While not all financial markets have been created equal, some share similar characteristics and boast a deceptively close relationship. Take gold and forex, for example, which are bound by various market factors despite completely different asset classes.
However, both gold and forex markets are also unpredictable and have variable risks and benefits, while each asset class can be combined successfully as part of a diversified trading strategy.
To achieve this successfully, you’ll need to understand the natural relationship between gold and forex, while asking how the latter can influence the price of the former.
Why are Gold and Forex so Closely Intertwined?
You may know that the US dollar (USD) is the world’s largest single reserve currency, with trillions held in greenback in developing nations such as China. Interestingly, China also owns an estimated $1.095 trillion (or 4%) of the total $28 trillion US national debt, with this a major concern to lawmakers stateside.
You may not be aware that the gold price is also dollar-denominated, however, with this having evolved from previous forex market structures which pegged currencies to the underlying value of gold.
As a result, dollar fluctuations have a significant and direct impact on gold prices, with the negative correlation between these two assets thought to be as high as 80%.
More specifically, the value of gold is likely to rise as the dollar price falls, while the appreciation of the greenback causes the precious metal price to decline.
The reason for this is simple as the dollars respective ups and downs are indicative of the market’s overall confidence on dollar-backed assets. So, a falling greenback price reflects declining market confidence and sentiment, which in turn encourages investors to seek out relative safe haven assets like gold.
This drives higher demand and price points for gold and similar precious metals, which can provide a secure and tangible source of wealth as the wider market fluctuates.
Exploring the Wider Impact of a Depreciating Dollar
However, this is where the relationship becomes a little complicated, as a depreciating dollar also causes the exchange rate of other major currencies such as the yen, Euro and British pound to increase.
This means that the Euro and yen-denominated gold prices are considerably cheaper in the domestic market, which can also attract investors to buy and increase demand even further.
So, in addition to increasing volatility and the scale of price movements in forex trading, these changing capital inflows naturally promote a rise in the price of gold.
As we can see, gold and forex prices tend to move against one another in most market conditions, which is why they can both contribute to a diverse and profitable investment portfolio.
However, the price of the dollar and wider forex fluctuations can also be used to predict the short-term trajectory of gold valuations, helping to inform your trades more effectively over time.