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Understanding the relationship between USD and Gold

Understanding the relationship between USD and Gold

Since its discovery in the Stone Age, gold is still an asset in modern society. Even though it has stopped circulating as a primary means of currency, gold continues to strongly influence the values of various currencies trading on foreign exchanges.

Until as late as the 70s, governments, including the USA, used to back their fiat money with gold bullions. With the Gold Standard, countries agreed to back their paper money with fixed units of gold. A country with a gold standard conducted transactions with gold with a fixed cost per unit. That fixed price is what set the value of currency.

All countries in the world hold gold as a foreign exchange reserve but it’s not really used to back paper money anymore. In foreign markets, gold is priced in US Dollars. The USD is the benchmark pricing mechanism for gold, which is why the relationship between gold and USD is so interesting.

Gold and USD share inverse relation. When USD weakens against other currencies, value of currencies of other countries increase and this increases demand for commodities like gold. Increase in demand for gold causes increase in price of gold.

Gold’s intrinsic value and limited supply guarantees that it retains value better than paper money and leads to an increased demand. Gold is considered as ‘safe haven’ and hence during uncertain market conditions or economic crisis, investors prefer gold as an asset class and hence prices of gold go up. While it is popularly understood that the prices of gold and the value of USD are inversely related, it is not always true. There have been instances where the USD and gold have grown together.

Additional Read: Why Gold is a Safe Investment Tool in an Economic Crisis

An increase in demand for gold strengthens the currency of the country that exports it. As long as a country is a net exporter, that is, it exports more than it imports- the value of its currency will continue to increase. Conversely, when a country spends more money on imports than it gains from exports, its currency value will decline.

When central banks purchase gold, they print currency to purchase gold, causing excess currency in circulation, which may lead to inflation and weakening of currency in their own country.

In India, the consumer demand for gold is tied to the culture around it. For Indians, gold symbolises wealth and financial protection, amongst other things. The demand rises during festive events and the purchasing power for it is otherwise consistent and growing. About 60% of gold in India is purchased and circulated in rural India.

Gold in India

Young investors also are attracted to investment schemes with gold as an underlying asset. While equity investments continue to be volatile because of their market dependence,  gold as a commodity provides a relatively stable growth rate despite it’s fluctuating price in the short-term. It is important to understand the relationship between gold and currencies while investing in such instruments.

Additional Read: Why is everyone buying Gold?

Tata Capital Wealth Management recognises the value of intelligent investments that generate wealth over time. With the wealth management plan, you can access bespoke solutions for investing and protecting this wealth against volatility. This includes a variety of promising instruments and gold-related investments, like gold mutual funds as well as gold exchange-traded funds.

Build Your Wealth with Expert Guidance from Tata Capital!

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