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The Inverse Relationship Between Gold and The Dollar
The Inverse Relationship Between Gold and The Dollar
By Stan Gold has been one of the hottest topics in the investing world in recent months, and with good reason. In 2009, investors received a 25 percent return on gold the biggest absolute annual gain in three decades. Arguably, gold s nine -year streak of positive returns is even more impressive. If you re considering whether to invest in gold, it s important to understand the close relationship between the value of gold and the value of the dollar.
An Inverse Relationship
Perhaps one of the most well-known relationships in currency markets is the inverse relationship between the U.S. dollar and the value of gold. This relation occurs because gold is typically used as a hedge against inflation through its intrinsic metal value. As the dollar s exchange value decreases, it takes more dollars to buy gold, increasing the value of gold. While the dollar s value is at risk of fluctuation through shifts in monetary policy, gold s value is largely determined by supply and demand, without interference from shifts in monetary and corporate policies.
Between January 1999 and May 2008, the correlation between the two has been a staggering (-0.84), indicating a very close negative correlation. As with any close relationship between two assets, the gold -dollar inverse relationship has not been without periods of temporary decoupling. The most significant exception to this rule occurred between April and December 2005 when the correlation between gold and the dollar was as high as 0.66. During this period, the U.S. raised interest rates while China revalued its currency, giving them an opportunity to snatch up gold and other commodities.
Although inflation is still a concern, Americans are spending a lot less and a stable economic recovery is a much bigger concern at this point than rising inflation. Once the economy shows any signs of surviving on its own without government aid, the central bank will most likely raise rates quickly, to subdue any risk of inflation. I would advise against investing in gold for now, but if you are interested in gold, the best and easiest way to gain exposure is through ETFs. Make sure you do your research before making an investment!
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What about you? Are you bullish on gold? Would you consider buying gold despite its recent run up? About the Author: Stan is a recent college graduate living in New York City, where he works for a trading firm. Before graduating from college, he was already running an investment fund for family and friends. He writes a weekly column providing economic and investing commentary and maintains his own blog, The Zen Financier.