If you spend enough time observing the market you will realize that action and reaction cause most of market movements. If you take a closer look you will see that three names seem to always appear close to each other when you read your daily market news. The US dollar, better known to traders as USD gets to be linked to gold very often. In the mix, we also throw their third friend; US interest rates.
Let’s take a look at how these three amigos seem to always be pushing each other around.
Interest Rates and the USD
Now the U.S. Federal Reserve, we’ll go on calling it the Fed, decides on interest rate movements in the United States. It makes those decisions based on broader economic conditions. When the economy is doing well the Fed removes policy accommodation in a controlled and measurable way. In other words, it begins raising interest rates.
What happens to the USD when interest rates rise? Things are not written in stone, but higher interest rates make USD-denominated accounts more attractive to investors. This, in turn, tends to raise the value of the dollar.
USD and Gold
Gold is priced in USD. Which means when any investor wants to buy gold they pay the value in the US dollar. If the US dollar is higher, gold becomes more expensive for foreign investors, who have to convert their local currencies into US dollars in order to buy gold.
This increase in price tends to put off many gold investors, which can lead to a drop in the price of gold.
Higher Interest Rates = Higher USD = Lower Gold Prices
Is This a Rule?
Of course, like everything else in the market nothing is ever a concrete rule. This relationship isn’t linear. The USD and Gold are affected by a great number of factors and therefore one’s movement doesn’t always directly affect the other.
As an example, gold has vastly outperformed the dollar percentage-wise since the beginning of the year.
For this example, we need to look at the mere expectation that the Fed would raise interest rates, which began around mid-2014. Over the next two and half years, the dollar surged over 20% against the basket of world currencies.
When the Fed, however, did accelerate rate hikes, the dollar’s gains slowed and eventually reversed. This is a classic example of “buying the rumor and selling the fact”.
But at the end of the day, anybody who follows the markets and reads the news will see that the USD, gold and US interest rates tend to find a way to follow each other at most times.
CNN Wire (14 June 20170. “Federal Reserve Raises Interest Rates for 3rd Time Since December.” KTLA5.
Reuters (12 July 2017). “Gold climbs as Yellen testimony curbs dollar, U.S. yields.” CNBC.
The Wall Street Journal (17 July 2017). “Trump Comments Weigh on the Dollar, Lift Gold.”
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