Gold heads lower as dollar strengthens

In the Lead: “Mumbai, We Have A Gold Problem”

While we are on the subject of continuing installments, we now bring you a couple more insights from the recently published and discussed academic research paper by commodities expert Claude Erb and Duke University Prof. Campbell Harvey. In last week’s article we covered the topic of gold and inflation-hedging but did not exactly come to an encouraging conclusion. Today, we will take a look at gold as a hedge against currencies. We will cover gold as a putative safe-haven and other similar beliefs in upcoming articles. Myth-busting never take a break here.

The Erb/Harvey study starts with the commonly held truism that “gold is a currency hedge.” In other words, note the authors, if the US dollar loses 10% against the yen, for example, then the price of gold should offset that loss by rising an equivalent 10%. That argument, unfortunately, only holds water if in fact one of the two countries involved in such a calculation/hedging can consistently boast an inflation rate of…zero percent.

What has, in fact, taken place is that, since 1975, the US dollar price of gold has risen and the US dollar has depreciated against the yen. On the other hand, the price of gold in yen also rose and the Japanese yen appreciated against the dollar. Last week, the World Gold Council (EGC) issued its report on the gold price performance in the second quarter of 2012, in which it noted that gold prices declined in most currencies with the exception of the euro, the Swiss franc and the Indian rupee.

For any particular currency pair, if gold is able to hedge one country’s currency, it certainly is not able to hedge the other’s currency. As regards gold as a hedge against “domestic” (pick your country) currency “debasement” (courtesy of the imaginary printing presses that are putatively running 24/7) the authors find that, from a macro-perspective, the mantra of “currency down – gold up” also does not hold true. As regards the following table of currencies, the authors conclude, there seems to be little connection between currency returns and gold returns:

All (speculative) eyes are now focusing on Friday’s US Q2 GDP report. You already know how that news day will play out; feeble growth figures will stoke the commodity bulls who will immediately read an imminent QE3 into the statistical “coffee grounds” on offer from the US Commerce Department. The US economy grew at the 1.9% rate in Q1 and estimates are that such expansion may have stalled to near 1.3% during the most recent quarter. Separately, a Chinese central bank advisor has warned this weekend that his country’s economic expansion could slow to 7.4% in the current quarter and that the contractive phase is not yet over. Much hangs in the balance these days. IMF Chief Ms. Lagarde has warned that this crisis knows no borders and that it is knocking on everyone’s doors.

Until Wednesday, well, hang in there…

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About the Author
Jon Nadler Jon Nadler is a Senior Analyst at Kitco Metals Inc. North America
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