Ecstasy for the Gold – the diminishing relations of gold and USD – A short analysis

As the spot gold price is soaring there are many theories that investors and traders try to compose in an attempt to understand the market and the driving force behind gold prices rise. Some consider the interest rates as the cause for this rise in spot gold price; other try to link gold with crude oil, and there is also the gold/XAU ratio.

I saw posts in several websites such in forexfactory in which traders and investors try to figure out the correlation among spot gold price and major currencies such as Australian dollar, US dollar, Euro etc.

I intend to show in this short post that using a rule of thumb regarding a correlation between gold and a certain currency is not a good idea.

To that end I have checked two basic facts: the trend of spot gold price vs. the EURO/USD, and the level of correlation among spot gold price and major currencies.

So let’s get started…

In the following graph you can see a time series of Spot gold price and EURO/USD for the years 1999-2010 (monthly basis prices). In order to make these series comparable I have normalized the figures to 100=1/1999 (i.e. January 1999 was set to be 100, the month EURO started).

A price of gold chart vs. USD/EURO 1999-2010 (1/1999=100)

The graph clearly shows as expected that Gold prices parted from EURO/USD during Jan 2001, and from Jan 2005 spot gold price soared, leaving behind the EURO/USD. For one thing, we should consider that since these two indexes are very well parted, it’s hard to consider that a relationship between them could serve us to understand how one affects the other.

Nonetheless, since we are not interested in just analyzing charts and trends I have also checked the correlation between the two series. Furthermore, since many consider other currencies as more correlated to the spot gold price, I have examined the correlation of other currencies, such as Australian dollar vs. US dollar, Canadian dollar vs. USD and GB Pound vs. USD.

In the table below I have checked the level of correlation among the monthly percent changes (from month to month) of Spot gold price and the above mentioned currencies. I have checked for the entire period (1999-2010) and for every couple of years (e.g. 1999-2000, 2001-2002 etc), to see that the long term connection is also the same when we break down the period.

Let’s examine the EURO/USD and gold prices:

While for the entire period there seems to be a strong positive correlation, between them, with a +0.41 correlation, if we examine the table and break down the period, we can see a different picture: for the years 1999-2000 and 2003-2008 there is a very strong positive correlation, but for the recent couple of years (2009-2010) there is a weak negative correlation of -0.09!!

The same is true for the rest of the currencies.

What does it all mean?

If you take one thing from this post, it should be that rule of thumbs regarding correlation among currencies and spot gold price should be taken skeptically. As investors and traders it’s much better to analyze this correlation on current basis. Furthermore, even though that on average there seems to be a strong positive correlation between EURO/USD and gold spot price, for the past couple of years this correlation has diminished and as you can see in the table above, this isn’t the first time (2001-2002). Therefore, if there is a correlation between a certain currency and gold price, then it’s on an ad hoc basis and isn’t reliable.

This could also mean that in the past couple of years gold spot price is experiencing a very bullish rise that is beyond the basic rise in gold consumption, and we should consider other alternative tools to understand this bullish rise.