The Dollar Index and Gold

You have likely heard, or perhaps read when we have discussed, the phenomenon of the Dollar going up or down. Today we will look at what that means in world markets, and more importantly, what that means for the average American. The Dollar Index (DXY) is a measure of the value of the US Dollar, relative to a basket of foreign currencies. The basket currently includes the Euro, Japanese yen, Pound sterling, Canadian dollar, Swedish krona, and the Swiss franc. When the Dollar is rising, it means that its’ value relative to this basket of other currencies is rising. When the Dollar falls, the opposite is true. In times of turmoil, people have historically turned to the Dollar as a safe haven. But when the Dollar weakens, Gold is often a better defense against loss of purchasing power.

As the chart above indicates, we have recently seen new highs for Gold measured in numerous (73) world currencies. This is often viewed as a precursor for new highs in Gold measured in the Dollar as well, as the Dollar takes it’s turn in the race to the bottom. This occurred briefly in the summer of 2020, and I believe we will likely see this happen again in 2021. While there are some professional traders that try to mitigate the risks of a falling Dollar by trading currency indexes on the International Currency Exchange (ICE), this is not a practical solution for most Americans. In fact, research from 2020 indicates that 95% of those trading currencies do not succeed, with 80% of traders quitting within 2 years. This is in spite of all the technological advances and computer enhanced trading capabilities.

Sometimes it is hard to guess which currency is going to drop next.  Meanwhile, the owner of Gold has been protected against fiat currency drops for millennia.  This being the Christmas season you might recall the story of the birth of Christ, how He was born in a manger prior to a visit from the wise men from the East.  They brought gifts, one of them being Gold.  A less familiar part of the narrative involves an emergency trip to Egypt, for an indefinite period of time.  Herod the king put out an order to kill all children 2 yrs old and under, with Joseph and Mary fleeing with the child to save His life.  Scholars disagree on the length of time they lived in Egypt, until Herod died and they moved back to Judaea; most estimates range from 2-7 years.  It is believed that the Gold helped make this stay possible, or certainly more comfortable.  Gold was viewed then, as now, as a universal currency providing purchasing power in any location.

Some analysts have pointed out that other currencies have risen against the Dollar this year, and believe the Dollar may fall an additional 20% in 2021. Since many of these currencies have seen Gold reach new highs, it implies that perhaps Gold is the ultimate strong currency. The current value of DXY is lower than where it was following the stock market crash of 1987, from which it continued to fall further. In November of 1987 the index was at 95, and continued a downward trend to 84, reached in July of 1995. With the stock market currently near all time highs, DXY is at 90.2, and trending lower. In other words, the Dollar is currently weaker with a strong stock market, than it was in 1987 after the markets crashed.

This begs the question, what will happen to the Dollar if the stock market begins to falter now? If history is any guide, it may fall further. A year ago today, the Dow Jones Industrial Average stood at 28,551. Today it has reached 30,130, a gain of 6%. But while the market was climbing the Dollar index has fallen from 101 a year ago, to 90 today, for a loss of -11%. While those invested in the stock market would have more Dollars if they sold today than a year ago, those Dollars would be worth less, by -5% on the world stage. Conversely, Gold measured in Dollars has increased 28% since this time last year. Even with Dollars worth -11% less, there is a net 17% gain in purchasing power for those owning Gold. This phenomenon of rising stock markets vs decreasing Dollar values is explained more fully in this article from 2017, which includes a look at Silver.

One of the issues leading to a lower Dollar and higher Gold and Silver recently and in the days ahead has to do with the laws of supply and demand. All else being equal, when you increase supply, prices tend to come down. When supply is reduced, prices tend to go up. The supply of currency being created has been moving up drastically. As the chart from economist Mike “Mish” Shedlock shows, nearly 24% of all the Dollars ever created were created this year. The supply has increased. This helps explain why the Dollar index has fallen by 11% in the past year. Conversely, the supplies for Gold and Silver have remained consistent, with a likelihood of being constrained in the future.

The old argument about Gold paying a zero interest rate is no longer a detractor, but rather a positive in the current environment. As the chart below from Bloomberg financial commentator Lisa Abramowicz indicates, the current real yield of 10-yr US Treasury bond is -1.05%. This is partly due to the declining value of the Dollar. As is often the case, it is currently more advantageous to hold Gold or Silver paying zero interest, versus government bonds paying a net negative interest rate.

On that first Christmas season many years ago, Gold was part of the story. Not only because it was a beautiful and shiny metal, but because it was practical for a young couple living in uncertain times. As we think about the unexpected twists and turns that have defined 2020, Gold and Silver have helped lead the way forward. It appears that the unsettledness of 2020 will continue into the early months of 2021, with the election results still uncertain, and reports of new virus strains and shutdowns dominating headlines. I believe we will see precious metals continue to lead the way, as pressures mount for fiat currencies worldwide.