How a Falling Dollar Affects Gold

Statements by Chairman Ben Bernanke on April 27 shouldn't have surprised investors. Following the Federal Reserve's press conference, the Fear Trade continued full speed ahead. Gold hit a new high while the dollar fell further.

As gold investors know, the metal has historically been negatively correlated with the dollar, meaning when the greenback is weak, gold tends to be strong. That correlation is reaching an extreme, widening substantially over the last year.

The Fed's announcement that it will continue its quantitative easing through June 2011 while keeping interest rates low was the driving factor weighing on the dollar. This is in contrast to the rest of the world where central banks have begun to increase interest rates in an effort to curtail inflation. In addition, the significant budget deficit facing the US will most likely continue to keep the dollar depressed while supporting the price of gold.

A weak dollar has been beneficial to more than gold investors. Emerging market stocks have been increasing as their countries' currencies grow stronger. US companies - particularly those in healthcare, energy, materials and technology sectors - with a footprint in the global marketplace, find their goods more competitively priced when the dollar is low. For example, the weak bill helped IBM exceed its earnings on income during the first quarter.

The Wall Street Journal, in an article about the dollar's effect on US exporters, called this tailwind, "a bright spot in the otherwise slow economic recovery." In other words, the weaker currency can help drive the US recovery.

While inflation and the deficit will need to be addressed in the next year, investors can offset potentially higher costs by making sure they participate in the areas of the market that are likely to continue to benefit from the declining dollar.

(Read previous posts addressing the fear and love trade of gold: Stay Focused Gold Investors and Outlook 2011: Fear and Love in Gold Trading.)

Frank Holmes is CEO and chief investment officer of U.S. Global Investors. This first appeared in his Frank Talk blog.

None of US Global Investors family of funds held any of the securities mentioned in this article as of 3/31/2011. The Comex is a commodity exchange in New York City formed by the merger of four past exchanges. The exchange trades futures in sugar, coffee, petroleum, metals and financial instruments. The US Trade Weighted Dollar Index provides a general indication of the international value of the US dollar.

About the Author
Frank Holmes

Frank Holmes is CEO and chief investment officer of US Global Investors. This first appeared in his Frank Talk blog. For more updates on global investing from Frank and the rest of the U.S. Global Investors team, follow on Twitter at www.twitter.com/USFunds or like on Facebook at www.facebook.com/USFunds. You can also watch exclusive videos on what research overseas has turned up on the U.S. Global YouTube channel at www.youtube.com/USFunds.

US Global Investors, Inc. is an investment management firm specializing in gold, natural resources, emerging markets and global infrastructure opportunities around the world. The company, headquartered in San Antonio, Texas, manages 13 no-load mutual funds in the U.S. Global Investors fund family, as well as funds for international clients.

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