U.S. Dollar and Gold: Is This Time Different?

U.S. Dollar and Gold: Is This Time Different? by Dr. Thorsten Polleit, Degussa Market Report USA Gold

On 13 August 2018, the price of gold fell below 1,200 USD/oz, declining to a 1.5 year low. What to make of this move? It seems that several factors have been at work in triggering the gold price decline. At the same time, it does not seem too far-fetched to think that the current market price of gold is now well below its true value, and so the chance for the gold price to go up outweighs the risk of a further drop by quite a margin. Here is why:

Given recent market uncertainty – amongst other things due to the Turkish Lira crisis and other emerging market currencies being affected by the turmoil – investors have substantially increased their demand for the Greenback. It does not only serve as a “safe haven” currency, but it also offers a positive interest rate (e.g. 2-year US bills offering a yield of around 2.6 per cent). In the international context, this is a rather attractive combination from an investor’s point of view.

What follows is an appreciating US dollar and – as its flipside – a decline in the price of gold in US dollar terms. In fact, investors seem to be convinced that the Greenback is the currency to hold, and that the US dollar can outshine the ‘gold currency’. This, however, appears to be a questionable proposition. For the end of the Fed’s hiking cycle might be closer than the market expects. The reason lies in the growing international US dollar indebtedness.

In the period of extreme low US interest rates, many foreign borrowers – in particular, those from emerging market economies – have taken on US dollar denominated debt. An appreciating US dollar causes them quite some trouble: It increases the costs of serving their debt. What is more, it makes rolling-over maturing US dollar debt more difficult: Lenders become hesitant to renew loans, and if they do, they can be expected to charge higher interest rates.

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