Debunk: Investors cannot rely on gold and US dollar's opposing relationship

Vijay Valecha, The National, December 30, 2024

Gold's historical role as a safe-haven asset and its reputation as a store of wealth during times of economic instability are directly linked to its well-established inverse relationship with the US dollar.

This correlation plays a pivotal role in influencing global financial markets as it has made gold a favoured option for investors seeking protection against the weakening of the dollar compared to other prominent currencies and assets.

But the negative relationship is not an absolute bet. Historical data from the past 20 years paints a different picture, dispelling the widely accepted belief in the negative correlation between gold (XAU/USD) and the US dollar index (DXY) – the predominant gauge for assessing the strength of the US dollar against a basket of currencies.

So, if you thought that an increase in the value of the dollar automatically makes buying gold a desirable option, you'll need to reassess your investment strategy, as other factors continue to have a greater influence on gold’s price.

Relationships matter

Gold is commonly viewed as a protection against inflation. Its prices experienced a significant decline when inflation surged to a peak of 9.1 per cent in June 2022, leading to a series of aggressive interest rate rises by the Federal Reserve.

"Nevertheless, it ended the year with a modest decline of 0.1 per cent, signalling its resilience even in an environment of elevated interest rates. A hawkish monetary policy outlook typically tends to strengthen the greenback while a dovish stance tends to weaken the currency instead," Vijay Valecha, chief investment officer of Century Financial, tells The National.

He quotes a study that analysed gold data from 1975 to 2012, and found that gold tends to have an inverse relationship not only with the US dollar but also with the trade-weighted values of several other major currencies, including the British pound, Japanese yen, and the Canadian and Australian dollars.

However, there have been several occasions when the US dollar and gold negative correlation are decoupled, causing both assets to move in the same direction.

Decoding the correlation

In addition to the weakening dollar, concerns about future inflation and persistent financial uncertainty also contribute to the metal's strength.

On the other hand, the strength of the US dollar and higher yields typically pose challenges for the price of gold. Higher bond yields can make gold less attractive as it does not offer interest or dividends.

But this is not always the case. During times of market turmoil, gold has the potential to increase in value even as the US dollar strengthens, providing a hedge against portfolio volatility and minimising losses.

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Source

The National