The euro
January 12, 2004

The euro has become quite the buzz in the gold market. No wonder, look at the close correlation between the dollar-euro exchange rate and the gold price in US dollars, shown on the chart below.

Such a close correlation is not a coincidence. The major driver behind the changes in the US dollar gold price since 1996 is nothing other than change in the US dollar exchange rate, which explains the correlation between the dollar gold price and the dollar-euro exchange rate.

The euro, as we all know, had a rough start. But that was probably more due to the fact that its launch happened to coincide with a feverish demand for US dollars than to anything else. The dollar was gaining against almost all currencies, and its momentum was too much for the new euro to deal with. This caused the euro to decline by 29% against the dollar from January 1, 1999 to October 25, 2000.

The demand for US dollars was also what caused the gold price decline from February 1996 to April 2001. You can see the dollar’s influence on both the euro and the gold price by noting that the rate of decline for both is the same, except for the spike in the gold price in September 1999 when the Washington Agreement was announced. If you remove the effect of the Washington Agreement on the gold price, the euro and gold mimic each other almost perfectly over a period that spans five years.

The euro is obviously not a commodity. It is clear from the chart that gold’ behavior is identical to that of the euro, the world’s second largest currency by GDP. We have seen before (see archives) that the price of gold does not respond to changes in net investment demand for gold, producer hedging, central bank sales, or other metrics that should have an impact on its price if it were a commodity. Therefore it is obvious that gold is not behaving as a commodity. It is, however, behaving like a currency, which is not surprising since gold is, after all, money.

As mentioned, the euro’s initial decline was mainly due to the dollar’s momentum. Fundamentally I am not a fan of either the euro or the dollar, since both are fiat currencies and therefore ultimately doomed. The euro is actually a worse currency than the dollar because of the diversity of Europe compared to the United States. But in the short to medium term, the euro is likely to continue to do well, not only against the dollar, but against most other currencies for the simple reason that the euro is replacing a portion of reserve assets currently held in dollars. It makes sense for countries that trade with both Europe and the United States to hold euros and dollars in proportion to the relative trade balances with each economic block. The dollar’s monopoly as the main reserve currency in which almost all trade, including all oil purchases, is settled, is slowly being dismantled and this will continue to put pressure on the dollar and boost the euro, for many years to come.

The expansion of the European Union is a built- in guarantee that the euro is going to continue to do well in the short term because any country joining the Union will automatically settle trade with other Union members with euros.

This does not mean that the euro cannot decline, or that the dollar won’t rebound in the short term. We have to distinguish between long-term trends and short-term volatility. In the short term anything is possible, and the euro will take a knock every now and then, and the dollar will get a B-12 shot from time to time. However, looking out five or ten years, I think it’s a safe bet that the dollar will continue to weaken and the euro will continue to strengthen.

As the chart above shows, the decline in the euro from January 1999 to June 2002, and the relatively stable gold price during the same time, implies that the price of gold in euros should have increased during those two and a half years, which it did, by 42%. As a corollary, the strength in the euro, in perfect step with the increase in the gold price since 2002, implies that the gold price in euros is no longer increasing. Since June 2002, the gold price in euros in fact dropped 4%, while the gold price in dollars increased by 31%.

Let me say it again: the decline in the price of gold from 1996 to 2001 was due to the strength of the US dollar on foreign exchange markets. The increase in the gold price since 2002 is, similarly, due to weakness in the dollar. What is currently being perceived as a bull market in gold is, in reality, only a bear market in the dollar. It is a dollar phenomenon: the price of gold in euros, as we have seen, has not increased since June 2002. Neither has the price of gold in South African rands (down 15% since June 2002) or Australian dollars (down 3.5% since June 2002), two of the largest gold producing countries in the world.

For all the talk about the cabal losing control, or the shortfall between mine supply and fabrication demand, or swings in net investment demand for gold, or concern about the world’s monetary system collapsing because it’s based on a fiat currency (the dollar), the evidence suggests that gold is merely maintaining its purchasing power. That is to say, gold is doing what it has done for centuries: acting as a store of wealth.


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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