Gold price movements are important for currency traders to understand. Gold acts in many ways as a surrogate currency. It becomes a “safe haven” basket when money moves out of the dollar in response to geopolitical crises. In this article, we’ll explore why gold is so important for currency traders and how they can use it to inform their trading decisions.
Gold as a Gauge of Market Fear
Gold prices are a gauge of market fear. In times of geopolitical crises or economic uncertainty, investors often move their money out of the dollar and into safe haven assets like gold. This kind of price reaction in crises makes gold prices a valuable indicator for currency traders. For example, during the Russian intrusion in Crimea in March 2014, gold prices spiked on initial reactions and then retraced. Similarly, gold prices spiked in reaction to the European Central Bank’s massive quantitative easing program where the ECB announced plans to purchase $60 billion euros per month. In this case, gold traders looked to protect against devaluation of the currency.
Understanding Gold Price Movements
Traders need to understand the reasons gold prices move and whether it’s a fundamental event, such as a change in inflation expectations, or a geopolitical event. Gold is also a commodity on its own, adding strength or weakness to currencies of countries that produce gold. South Africa, of course, is the leading producer of gold, but its currency, the rand, is not floating. Traders can look to the Australian dollar and the Canadian dollar for trading those currencies; when gold is in the news, it is important to spot-check the co-movements of gold and the AUDUSD and detect whether they are moving in the same direction. If they are diverging, it is most likely temporary.
Viewing Gold as a Cross Pair
A more useful way of looking at gold from a trader’s perspective is viewing it as a cross pair. In effect, it is USD/gold. Deciding on gold direction requires understanding US dollar direction. If the dollar is strong, then gold will be weaker, and vice versa.
The Role of Central Banks
Central banks have an important role regarding gold. They hold gold as part of their reserves, which helps to stabilize the currency markets. The World Gold Council estimates that at the end of 2013, central banks held around 30,500 tonnes of Gold, which is approximately one-fifth of all the gold ever mined. The European Central Bank is estimated to have about 26 percent of its assets in gold. Gold traders need to follow news on central bank buying of gold. For example, Russia is reported by Reuters to have purchased 150 tonnes, which is reported to be about one-third of the total global central bank in 2013.
The Impact of Central Bank Gold Reserves on Currency Prices
The key variable that can affect currency prices is whether a central bank will increase its gold reserves and thereby decrease its reserves of dollars or another currency. As a result, traders should monitor rumors of central banks increasing gold reserves because such rumors can disrupt currency prices.
Conclusion
The idea that gold is important to currency moves is sound, but needs to be qualified and put in the context of world events. Sometimes gold acts as a store of value in times of crisis. But the correlations between gold moves and currency moves provide a great deal of variation. The trader needs to be vigilant regarding what factors are moving gold. At the end of the day, in the words of Phillip M. Hildebrand (member of the Governing Board, Swiss National Bank), “the yellow metal continues.”