Why gold and the dollar move in opposite directions

A two-pronged case for holding gold (Part 3 of 4)

(Continued from Part 2)

While the US dollar is strengthening, I still believe that investors should consider maintaining their allocation.

Market Realist –

Gold and the dollar move in opposite directions

The above graph compares the dollar index (UUP) with gold (GLD)(IAU) prices for the last five years. It illustrates that gold and the dollar move in opposite directions.

There are many reasons why the value of the dollar affects commodity prices. The main reason is that most commodities are priced in dollars. When the US dollar strengthens, it will take fewer dollars to buy commodities. In other words, commodity prices fall. Exactly the opposite happens when the dollar weakens.

The S&P 500 (SPY)(IVV) has given splendid returns in the last three years or so. The markets perceived the Fed’s QE (quantitative easing) program to be positive for equities, which led to funds flowing from safe assets like gold toward equities. However, Treasury (TLT) prices rose due to aggressive buying by the Fed.

More recently, the end of QE and the fear of a rate hike has led to a further decrease in gold prices. As higher rates are positive for the dollar, the dollar index has soared. The fact that interest rates remain low elsewhere while those in the United States could rise soon is a positive for the dollar.

However, as long as the uncertainty regarding global growth lingers, gold could benefit. It could take a while before we see improvement.

Read on to find out the main advantage of holding gold.

Continue to Part 4

Browse this series on Market Realist:

  • Part 1 – Why gold outperformed other assets recently
  • Part 2 – Why gold underperforms when real rates are high
  • Part 4 – Why you should own gold: The diversification angle

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