can be approximated using the inflation-adjusted 10-year Treasury yield.
This correlation suggested that inflation is a friend to gold, while higher interest rates are not.
TradingView explains: “Rising interest rates also mean rising opportunity costs of holding gold. Gold neither pays dividends nor interest. Thus, it is relatively expensive to hold it in the portfolio when real interest rates are high.
“On the other hand, when real yields are negative, holders of cash and bonds are losing wealth. In such a scenario, they are more prone to buy gold.”