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The Representation of Gold in the Forex market

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time is money

time is money

Talking Points: 


When Does Gold Do Well?


When Does Gold Do Poorly?

What Markets Communicate Gold Fever or Disgust?

Few markets attract the attention, passion, and debate like gold. The yellow metal went on a meteoric rise from 2000 to 2011 as many were forecasting the fall of the current monetary method and the resurrection of a rare metal-based global monetary system. However, multiple corners of the foreign-exchange market can help you see what the direction and current view of gold means for the Forex trader while often presenting trade ideas.

When Does Gold Do Well?

In its purest form, gold is a commodity like oil or copper or iron are. However, Gold often has a following of faithful buyers who favor the yellow metal should government start default on their sovereign debt. It’s not a coincidence that gold peaked in real dollar terms when the US government shut down during 2011.

This is because faith in the current monetary policy and government was sitting multi-decade lows.

In addition to distrust in monetary policy and governments managing monetary policy, gold does incredibly well at times of high inflation. Inflation is another way of stating that the dollar in your pocket is losing purchasing power. Because there is a fixed amount of gold, it is seen as a trustworthy source of value should the purchasing power of available money plummets. Currently, as seen in commodity markets and inflation readings, gold isn’t in a supportive environment for price increase.

When Does Gold Do Poorly?

If gold does well when governments are doubted and inflation is high then it is easy to see that gold does poorly or drops in value when faith in central banks and government manage monetary policy is high and inflation is subdued.

In 2015, not only is inflation subdued but deflation appears to be on the horizon.

In the last few years, it’s been common to hear central bankers discussed their 2% inflation range target. 2% with very common before the great financial crisis of 2008 but has become seen as an unrealistic goal over the last few years.

Earlier this year, the Bank of England noted that their year-over-year inflation change was 0% and for a short while to be negative signaling deflation.

Currently there appears to be little fear in a sharp drop of purchasing power due to the lack of inflation. Additionally, many central banks have the confidence of markets, which is keeping gold subdued. Whether or not the central banks will keep the trust of markets is a subject for another time.

What Markets Communicate Gold Fever or Disgust?

Because gold is often bought as a way to store value when things are going wrong there are a few markets can be looked at to see whether or not Gold has the potential to drop further, rise further, or move sideways. Two of the most popular markets to look at are the VIX and US dollar.

The volatility index or VIX is the ticker symbol for the Chicago Board options exchange volatility index which measures implied volatility on the S&P 500 index options. If the VIX is moving higher, options traders expect volatility in the S&P 500 and therefore the cost to protect against volatility rises. If traders see high risks of change in prices, this often aligns with uncertainty where you can see gold rise along with the VIX. As you can imagine, during the worst of the crisis in 2008 the volatility index was hitting all-time highs as uncertainty was abundant allowing gold to be bought on a similar spirit of uncertainty. Recently, in the summer of 2015, the VIX has been sitting near multi-decade lows, which aligns with gold weakness in price.

The second market that heavily dictates the value of gold is the US dollar. The reason for the inverse relationship between dollar and gold is very simple. The fact that gold is often priced in the US dollars means that the dollar falling provides gold with a higher price. Conversely, a rising dollar, which we have seen over the last 12 months has correlated to a falling price in gold. In July 2015, the US dollar index is near multi-decade highs, which helped push gold toward five year lows.

Conclusion

Whether you want to look at the Inflation, public sentiment on central banks, the VIX, or the US dollar the spirit behind gold’s direction is important for Forex traders to understand. In the current environment, it is likely best to wait for a significant turn in the US dollar before expecting a significant turn in the yellow metal regardless of how long the downtrend in gold lasts.

Happy trading!

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