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.
head of research – commodities, ESG and emerging markets research at MUFG Emea
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.
“This correlation sometimes turns positive, and this is pretty clear at times of severe turmoil and sharp fluctuations in financial markets because of global crises like wars, pandemics, and trade tensions,” says Mohamed Hashad, chief market strategist at Noor Capital.
This is because gold and the dollar are both commonly regarded as safe-haven assets. As a result, there are occasions when both may experience simultaneous increases in value during times of economic uncertainty and geopolitical tensions as investors seek safety.
While analysts acknowledge that the idea of a negative correlation between the US dollar and gold price is not a myth, they explain that the correlation depends on the strength of driving factors at the given time period.
“For instance, a sharp rise in geopolitical risks has the ability to boost gold and the US dollar at the same time, as both are safe haven assets,” Sabrin Chowdhury, head of commodities analysis at BMI, a Fitch group company, tells The National.
In the first half of 2020, the Covid-19 pandemic led to a significant appreciation in both gold and the US dollar. The DXY soared as investors flocked to the liquidity and security of the US dollar, while gold surged as a safeguard against unparalleled economic uncertainty and monetary policy measures that led to lower interest rates.
At the same time, in March 2020, the Fed made the decision to decrease short-term interest rates to a range of 0 per cent to 0.25 per cent, aimed at encouraging borrowing and investment to stimulate economic growth. Since interest rates and gold prices move in opposite direction generally, this played a crucial role in disrupting the negative correlation between gold and the US dollar throughout much of 2020.
Likewise, during the 2007-2009 subprime mortgage crisis, the Fed used a tool known as quantitative easing to provide additional stimulus. This involved the large-scale purchase of Treasury securities and mortgage-backed securities with the goal of reducing interest rates across the board.
During this period, there was a notable increase in demand for the US dollar as investors sought safety by shifting towards low-risk, dollar-denominated assets. This surge in demand played a significant role in the 21 per cent rise of the DXY, which increased from 95 in July 2008 to 115 in March 2009. As a result, the negative correlation with precious metals broke down during this period.
Will this correlation last?
Analysts say the relationship between gold and the US dollar could continue to be more fluid as their negative correlation evolves, affecting how investors perceive influences on the greater economy.
The breakdown in the “gold-dollar correlation suggests that a new framework is needed to understand the path from here”, says Ehsan Khoman, the head of research – commodities, ESG and emerging markets research at MUFG Emea.
“Considering gold as a barometer for fear and wealth offers guidance. The fear component can be cyclical (such as during the global financial crisis or Covid) or more structural, where confidence in the dollar-backed international monetary system is challenged," he said.
