Gold bugs have been forecasting a dollar collapse for years. They have been correct about the gold price, which has advanced nearly 400% in the past 12 years versus a gain of just 64% for the S&P 500. They were also correct about the dollar during the first phase of the gold bull market (2001-2008), when the USD index fell from 120 to around 72.
But the dollar did not continue to plummet after 2008 and indeed has held up remarkably well. The USD index has put in a series of higher lows over the past few years, showing strength against other currencies. But this strength is being tested once again as the index has fallen to critical support around the 80 level. While these tests of support are typically spaced out by several months, this will be the second test of support in the past month. Pressure on the U.S. dollar appears to be increasing and failure of support could ignite a massive decline.
Looking back to the start of the gold bull market, we see that gold and the dollar have maintained a fairly consistent inverse relationship. When the dollar moved up, gold moved down. When the dollar fell, gold pushed higher. The only major exceptions were 2005 and early 2010, when gold and the dollar moved higher in lockstep.
It is interesting to note that over the first 12 years on this chart, there was never been a prolonged period where gold and the dollar dropped together. This has changed over the past year.
When we zoom in on the chart, we can see a new anomaly in boxes 1, 2 and 3, whereby the gold price has been dropping alongside the dollar, rather than rallying. If we add together gold’s losses in these three boxes, we get a decline of nearly $300, despite a weakening of the U.S. dollar. Something is clearly out of whack as gold has failed to push higher against the backdrop of a lower dollar for the first time in over a decade.
Lastly, in box 4 we can see gold rising alongside the U.S. dollar for the first time since 2010. When combining these time periods, gold and the USD have actually had a positive correlation for a good part of the past 18 months.
I believe the anomaly is due to increased manipulation and use of HFT algos in the precious metals market. I don’t suspect that the positive correlation will persist, especially with the increasing spotlight on gold price manipulation. Additionally, fundamental conditions are becoming increasingly favorable for a major drop in the value of the U.S. dollar.
Next page: The dollar and trade