Minyan Mailbag - Gold & Currencies
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
Regarding gold's inverse correlation to the dollar and more specifically its correlation to the Euro, in the words of Jackson Brown, "Someone's gonna have to explain it to me, I'm not sure what it means."
Why has gold become so closely correlated with the euro?
The recent rise in the dollar was attributed to the anticipation the Fed raising rates and comments by the Hong Kong Monetary Authority, but we didn't hear much about the ECB's comments regarding the EU's changes to the Stability and Growth Pact. Those changes are basically that the EU is now going to adopt more U.S. style accounting policies, i.e., just excluding certain aspects of spending to bypass the rule that deficit spending not exceed 3% of GDP. See here.
So while the EU has not been in great shape economically, they have maintained or at least have been perceived to have maintained some sort of fiscal discipline. This could be changing. I can't look at JY/Euro chart, but I am guessing the Euro has outperformed the Yen over the 1/2 years? With the Japanese reflation policy, and the ludicrous U.S. fiscal and monetary policy, the Euro has offered a better choice and thus developed this correlation with gold? I don't know, I am just speculating. However, I think it could offer some clues if gold starts rising independently from any currency - that is, up on days when the dollar is down and up on days when the dollar is up. Any comments on this gibberish?
First three points:
(1) Gold is priced in U.S. dollars.
(2) In general, it is inversely correlated with the U.S. dollar index, with a -0.907 correlation for daily changes over the past year, and a -0.955 correlation with weekly changes for the U.S. dollar index over the past 5 years. The Euro is the largest weighted currency in the U.S. dollar index with a 57.6% weighting.
(3) Of the alternative choices to the U.S. dollar, for the purpose of holding foreign exchange reserves, currently the Euro stands ahead of the other European currencies, as well as the Japanese Yen and the fixed-Chinese-Yuan, and other Asian currencies. This is a result of a largely laissez-faire approach adopted by the Europeans versus an interventionist approach adopted by the Asians. The Asians, Japan and China, have basically said, "don't come into our currency because we are fixing it against the dollar." In essence, they have decided to print as much of their own currency as the U.S. The Europeans have conducted a much more stable policy relatively and have indicated that they will only intervene if the dollar causes instability.
The Europeans are not playing the fiat game, at least not yet. Many have commented on the remarks that you refer to about the EU targeting higher debt targets (thus increasing their willingness to print currency), but this discussion has been going on for some time and right now I see no real change in their stance. The only thing that has happened is that the discussion is getting more print lately.
So gold will correlate to the dollar and as of now the dollar has really dropped predominately against the Euro. Did you know that since 2000 the Yen has dropped by 50% against the Euro?
If the Asian currencies all of a sudden begin to fall, gold will rally while the DXY, which is heavily weighted in Euro, may not move that much. You are just seeing coincidence movement.
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