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« Investment Legends: “Dollar Collapse Inevitable” | Main | The World’s Best Gold Experts: “Buy and Hold!” »

Why Gold Is No Longer An Effective USD Hedge

During the first nine years of this gold bull market, gold prices moved with a near perfect inverse relationship to the US dollar. Indeed, in the early years gold was only really moving up against the greenback, it was only after a few years that it began to appreciate against all currencies. The game plan was simple; the dollar is going down, so gold in USD terms is going up with some leverage factor. Gold worked well as both a USD hedge and as a tool to speculate on a USD decline. This is no longer the case.

USD Gold 2001-2009 SK Options Trading

Nothing lasts forever and over the past two years or so this inverse relationship has broken down significantly. The gold story is no longer simply a USD devaluation play.

USD Gold 2009-2011 SK Options Trading

As the above chart shows, although there are times when the inverse relationship remains intact, there are long periods where gold and the USD move together.

The most significant reason for this is that the Euros are a lot less desirable than they were a few years ago. Since all currencies trade on a relative basis, it doesn’t matter if the USD has poor fundamentals; if the picture for the Euro is worse relative to the USD, then the greenback will make gains against the Euro. During periods where the Eurozone debt crisis has been the focus of market attention, gold and US dollars have been bought since both are preferable to Euros and provided a safe haven.

The key point of this article is not to say that gold will not rise is if the US dollar falls, it is to point out that gold is no longer as effective as a USD hedge. To show this we present a scatter plot of the closing prices for the USD index and gold over the last 2 years.

Gold USD Closing Scatter

Although the trend line has a slightly negative slope it is hardly convincing, and the R-squared value of 0.0188 further diminishes the creditworthiness of gold as a USD hedge. For those unfamiliar with this, the R-Squared value is a statistic that indicates how good one variable is at predicting the other. For our purposes it is a measure of how good a decline in the USD index is at predicting a rise in gold. If the R-Squared value is 1 then given the value of one variable, one can exactly predict the value of the other. If R-squared is 0 that means that knowing the value of one variable does not help you predict what the other variable will be. So the higher the R-Squared value the better one variable is at predicting what the other may be and therefore the stronger the implied relationship is between them. An R-squared value of 0.0188 is extremely poor, and almost indicates no predictive abilities between the movements in the USD and gold.

However to get a fairer picture we should look at the relative returns of the USD and gold.
Gold USD Daily Returns

This does give us a higher R-squared value at 0.0946, but it is still very low and hardly convincing that gold has been an effective hedge against declines in the USD over recent years. Repeating the above exercise for silver and the USD index yields similar results, with R-squared values of 0.0844 and 0.1269. Although these are slightly higher than gold is it is still nothing to write home about, let alone base a trading or investment strategy on.

Silver USD Closing Scatter

Silver USD Daily Returns

To give you an idea of what a strong relationship between two assets should look like, we have repeated the above exercise for gold against silver, a relationship which is much stronger.

Gold Silver Closing Scatter

Gold Silver Daily Returns

Although gold and silver obviously have a positive correlation versus the negative correlation between gold and the USD and silver and USD, we are not looking at whether the relationship is positive or negative, we are only concerned with the strength of any such relationship.

Furthermore when we calculate the correlation coefficients for gold and the USD we get -0.137 and for the USD and silver we get -0.290; both of which imply a very weak negative correlation. Compare this with the very strong positive correlation between gold and silver of 0.905.

Therefore statically speaking, over the past two years gold has been a very poor hedge against a declining USD. Of course this situation may change, and just because the relationship has been weak over the last couple of years doesn’t mean that there were not periods where the USD and gold exhibited strong negative correlations. If the USD index were to fall out of bed we would be expecting gold prices to rise, however over a broader horizon or when moves are more moderate or contained within a range, don’t count on gold moving the opposite direction to the greenback.

In our opinion, if you hold a view that the USD Index is going to fall, then short the USD index rather that taking a long position on gold. You are running the risk that gold and USD could move together, and you are not being compensated for that risk by any leverage factor in gold. If you cannot trade futures, there are ETN’s that allow you to gain exposure to the USD index, such as the PowerShares DB US Dollar Bullish Fund (Symbol: UUP) and the PowerShares DB US Dollar Bearish Fund (Symbol: UDN). Options are traded on these funds as well if you wished to use options to play a move in the USD index.

In conclusion we hope to have shown that gold simply isn’t a clean hedge against the USD any more. When trading one should aim to tailor positions to match your view and optimize the risk/reward dynamics. If you think that the USD is going to fall, short it. If you think gold is going to rise, then buy gold. Taking a long position on gold purely since you think the USD index is going to fall is not really statistically justifiable due to the weakness of the relationship between the two. At SK Options Trading we are constantly refining trading techniques to ensure we are optimizing our risk/reward and tailoring our position using options to fit our view. Our model portfolio is up 138% since inception so if you would like more information on subscribing to our premium options trading service SK OptionTrader feel free to visit our website

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Reader Comments (6)

That is about the most daftest article that I have read for a very long time. Roger Levinson.

March 21, 2011 | Unregistered CommenterRoger Levinson


Within our team there are many views on each topic and we try not to suppress any of them. This is another view, some people will get something out of it and some wont. We can become repetitive and so we try and take a 'look' from a different angle from time to time.

March 21, 2011 | Unregistered CommenterGold Prices

After having 2 semesters of statistics in both undergrad and grad school (ANOVA killed me) back in the day, this is some of the deepest statistical analysis this viewer has ever seen. Kudos to the folks at Gold Prices for such detailed analysis of gold, silver, and the US dollar relationship. You knocked 'em dead with this work. Truely. Rock On, gentlemen!

March 22, 2011 | Unregistered CommenterSnakeman

Gold and the USD
The fact that there is no inverse correlation between Gold and the USD for the last two years doesn't persuade me. I have to ask what changed from the last ten years when going long Gold to hedge the USD worked to the last two years that it didn't work. Do you think there was government interest to cap Gold to keep the fever down?

Today Gold is very close at today's close to making new all-time highs and the USD looks sick. I'll stick with my hedge, thank you very much. It's worked so far.

March 22, 2011 | Unregistered CommenterMike Landfair

To "Gold Prices". You are too defensive to what you see as adverse comments when the intention was not of attack. To the Author of the article I will say just this. Gold is priced in Dollars, the price of the dollar then must have an influence on the price of gold. Gold priced in Euros has the influence of the Euro to contend with as we have seen. Ofcourse there are other important influences on the price of gold, not least of them is the continual debasing of paper currencies and the massive unrepayable debt and, the not to be forgotten influence of intelligence challenged politicians, but to contend from a group of 'painted' graphs that gold is not a hedge against a devaluing dollar when considering the dollar as pricing gold is plainly stupid. It is all very well to look for new angles on the price of gold to write about but lets at least include a modicum of sense and logic to such comments.

March 22, 2011 | Unregistered CommenterRoger Levinson

Gold Prices was simply stating some facts about the recent relationship of gold, silver, and the US dollar, and supporting it with statistical analysis. They weren't comparing these relationships with the myriad of other influences that determine the bull market in PM. The fact remains that gold prices are decoupling from the US dollar, supported by the statistics I hated so much in school. In my view it shows that gold and silver are only getting stronger in their autonomous financial behavior, not dependent on the US dollar.

March 22, 2011 | Unregistered CommenterSnakeman

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