Gold and the USD

As we have shown in previous blogs, the relationship between the US Dollar and Gold is complex and not quite as simple as it is often described.

The complexity of the relationship can be seen in the following chart, which shows the monthly % change in the Gold price against the monthly % change in the USD effective exchange rate index ranked by decile from 1980–2014. The 1st decile is the 10% of observations where the USD had the largest monthly decline (and vice versa): so, in the decile of largest monthly USD declines the Gold price rose, on average, 3% and in the decile of the largest monthly USD increases the Gold price fell, on average, 1.9%.


The graph shows, on average, that dollar weakness tends to correspond with gold strength but dollar strength doesn’t really hit gold prices until it becomes serious (i.e. out in the 10th percentile). There is no clear symmetry in the relationship between the USD and Gold prices.

With a number of identifiable, and negative, tail risks, including:

  • BREXIT fallout;
  • Extreme US equity overvaluation;
  • Chinese Yuan devaluation risk;
  • Saudi Riyal devaluation risk;
  • US recession and Global deflation risk;
  • Persistent Yen strength and the increasing frailty of the Japanese banking system and;
  • the perilous state of Italian Banks;

we can see many reasons for US Dollar strength.

Whilst modest monthly USD appreciation has little or no impact on Gold, we can see an environment where that “normal” decline in Gold at extremes of USD strength fails to materializes, where Gold and the USD both rally on rising risk aversion.

A stronger USD and rising Gold price will, no doubt, puzzle many investors used to the “normality” shown in the next chart, which shows the frequency with which the Gold price fell within each USD decile: so, for example, in the 10% of months where the USD had its biggest increases the Gold price fell 72.5% of the time and, on average, by 1.9%.


With large USD declines, the Gold price only fell 22.5% of the time.

The breaking of this relationship will, in our view, signal the loss of confidence in the ability of Central Banks to ride to the rescue of an overleveraged, deflationary biased and horribly unbalanced global economy with a crude assertion that all that ails the economy and markets is a lack of liquidity.

Alongside Gold versus USD, we also need to watch the relationship between European Bank stocks and US Treasury yields. Falling European bank stock prices mean just one thing: lower US Treasury yields.


So, look out for a rising Gold price, a stronger USD, falling European bank stocks and declining US Treasury yields simultaneously. It’s one very large canary!