Gold: Dollar Hedge or Expensive Door Stop?

At a Glance

  • The U.S. dollar and gold traditionally have had an inverse relationship. However, over the last 14 months, both have strengthened in tandem
  • Gold performance will likely be influenced by the direction of the U.S. dollar and interest rates in 2020

Depending on who you talk to, gold is either an inflation hedge, a currency proxy, a safe-haven asset or a zero-yielding waste of time and money. Regardless of an individual’s opinion on gold, two things are usually agreed upon.

First, gold tends to do well as the U.S. dollar weakens. This makes perfect sense because gold is denominated in dollars.

Secondly gold likes a low rate or declining rate environment. This is also intuitive because the cost of holding zero-yielding assets declines as opportunity costs also decline.

Tracking the Gold and USD Relationship

There are plenty of times that gold and the U.S. dollar have rallied together. These instances usually are centered around moments of global macro-economic stress. The positive correlation between gold and the U.S. dollar then tends to fade quickly as the risk situation resolves itself.

However, something unusual has happened over the last 14 months with the gold and U.S. dollar relationship. From the period of early September 2018 until early October 2019, both assets began a steady correlated grind higher.  The U.S. dollar gained 11% and gold gained 30% (gold has lost some of its strength in November 2019, butcurrently sits at a 23% gain).

It should be noted that during the same period, September 2018 until early October 2019, 10-year treasury yields cratered from 3.25% to a current level of 1.8%. To be fair, this article could easily be focused on the disconnect between the U.S. dollar and interest rates as the details are roughly the same.  I’m currently more concerned with how I will position myself in gold.

Bullish Signs for Gold

What’s interesting is the precious metal has chosen to ignore the U.S. dollar’s ascent and instead focus all its attention on the decline in interest rates. The message?

I think that financial markets are saying that all U.S. dollar strength is not created equal. The dollar index is a snapshot of the dollar’s value versus the basket of six major world currencies, including the euro. A strong and long rally in the U.S. dollar suggests one of two things: 1) The domestic economic story is good.  Or the story in the rest of the world is less than good. Spoiler alert, it’s the latter. 2) When we balance the dollar’s strength against declining rates and buoyant gold prices, the obvious conclusion is that the domestic story is neutral, and the rest of globe is perceived to be struggling.

There are some clues that the ongoing trade war is partially to blame. For instance, the Australian dollar, a currency closely associated with China’s economy, is one of the weakest currencies, down 16% from 2018 highs heading into December. A reasonable conclusion is that market action is saying that the ongoing trade war is dragging the global economy down.  And only the U.S. economy is best equipped to deal with the effects.

2020 Trading Themes

My belief is that the biggest outlier in the gold market is that the U.S. economy begins to turn south and drags the dollar with it. Gold bugs could get very enthusiastic very quickly if they felt that the last, and potentially most important, piece of the bull puzzle was in place.

Jim Iuorio is managing director of TJM Institutional Services and a veteran futures and options trader. Jim has spent his career brokering futures and options trades for large institutional clients in equity indexes, interest rate products, commodities and foreign exchange. His recommendations to clients blend macro-economic themes with technical analysis.

Additional Recent Articles in Commodities