Why Gold & Dollar Index are drifting apart?
Why Gold & Dollar Index are drifting apart?
Gold and Dollar Index’s 8-Year Cycle since 1971
Since the collapse of the Bretton Woods system in 1971, which unpegged the U.S. dollar from gold, both gold and the U.S. Dollar Index (DXY) have exhibited cyclical patterns. Notably, they tend to follow an 8-year cycle of alternating strength and weakness, often moving inversely to each other.
a)????? Gold Cycle: Gold prices tend to rise during periods of inflation, geopolitical uncertainty, or when the dollar weakens. The 8-year cycle often aligns with phases of economic instability, such as the 1980s inflation crisis, the 2008 financial crash, and recent concerns over fiat currency devaluation.
b)????? Dollar Index Cycle: The DXY, which measures the dollar's strength against a basket of major currencies, also follows an 8-year pattern. During periods of U.S. economic strength or rising interest rates, the dollar strengthens, often corresponding with a decline in gold prices, as seen in the early 1980s, mid-1990s, and 2014-2021.
These cycles reflect broader global macroeconomic trends, including shifts in monetary policy, inflation, and geopolitical risks.
Why Gold & Dollar Index are drifting apart?
Gold and the U.S. Dollar Index (DXY) are drifting apart due to several macroeconomic and geopolitical factors, despite their historically inverse relationship. Here's why:
1. Diverging Economic Conditions:
i.??????????? U.S. Dollar Strength: The Dollar Index has remained strong due to higher interest rates, aggressive monetary tightening by the U.S. Federal Reserve, and a robust U.S. economy compared to other global economies. Higher interest rates attract foreign capital, boosting the dollar but making non-yielding assets like gold less attractive.
ii.??????????? Global Economic Uncertainty: Gold, traditionally a safe-haven asset, is driven by fears of inflation, geopolitical tensions, and currency instability. Despite the dollar's strength, concerns about global recession, rising geopolitical risks (e.g., Ukraine war), and inflation have kept gold prices relatively resilient.
2. Inflation & Real Interest Rates:
i.??????????? Gold as an Inflation Hedge: While central banks globally are raising rates to combat inflation, inflation levels remain high, which typically boosts demand for gold as a hedge.
ii.??????????? Real Yields: Even with higher nominal interest rates, inflation-adjusted (real) interest rates are low or negative in many economies. This environment makes gold more attractive, while the stronger dollar draws demand for dollar-denominated assets.
3. Geopolitical Risks: Ongoing geopolitical risks, including tensions with Russia and China, have driven gold's appeal as a store of value, even as the dollar benefits from its status as the global reserve currency. Both assets are reacting to different facets of risk, keeping them from aligning as they have in the past.
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4. Central Bank Buying of Gold: Central banks, especially in emerging markets, have been buying gold to diversify reserves away from the dollar, partially in response to sanctions and currency risks. This supports gold prices, even as the dollar remains strong.
5. Decoupling of Inflation and Dollar Policy: Inflation-driven gold prices are no longer as tightly linked to the dollar as before because of global inflationary pressures not directly tied to U.S. economic performance. The dollar can remain strong due to U.S. monetary policy, while inflation worries elevate gold prices globally.
The divergence between gold and the Dollar Index stems from a mix of inflation dynamics, central bank policies, geopolitical tensions, and global financial uncertainties, which are pushing both in different directions despite their historical inverse relationship.
Since President Nixon abandoned the Bretton Woods system and the gold standard on August 15, 1971, the U.S. dollar has followed a distinct cycle, averaging 7.4 years, until the Global Financial Crisis (GFC). As shown in the attached chart, there were five clear cycles during this period, with the dollar index fluctuating more than 50% from peak to trough. However, the GFC and the era of Quantitative Easing (QE) that followed disrupted the last bull cycle in the dollar.
The dollar likely peaked in late 2022, coinciding with the Federal Reserve’s shift to Quantitative Tightening (QT). Now, with the Fed signaling a transition towards an easing cycle, it's more probable that we have entered a dollar bear cycle. This shift aligns perfectly with the beginning of a bull market in commodities, as a weaker dollar tends to support higher commodity prices.
This trend is particularly evident in the price of gold. After we identified a bottom for gold at the $1,600 level in March 2020, the metal has not fallen below that level. Despite a period of consolidation, gold has remained in a clear uptrend, now challenging the $2,700 level. Gold has surged by over 25% this year and has even outperformed the S&P 500.
Key Drivers of Gold's Rise:
Several factors are fueling gold's rally:
1.?????? U.S. Fiscal Recklessness: Increasing deficits and debt levels are raising concerns about the long-term stability of the U.S. dollar.
2.?????? Global Money Printing: Central banks worldwide continue to print money to support economies, devaluing currencies and increasing the appeal of gold as a stable asset.
3.?????? Seizure of Russian Assets: The U.S. seizure of Russian assets has raised concerns about the safety of foreign reserves held in U.S. dollars, prompting countries to diversify into gold.
4.?????? Geopolitical Risks: Ongoing geopolitical tensions, including the Russia-Ukraine conflict and broader global instability, are boosting gold’s safe-haven status.
5.?????? Central Bank Buying: Central banks, particularly in emerging markets, have been accumulating gold at record levels. This concerted buying could signal a shift towards a new financial order where gold plays a more central role, as it carries no counterparty risk.
Gold traditionally trades inversely to real interest rates, and as we discussed in the last report, real rates are now declining. This creates further upside potential for gold. Its safe-haven appeal, coupled with ongoing macroeconomic uncertainties, indicates that both gold and silver are likely to continue their upward momentum.
In light of these developments, it is plausible to think that gold may be positioning itself as a key player in a changing global financial landscape, driven by central banks’ actions and rising demand for assets without counterparty risk.