WGC Report: Weakening Dollar Tends to Support Rising Gold Price

Conventional wisdom holds that rising interest rates are bad for gold. The fact that the Federal Reserve has been nudging rates up over the last couple of years has accounted for a lot of the bearishness in the gold market. But the conventional wisdom doesn’t line up with the current reality. Even as the Fed has hiked rates, the price of gold has gone up – increasing by 8.5% since the Federal Reserve’s first rate hike of this cycle in December 2017.

A recent report issued by the World Gold Council indicates that gold investors focused primarily on interest rates are looking in the wrong place. They need to be watching the dollar.

Our analysis shows that the correlation between gold and US rates is waning and that the US dollar is again a stronger indicator of the direction of price. And, in our view, this will continue over coming months.”

According to the WGC, there exists “a consistently negative correlation between gold and the US dollar.”

WGC analysis did identify a short-term correlation between gold and interest rates between 2013 and 2017, but in general, rising rates are not necessarily negative for gold. Peter Schiff has made this very point.

Rising interest rates are not negative for gold. I mean, the main reason that interest rates are rising around the world is because inflation is picking up around the world. Higher inflation is positive for gold. I mean, it is the most bullish thing for gold. And in fact, when inflation rates are rising, that means money is buying less, right? The purchasing power of money is going down. And that’s when you want to own gold.”

The WGC noted another problem with focusing solely on US interest rate policy – it takes too narrow a view of the gold market.

US interest rates do not necessarily influence the behavior of global consumers of gold jewelry or of technology demand. Nor do they affect the behavior of investors outside the US for whom local interest rates matter more than US rates.”

Analyzing trends reveals even when real US interest rates are positive, gold returns tend to remain positive. As the WGC put it, “falling rates are generally linked to higher gold prices; yet rising rates are not always linked to lower prices.”

Dollar movements have a much strong correlation with gold and the current trend for the greenback is decidedly downward.

The greenback rallied on Monday, pulling the price of gold lower, but the dollar has generally been falling since early 2017. A recent Bloomberg Intelligence report projected that trend would continue.

Despite the Federal Reserve’s accelerated rate-hike schedule, the dollar declined. Down remains its longer-term path of least resistance.”

The WGC also anticipates continuing dollar weakness.

In our view, one of the reasons the dollar will overtake rates to explain the direction of the gold price, is that movements in the dollar already reflect inflation expectations of monetary policy in the US. At the same time, they also reflect expectations of interest rate differentials between the US and major economies, as well as investors’ views on trade imbalances – all factors that are currently relevant for gold. And, generally, the dollar is expected to weaken as the ECB and other central banks move towards monetary policy normalization. Concerns about the effect of potential trade wars have also dampened the dollar’s ascent.”

The ballooning national debt is one factor dragging the dollar, and that isn’t going to change any time soon.  In February, ING head of currency strategy Chris Turner told Reuters he thinks the weakening dollar could be explained by the fact that yields are rising on the back of worries over the budget deficit rather than inflation.

This year’s rise in Treasury yields has been driven more by the term premium – that’s a risk premium investors require for holding long-term debt. International investors are requiring a concession in the dollar to hold US assets because of the fiscal risk.”

So, why would budget deficits push yields up? It’s simple supply and demand. The Treasury Department is going to have to sell trillions of dollars in bonds over the next few years to pay for all of this spending. This comes at a time when the three biggest buyers of US debt aren’t in a buying mood. Yields have to rise to entice people to buy all of these Treasuries.

In an interview last December, Peter Schiff gave several reasons he sees continued dollar weakness in 2018, including moves by countries like China and Russia proactively trying to dethrone the dollar. Just last month, the Chinese finally launched the much-anticipated yuan-denominated oil contract.

The WGC concluded its report saying gold’s behavior is best understood as a broad fiat currency hedge rather than simply a dollar hedge.

This is apparent in periods when major currencies weaken, and investors buy gold to hedge that risk – for example, during the European sovereign debt crisis. In such instances, gold and the dollar have tended to move in sync, with both benefiting from safe haven inflows. A period of heightened geopolitical risk with the potential to impact the global economy could, thus, be supportive of gold even if the dollar were to strengthen. As such, we believe that investors benefit from holding a strategic allocation to gold as a source of returns, diversification, liquidity, and portfolio impact.”

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