Gold is more than just a precious metal. It is a symbolism for wealth and status not just among individuals but also across nations. There’s a notion that when one acquires gold, it can provide financial security. However, there’s more to gold than just being a valuable commodity, because it has an impact on forex as well. In other words, the gold prices, like all prices in general, reflect not only the inherent value of gold, but also the relative strength of the currency in which it is quoted.
Gold is a leading economic indicator, and the changes in gold prices can explain investor sentiment about the state of the U.S. and world economies. An increase in gold prices typically signals that the U.S. economy is struggling. Factors that contribute to an increase in the price of gold include a weak dollar, an increase in inflation and low interest rates over the long term. Individuals interested in investing in gold should understand the relationship between the price of gold and the forex market.
The U.S. dollar is considered the world’s reserve currency, and an inverse relationship exists between gold and the dollar. As the dollar weakens, the price of gold increases and vice versa. The dollar is considered strong or weak in comparison to its trading against other currencies. For example, when the dollar is weak against the Japanese yen, it means that the dollar is exchanged for a decreasing amount of yen than in the past. As the dollar continues to weaken against foreign currencies, investors lose confidence in the dollar and invest more money in gold.
A crisis in another currency while the dollar remains stable can drive the prices of both gold and the US dollar as foreign investors use both as a safe harbor. The history of the currency’s relationship with gold, and particularly the manner in which the gold standard had to be temporarily abandoned during wars and depression in the past can indicate the types of situations that will trigger the instinct to turn to gold and bring the inverse relationship into play, thus opening up investment opportunities.
An advantage of investing in gold is that it protects a diversified portfolio from experiencing substantial losses in a volatile economic climate. Investors with a portfolio of diversified assets may experience a decline of certain stocks and bonds and an increase in the price of gold in a struggling economy. A disadvantage of investing in gold is that gold prices are affected by speculators involved in day trading, which can make gold prices volatile.