Gold Price Wobbles As Geopolitical Concerns Grow

October 19, 2017

The correlation between the price of gold and the US dollar is an interesting one. For starters, gold is inversely correlated with the USD. Simply put, as the dollar appreciates (strengthens) the price of gold rises and demand for it falls on global markets. Conversely, a weakening USD makes gold more attractive. The rationale behind this is as follows: Foreign buyers of gold will be able to purchase more USD for every unit of their currency, allowing them to buy more gold at a lower cost. The real drivers of gold are fear and uncertainty, otherwise known as volatility in the financial markets. Geopolitical uncertainty such as the tensions between North Korea and the West, or Middle Eastern terrorism, are catalysts in driving traders and investors to safe-haven assets like gold.

The US dollar can appreciate for a variety of reasons, some of which the government (fiscal policy) and monetary authorities have control over. For example, quantitative tightening drives sentiment in financial markets. When the monetary authorities such as the Fed FOMC decide to tighten the reins, the USD appreciates. This is done through several mechanisms such as a hike to the federal funds rate (FFR), or a gradual tapering of asset purchases. Recall that the Fed was involved in widespread QE, buying up trillions of dollars in assets. At the time of writing, the Fed’s balance sheet had swelled as much as $4.6 trillion. By selling its assets to the public, the Fed removes excess liquidity from the markets, thereby draining dollars from the economy. This has the same effect as a rate hike. With less dollars available, demand for USD increases and the currency appreciates.

The next meeting of the Fed on Wednesday, December 13, 2017 is likely to be met with a 25-basis point rate hike to the federal funds rate. If this happens, markets will enjoy a boost, and the USD will get bumped higher on currency markets. The gold price will be relatively more expensive, but it may not impact global demand since the size of the rate hike is negligible. One of the most obvious ways to gauge the strength of the USD – besides for individual currency pairs – is the US dollar index. This economic indicator is heavily weighted in favour of the EUR (57%), the GBP, JPY, CAD, SEK, and CHF. The current level of the DXY is 93.60 (October 17, 2017). The USD has a 1-month appreciation of 1.91%, and a 5-day appreciation of 0.32%. However, for the year to date, the greenback is down 8.58%. This typically bodes well for foreign buyers of gold who enjoy cost-effective purchases of gold bullion with less of their currency.

The North Korean situation was responsible for the spike in the gold price during September, but simmering tensions have eased somewhat since then. Over the past 30 days, the gold price has dropped from $1,306.30 per ounce on Monday, 18 September to its current level of $1,285.09 per ounce on Tuesday, 17 October 2017. Cross currency exchange rates result in significant fluctuations in gold price movements on an annual percentage basis. The EUR has been one of the stronger currencies of 2017, particularly since robust manufacturing data was reported recently. The UK economy remains stressed with Brexit-related stress factors, and UK Prime Minister May is under renewed pressure to resign. However, Prime Minister Theresa May’s push to get involved in direct Brexit negotiations recently has renewed strength in sterling and this bodes well for UK currency traders. Gold tends to perform poorly when geopolitical tensions are quelled.

Is Now The Time To Buy Gold?

According to Wilkins Finance chief strategist, Montgomery Pearson, ‘This is perhaps one of the most-asked questions in the market. There are several ways to ascertain whether it is apropos to purchase gold. Firstly, what is the nature of geopolitics? During times of rising tensions such as the North Korean ballistic missile testing program, gold demand typically spikes. But will this spike be anything more than a pyrrhic victory for gold bulls?

Another question to bear in mind is the following: What is the nature of your financial portfolio? If your portfolio does not include gold, there is your first error. Gold should always be used as a counterbalance to equities since it is the perfect safe-haven asset during economic downturns. By bolstering your portfolio with gold, you can guard against any capital flight from equities markets.’

Analysts like Pearson routinely recommend purchasing gold on the rebound. If prices have recently plunged from a multiweek high, there is value to be had from investing in gold bullion and holding it as a long-term asset. For traders, news cycles are particularly important where bellicose rhetoric and political posturing come into play. Important economic indicators like jobs reports can result in a deluge of traders flocking to gold. But as the USD strengthens relative to other currencies, the demand for gold plunges instantaneously. Such is the precarious nature of gold trading that it is important to keep your eyes on the markets at all times.

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Luis Aureliano is a business writer and financial analyst. With over 15 years of experience in global finance and an MBA in economics and management, Luis’s areas of expertise include business, marketing, communications, personal finance, macro economics, stocks and emerging markets.

Gold was first discovered in U.S. at the Reed farm in North Carolina in 1799, a 17-pound nugget.

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