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The US dollar and the gold price
January 23, 2004

Recall from last week that the PVE Gold Index consists of the GDP-weighted gold price in thirty-six countries, including the United States. Since nine of the countries in the index use the euro, twenty-eight currencies are represented. For convenience, I copied last week’s chart below; let’s see what we can glean from it.

The PVE Gold Index gives us an idea of how the average gold price in the world is changing. When the gold price in any given currency deviates from the PVE Gold Index it implies a change in the exchange rate of that currency with respect to the other currencies in the index.

We can therefore see that the US dollar exchange rate was relatively stable from January 1990 to the middle of 1992, when the dollar started to strengthen. We know the dollar strengthened because the gold price, in dollars, started to drop below the PVE Gold Index indicating that the dollar’s purchasing power was increasing. But why did the dollar strengthen?

In 1992 the Brazilian real collapsed and capital in search of safety made its way, mainly, to the United States. The real was devalued to practically nothing; it was replaced by the new real on July 1, 1994. As a result of the Brazilian currency crisis the demand for US dollars soaked up US currency that would otherwise have been used for settlement of international trade. The dollar, therefore, increased not only against the real, but against many other currencies as well. Between 1992 and 1994 the dollar increased by about ten percent against the other currencies in the PVE Gold Index.

This increase in the dollar’s exchange rate on foreign currency markets is represented in the chart above by the decline in the US dollar gold price relative to the PVE Gold Index that started in 1992.

The Brazilian real crisis was hardly behind us when, in 1995, the Mexican peso dropped more than fifty percent against the dollar. This was the worst financial crisis in Mexico since the Mexican Revolution. More capital flowed into the United States, competing for dollars on foreign exchange markets and keeping the dollar strong.

Between 1995 and 1996 the Japanese yen lost about twenty-five percent against the dollar. More demand for dollars meant that the dollar continued to strengthen on foreign currency markets, further increasing the gap between the average, worldwide gold price and the US dollar-gold price. Japan set the stage for the big one, the Southeast Asian currency crisis.

Between 1996 and 1997, the Indonesian rupiah dropped seventy-six percent; the South Korean won fell fifty-six percent and both the Malaysian ringgit and the Philippine peso lost forty percent of their value against the dollar. This was a financial catastrophe and its effect was felt across the globe. Since the US dollar was performing well on foreign currency markets, thanks to the Brazilian, Mexican and Japanese devaluations earlier in the decade, a tidal wave of capital made its way to the United States.

Still shaken from the events of 1996 and 1997, Russia defaulted on its foreign debt in 1998, sending the ruble down seventy percent in just one year. In conjunction with the Southeast Asian crisis the mood is grim, and international capital pours into the US seeking refuge.

The increase in the US dollar following the Southeast Asian currency crisis crushed the US dollar-gold price and was large enough to be evident in the PVE Gold Index. The US dollar represents twenty-eight percent of the Index and contributed to the Index’ decrease of more than twenty percent during 1996 and 1997. As you can see though, the US dollar-gold price declined much more and for much longer.

When the euro was launched in January 1999 it collapsed almost twenty-five percent, on average (PVE Euro Index), and about thirty-five percent against the dollar. As if this was not enough, the Argentine peso had trouble in 1998; in 2000 it was the Turkish lira and in 2002 it was back to Brazil for another round.

As an aside, all the currency devaluations mentioned are examples of how the dollar’s exchange rate affects the US dollar-gold price. Even though the world is currently fascinated by the euro’s exchange rate as a leading indicator for the US dollar gold price we cannot ignore the impact of other currencies. Collectively, they could be more important.

The compounding effect of capital flight during all these currency crises can be seen in the increasing deviation between the US dollar gold price and the PVE Gold Index. The index is currently more than sixty percent higher than it was in 1990 while the US dollar-gold price has only recently recovered to its January 1990 level.

The dollar’s strength stemmed from the weakness in other currencies. It had very little to do with America’s productivity, or a “New Era”. Because most major currencies in the world had already devalued against the dollar it was obvious that the dollar could not continue to increase indefinitely. A PVE Dollar Index, using the same GDP-weighted currency data as for the PVE Gold Index, shows that the US dollar gained 112% from January 1990 to February 2002 (its peak) and has since declined by fourteen percent.

We have seen that the decline in the US dollar-gold price, and its under-performance relative to the rest of the world, is a reflection of the US dollar’s exchange rate. It is my belief that the US dollar gold price will again catch up with the PVE Gold Index as a result of continued weakness in the dollar to correct America’s enormous trade deficit. This correction of the dollar has only just begun and is likely to increase the US dollar-gold price by approximately thirty-five to forty percent more than the concurrent average increase in the gold price in other currencies.

Paul van Eeden

Paul van Eeden works primarily to find investments for his own portfolio and shares his investment ideas with subscribers to his weekly investment publication. For more information please visit his website ( or contact his publisher at (800) 528-0559 or (602) 252-4477.


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