Gold's Divergence from the U.S. Dollar
Tony Bortolin
In this article, Joe Investor presents two things about the price of Gold:
(1) Over the long term, there is a hidden multi-year uptrend or “divergence” in Gold which is carrying it higher than the mere downtrend in the US Dollar; and,
(2) Studying Gold’s divergence from the Dollar on a daily basis helps to identify manipulations or other temporary anomalies so as to better predict the price of Gold in the short term.
GOLD’S INVERSE RELATIONSHIP TO THE DOLLAR: As discussed in other articles, the price of Gold can be anticipated as an opposite move to the U.S. Dollar. Gold is priced in U.S. Dollars. Thus, if the value of the U.S. Dollar goes down, more of those Dollars are needed to buy the same amount of Gold, so the price of Gold instantly goes up; conversely, if the U.S. Dollar goes up, the price of Gold goes down. It's a direct, mathematical relationship.
As shown in the chart below titled “$US vs. POG”, in the year 2000, the Dollar was headed up and, sure enough, Gold was headed down.
Since then, the Dollar has been heading down and so Gold has been heading up.
To understand the relationship more precisely, the Dollar has an “inverse” affect on Gold. While it’s true that a 1% drop in the Dollar would basically mean a 1% rise in Gold, a 50% drop in the Dollar would not equate to a 50% rise in Gold, it would actually equate to a 100% rise because it would obviously cost twice as many Dollars for the same amount of gold (twice as many being the inverse of 50%). If the Dollar is down 20%, that is, 80% of its previous value, then gold should be up by the inverse of 80%, or 100 divided by 80, which is 1.25 or an increase of 25%. If the Dollar is down 10%, then gold should be up by about 11%. And so on.
These percentages have been calculated and applied to the various data contained in the first chart and are displayed in the chart shown below, titled “%$US vs. %POG”.
GOLD’S LONG TERM DIVERGENCE FROM THE US DOLLAR: In looking at the above charts, it can be seen that, from January 2000 to date, the Dollar has dropped from about 100 to 90 on the index, or about 10%. As discussed above, mathematically, Gold should be up about 11%. But instead it’s up about 38%.
Clearly, something else has been lifting the price of Gold since 2000. That’s no secret. Gold has its own supply and demand fundamentals. In particular, it should be remembered that there are factors affecting the POG that have less of an affect on the U.S. dollar or none at all. These factors include news of central bank selling or holding under the Washington Agreement, changes in demand for gold for jewelry or for industrial or dental applications, increases or decreases in mining, new gold exchanges and gold-backed currencies, and news on terrorism or war.
Such factors have been discussed before but perhaps never charted collectively as set out below. Most importantly, does this group of factors have its own trend?
Lately, yes. Recalling the inverse relationship of Gold and the Dollar, the value of Gold in the above charts has been calculated since January 2000 on the assumption that the Dollar is the only factor affecting it. This “simulated” price of Gold is displayed in the light blue line in the chart shown below, and is contrasted to the actual price of Gold.
In other words, from January 2000 to November 28, 2003, if affected solely by the Dollar, Gold would have gone from about $288 to $320. Instead, as we know, (and as shown again in the dark blue line), it has gone to about $400. Gold has clearly “diverted” from its supposed inverse tracking of the US Dollar.
What’s the trend in this divergence? This is shown below in the next chart. It shows the difference between the two lines in the previous chart; the actual price of Gold since 2000 has been subtracted from simulated price of Gold. The net result is the divergence itself.
Clearly the trend in this divergence is up.
In fact, the trend began in about March 2001, even before the Dollar started its current multi-year downtrend.
Another interesting fact is that, as shown in the above divergence charts, Gold is currently about $80 higher than it would have been had it been affected solely by the Dollar; that’s not to say Gold is too high; perhaps it was too low and is finally correcting. For example, in 1980, the Dollar was where it is today, at about $.90, while Gold was actually averaging in the range of $600.
So Gold is currently being lifted by two different trends: the decline in the Dollar and Gold’s upward divergence from the Dollar, and that divergence is growing.
IDENTIFYING SHORT-TERM MANIPULATION: The above technique can also help to identify short-term manipulations, stop-loss orders being unnecessarily triggered, and other anomalies so as to better predict the price of Gold on a daily scale.
As may be recalled, on Friday, October 3, 2003, Gold dropped about $13. It’s true that there was jump in the value of the US Dollar on that day, but only of about 1%. Based on that jump alone, Gold would have only dropped about 1% or about $4. Instead, by dropping $13, it dropped about 3.5%. In the absence of any other news to justify the exaggerated drop in Gold (such as news of a peace agreement, a terrorist being caught or a central bank selling gold or some other change in Gold’s fundamentals as discussed above), and assuming Gold had been in a temporary equilibrium with the Dollar, it could have been better anticipated that Gold would bounce back, as it did.
The same can be said about the drop in Gold on September 26, October 10 and October 17, 2003. On those days, there was a rise in the Dollar, but not so high as to be the sole explanation. The collective effect of those dates is illustrated in the chart shown below:
In this chart, September 4, 2003 is selected as the reference point. Using that date, we see that Gold tracked the movement of the Dollar during the first and third weeks of September fairly well. In other words, Gold (shown in dark blue) rose in lockstep with the falling Dollar (its inverse again being represented in light blue). There was an equilibrium and provides a reference. Gold then fell well below that reference line, especially on each of the four dates mentioned above, without any apparent reason. Gold then recovered to that line on about November 13 and has moved in lockstep for the rest of the month.
Whether it was a series of attempts to “manipulate” Gold or not, by comparing the price of Gold to the Dollar in the above manner, the movement in Gold can be better understood and therefore predicted in such cases.
The technique takes advantage of the fact that, while the price of Gold can be easily manipulated, it’s fairly hard to manipulate the US Dollar. So it’s more than likely that, if Gold diverts downward from the Dollar for a day or two, and there is no apparent reason for it (no change in Gold’s own fundamentals), then Gold can be expected to “correct itself” or revert to where it should be, relative to the Dollar, and resume its long term upward movement.
In conclusion, the above technique would appear to be another helpful indicator in predicting the price of Gold, both short term and long.
The author is a private investor, not a qualified advisor. The author was not paid to prepare this article (not even a gold comet). If you found it helpful, you may wish to donate something to you favorite charity.
Yours sincerely,
Joe Investor
Copyright © T. Bortolin, December 2003
Tony Bortolin
eMail bortolin@pathcom.com
Toronto, Canada
Nothing in this article is intended as investment or professional advice or as a recommendation to buy or sell anything. Each reader is solely responsible for doing their own due diligence or obtaining their own professional advice before making any investment. All information is taken from sources believed to be correct and complete. Best of luck.
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