When the U.S. dollar is going down, the price of gold goes up. The reason is simple: it is basic math. Gold is priced in U.S. dollars. Therefore, if the U.S. dollar is weakening, it takes more dollars to buy the same ounce of gold.
That is the logic, anyway. But does the logic actually work in the financial markets?
Sometimes it doesn’t. As the economist John Maynard Keynes famously said, “The market can remain irrational longer than you can remain solvent.” As it turns out, the logic works here with gold and the dollar.
Gold’s compound annual return since the early 1970s has been about 6.9% a year. But when the dollar is weakening, gold goes up at 12.2% a year. Meanwhile, when the dollar is strengthening, gold only goes up 1.8% a year.
Take a closer look below:
Compound Annual Gains in Gold
During a dollar downtrend
During a dollar uptrend
To identify uptrends and downtrends, we looked at whether the dollar was above or below its 10-month moving average at the end of a month. Then, starting at the date of that signal, we measured gold’s performance over the following month.
You can see dollar downtrends led to strong gains in gold:
Why is this important today? Consider that we are now in one of those times when gold has historically delivered double-digit compound annual gains.
My colleague’s conclusion was that the dollar could decline for the next two years.
If that’s true, then gold could be starting a multi-year bull market.
For now, do not be too worried about the short-term fluctuations. We actually think the dollar could go up a bit more before it resumes its fall. Yet, the dollar’s long-term trend is clearly down. The time has come- we are finally on board with gold again. If gold could be starting a multi-year bull market, you will want to be on board the gains train too.