Effects Of Interest Rates And Value Of The Dollar On Gold Price

July 26, 2016

According to international pundit Kim Iskyan, “Gold is falling because of the Fed — but not for the reason you think.”  Ms Iskyan goes on to clarify:  “Gold investors can stop worrying. Despite recent chatter, interest rate tinkering at the Federal Reserve is not driving the price of gold. Actually, the Fed doesn’t have much pull on gold. But the US dollar does.  The chart below demonstrates that overall, gold does not necessarily go one way or another when the Fed raises rates.

Although the Fed doesn’t have much pull on the gold price, contrarily, the US dollar does – as the chart below clearly indicates.

Analyst Iskyan paints a vivid picture how this occurs:

“The strength or weakness of the US dollar – measured here by the US Dollar Index, which tracks the dollar against other major currencies – is a strong indicator of gold’s next move.

Gold prices and the US Dollar have a strong negative correlation. Historically, it lingers near -0.4. That means that when the value of the dollar goes up, gold prices tend to go down, and vice versa.

This strong negative correlation is apparent when you look at their long-term price histories. The next chart shows the US Dollar and gold prices over the past 40 years. Notice how gold prices (in red) tend to go up when the value of the US Dollar (in black) goes down.”

“When gold prices climbed in the late 1970s, the US Dollar was struggling compared to other major currencies. Then, as the dollar climbed 88 percent higher from June 1980 to February 1985, gold prices fell 56 percent.

When the US Dollar started falling in 2002, gold began a massive bull run. It climbed 55 percent over the next 35 months.

And, as the US Dollar climbed 37 percent from April 2011 to November 2015, gold prices were weak, falling 32 percent.”

(Source:  http://www.businessinsider.com/gold-is-falling-because-of-the-fed-2016-6 )

Although the Fed can steer interest rates in either direction, it is really the US Dollar that drives the gold price.

This begs the question:  Where Is The US Dollar Going Now?

INVESTOPEDIA Explains How the Fed Fund Rate Hikes Affect the US Dollar

Fed Funds Rate vs US Dollar Since 1998

“Changes in the Federal Funds Rate will always affect the US dollar. When the Federal Reserve increases the Federal Funds Rate, it normally reduces inflationary pressure and works to appreciate the dollar.

Since June 2006, however, the Fed has maintained a Federal Funds Rate of close to 0%. In the wake of the 2008 financial crisis, the federal funds rate fluctuated between 0 and 0.25%.

The Fed used this monetary policy to help achieve maximum employment and stable prices. Now that the 2008 financial crisis has largely subsided, the Fed will look to increase interest rates to continue to achieve employment and to stabilize prices.”

Appreciation of the US Dollar

“Increases in the Federal Funds Rate also result in a strengthening of the US dollar. Other ways that the dollar can appreciate include increases in average wages and increases in overall consumption. However, although jobs are being created, wage rates are stagnant.

Without an increase in wage rates to go along with a strengthening job market, consumption won’t increase enough to sustain economic growth. Additionally, consumption remains subdued due to the fact that the labor force participation rate is close to its 35-year low. The Fed has kept interest rates low because a lower Federal Funds Rate supports business expansions, which leads to more jobs and higher consumption. This has all worked to keep appreciation of the US dollar low.

However, the US is ahead of the other developed markets in terms of its economic recovery. Although the Fed raises rates cautiously, the US could see higher interest rates before the other developed economies.

When the Fed increases interest rates, it attracts foreign funds to the US. This leads to a natural appreciation of the US dollar, even in light of stagnant wages and low domestic consumption.

Overall, under normal economic conditions, increases in the federal funds rate reduce inflation and increase the appreciation of the US dollar. In the 2015 economic environment, increases in interest rates will slow the growth of inflation to the 2% benchmark and increase appreciation.”

(Source:  http://www.investopedia.com/articles/investing/101215/how-fed-fund-rate-hikes-affect-us-dollar.asp )

The Chart below shows the Fed Funds Rate vs the value of the US Dollar Index from 1998 to the present. In general they run in tandem, i.e. Fed Funds Rate over time drives the value of the greenback.

Further evidence that the value of the US Dollar is a function of interest rates is the following chart of the 1-Year US Treasury Yield vs the USD (1998-Present).

One-Year US Treasury Yield vs US Dollar

And Where Are We Today?

The last chart is a close-up bird’s eye view of US Interest Rates vs the US$. Clearly, interest rates are rising with fervor…which inevitably and eventually will strengthen the US Dollar.

And Then There Is The Potential Collapse Of The Euro Union (EU)

Europe is an economic disaster, exacerbated by increasing Terrorist Attacks (e.g. France, Turkey and Germany). Moreover, some of the oldest and largest banks in Germany, France, Italy and Switzerland have seen their share prices plummet toward ZERO.  Consequently, many, many prudent conservative investors in the EU will methodically convert their euro currency into the US Dollars, which has been the world’s Foreign Reserve Currency for decades. This will translate to a relentless increase in the value of the US greenback.

http://stockcharts.com/h-sc/ui?s=%24USD&p=M&yr=15&mn=0&dy=0&id=p71152201089&a=425584301&listNum=2

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Founder of Gold-Eagle in January 1997.  Vronsky has over 42 years’ experience in the international investment world, having cut his financial teeth in Wall Street as a financial analyst with White Weld. Vronsky speaks three languages with indifference: English, Spanish and Brazilian Portuguese.  His education includes a degree in Petroleum Engineering from the University of Oklahoma, a Liberal Arts degree from Hartnell College and a MBA in International Business Administration from UCLA – qualifying as Phi Beta Kappa and Tau Beta Pi for high scholastic achievements.  Vronsky believes gold and silver will soon be recognized as legal tender in all 50 US states…and many countries worldwide.  You may reach I. M Vronsky at: vronsky@gold-eagle.com and/or vronsky@bellsouth.net

It is estimated that the total amount of gold mined up to the end of 2011 is approximately 166,000 tonnes.