How the Currency Market affects the Price of Gold and Silver

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There are many drivers of precious metal prices, such as global economic growth, supply and demand, inflation expectations, interest rates, production, geopolitical turmoil, etc. Having said that, one of the primary drivers of the prices of the two most popular precious metals gold and silver, that investors always need to keep an eye on, are movements in the global currency market.

Gold, silver and the US dollar

The US dollar is the base currency for both gold and silver. That means in the global commodity markets, both gold and silver are generally bought using US dollars. Therefore, if the dollar weakens, gold and silver become cheaper to purchase and their prices increase, whereas, if the dollar strengthens, it becomes more expensive for investors to buy gold and silver and, on average, their prices will drop.

While this partly explains the negative correlation between gold and silver versus the US dollar there is more to it. The key driver behind the value of the US dollar is the level of the US benchmark interest rate. This is because the more interest you are receiving for holding US dollars, the more people will exchange their money into US dollars. Hence, a rise in US benchmark interest rates, or an indication that an interest rate hike is near, will strengthen the currency. This in turn will weaken gold and silver, not only because it becomes more expensive to buy these precious metals, but also due to the opportunity cost of holding a non-interest bearing asset. If holding the US dollar pays you reasonable interest, then holding gold or silver becomes less attractive to investors as they do not pay any interest.

Gold, silver and the Aussie dollar

However, the US dollar isn’t the only currency that shows a correlation with precious metal prices. The Australian dollar and the price of silver have been known to show a positive correlation. This is due to the fact that Australia is one of the biggest producers of silver. Hence, when looking to invest in silver, keeping an eye in price developments of the Aussie dollar is very advisable.

The same goes for gold. As Australia is currently the second largest producer of gold, behind China, its currency correlates with the performance of the gold price. It is therefore not surprising that the Australian dollar is one of the most traded currencies at foreign exchange firms as it is the most popular commodity currency due to its strong links to gold and silver.

How the price of gold can affect currencies

While movements in the US dollar tend to have a strong negative correlation with the price of gold, the gold price can also affect movements in other currencies, especially those in emerging markets.

During times when a country’s domestic currency is weakening aggressively, central banks tend to buy gold to compensate for that drop in value. We were able to witness this recently, when the Malaysian ringgit, the Indonesian rupee and the Thai baht weakened heavily against the U.S. dollar. Their central banks and many emerging markets investors subsequently started to buy gold as a safe-haven investment against the local currencies, and because gold became an increasingly lucrative alternative, due to its strong rally during the beginning of 2016.

Furthermore, countries suffering from high levels of inflation tend to purchase gold as an inflation hedge. As gold can be bought and sold relatively easily it is sometimes seen as an alternative currency for countries with volatile currencies, hence it is a popular investment for many central banks.