Uncoupling of the gold price
June 16, 2005
I was in Vancouver over the weekend attending an investment
conference. Several speakers seemed to be very excited that gold was finally
moving up coincident with a strengthening dollar.
As a consequence of having floating exchange rates the gold
price should always reflect changes in the exchange rate of the currency
it is measured in. But to get a sense of a currency’s movements
it is dangerous to look at just one exchange rate, such as the dollar-euro
rate for example. Ideally, all exchange rates should be used, and in practice
we should use several exchange rates to define a currency’s movements.
It may seem that gold has momentarily decoupled from the dollar-euro exchange
rate but the move in gold over the past few weeks should not be taken
out of context.
Let us look at the dollar, the euro and the gold price in
both currencies for a bit. I am going to post all three charts one after
the other, so we can easily compare them with each other, and then analyze
In the first chart we see that the euro fell quite dramatically
from January 1999 until around the first quarter of 2002. The second chart
confirms that the gold price in euros increased by the amount expected
(1) if the gold price in other currencies was relatively stable and, therefore,
that the increase in the euro-gold price was purely due to the devaluation
of the euro. Looking at the third chart we can see that the gold price
in US dollars, as an example, was in fact relatively stable from January
1999 to the first quarter of 2002. There is no doubt that the increase
in the euro-gold price during that time was merely a reflection of weakness
in the euro.
Now, if we look at the first chart again we can see that
the euro performed very well against the dollar from early 2002 until
the first quarter of this year. We also see from the second chart that
the gold price in euros was relatively stable during that time. The third
chart confirms that the gold price in US dollars increased in direct proportion
(2) to the fall of the dollar, as measured by euros.
So what did we learn? The gold price from 1999 to 2002 was
stable in dollars, reflecting stability in the dollar itself, and increased
in euros as a result of weakness in the euro. From 2002 to earlier this
year the gold price was stable in euros, reflecting stability in the euro,
and increased in dollars as a result of weakness in the dollar.
Since April of this year, however, the euro has come under
pressure as first France and then the Netherlands voted against ratifying
the proposed European Constitution. Selling pressure on the euro caused
that currency to decline almost 8% against the dollar and, as expected,
the gold price in euros increased by almost exactly (3) the correct amount:
So, yes, the gold price has made a new high against the
euro but that is a direct result of weakness in the euro, just as happened
from 1999 to 2002. It does not imply anything more than that.
If you look very, very carefully at the third chart you
will notice that there was a small increase in the US dollar-gold price
during the past two weeks (the up-tick on the far right-hand side of the
chart). That is what got some people excited. The fact that gold increased
against both the euro and the US dollar is taken as a sign that a new
bull market in gold has finally commenced, and that the gold price will
now rise against all currencies. I doubt it. Yes, the gold price may one
day decouple from exchange rates and rise in all currencies. We would
call that a bubble, but one is not evident yet.
Given how many people asked me to address the increase in
the gold price in both euros and dollars, and in light of all the chatter
about a bull market in gold where the metal’s price rises in all
currencies, it is worthwhile to point out that the price of gold is by
definition dependent on currency exchange rates. It is a consequence of
floating exchange rates, no more, no less. It is why gold is an excellent
way to protect your capital from a devaluation of your local currency.
It worked during every currency crisis in the 1990s, it worked for Europeans
from 1999 to 2002 and it has worked for US residents for the past five
The increase in the US dollar-gold price of the past two
weeks is insignificant. I would not pin my hopes on a measly two percent
increase in the US dollar gold price. The gold price is unlikely to uncouple
from exchange rates any time soon.
The US dollar will continue to benefit from the uncertainty
surrounding the European Union and the euro. If the euro remains under
pressure the gold price in euros will continue to rise but that does not
mean the gold price in dollars, or any other currency for that matter,
will also rise. Until we see the dollar start to lose ground against the
Asian currencies, especially the yen and the renminbi, the gold price
in US dollars is likely to remain flat or even decline. But once the dollar
starts to lose ground against the yen and the renminbi we should see the
gold price increase significantly in US dollars, to over $700 an ounce
by my calculations.
Paul van Eeden
The euro fell from $1.17 in January 1999 to $0.87 in February 2002. That
is a 26% decline. One would therefore expect the gold price (or anything
else with a stable price that is bought with euros on international markets)
to increase by 35%: 100 – 26 = 74 and (100 – 74)*100/74 =
35%. The gold price in euros actually increased by 38% from January 1999
to February 2002. The difference between an expected 35% increase and
an actual 38% increase is statistically insignificant. The conclusion
is therefore that the rise in the euro-gold price from 1999 to 2002 was
due to the decline in the euro exchange rate.
Looking at the first chart, it appears that the euro strengthened from
$0.87 in January 2002 to $1.35 in March 2005. In reality, though, the
dollar weakened while the euro remained stable. This is seen in chart
2 by the fact that the gold price was stable in euros during that time.
The inverse of 0.87 is 1.15 and the inverse of 1.35 is 0.74. Therefore
the dollar fell from 1.15 against the euro to 0.74 against the euro, a
36% decline. Accordingly, the gold price in US dollars should have increased
by 56% from February 2002 to March 2005 if the increase was purely due
to the fall of the dollar on foreign exchange markets: 100 – 36
= 64 and (100 – 64)*100/64 = 56%. In January 2002 the gold price
was $280 an ounce and in March it was $440, a 57% increase. Again, the
difference between 56% and 57% is insignificant. The increase in the gold
price in US dollars from 2002 to 2005 was due to nothing other than the
weakness in the US dollar.
100 – 8 = 92 and (100 – 92)*100/92 = 9%. We could have expected
the gold price to increase slightly more than it did: 9% instead of 8%.
However, once again, the difference between the calculated increase in
the gold price and the observed increase in the gold price is statistically
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