How Does Gold Affects the Forex Market?

Gold and Forex… Have you ever considered there might be a correlation between these two? No? Well, it may seem unlikely if you are hearing about this for the first time, but there is a correlation between fiat currency and gold prices.

And, SPOILER ALERT: the forex market and gold mesh pretty well!

Ready to find out more and explore how gold affects the forex, fiat money, and central bank policy decisions? Read on!

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Why Purchase Gold With Fiat Currency?

First and foremost, gold is one of the most heavily traded commodities worldwide. Why? There is a multitude of reasons for this, including gold’s scarcity, utility, and desirability.

Its price fluctuations significantly impact three major currencies: the USD, AUD, and CHF.

Utility

Gold’s ductility and luster make it a sought-after medium for jewelers and artisans around the globe. In addition, bullion serves a variety of purposes, from applications as precious metal superconductors to gold coins.

Given the yellow metal’s utility, it has a steady demand from the art, jewelry, and industrial sectors.

gold trading, forex

The need for gold reserves

Gold is an inherently scarce commodity. In fact, the world’s supply is believed to originate in a meteor shower that took place billions of years ago. As an “extraterrestrial element,” gold is not readily cultivated. Reserves are found deep within the Earth’s crust and require vast resources to bring to market.

Due to the rare nature of gold, many central banks and governments stockpile bullion as reserves. Reserves can be used as collateral or as backing for a country’s currency (see gold standard).

Desirability

Traders believe that gold reflects the condition of economic and political stability. Thus, during times of crisis, traders and investors tend to seek safe-haven assets such as gold. Amid periods of geopolitical or financial tumult, many flee from paper money for the relative safety of bullion.

Conversely, in times of economic prosperity and political stability, the opposite is true. Gold investors seek higher profits in other, more profitable markets such as forex. 

However, no matter the economic cycle, gold has never been worthless! Gold prices have always been north of zero – that’s a fact!

The USD and Gold Prices

Generally, when the US dollar goes up, the value of gold falls. On the other hand, as the price of gold rises, the value of the USD falls. This is a broad generalization, but it does establish a basic inflationary/deflationary relationship between the gold price and the value of fiat currencies.

As the world’s reserve currency, the USD was once privy to the “gold standard.” The gold standard is a term used to describe fiat currencies (paper money) that are pegged to the value of gold. The United States was on the gold standard from the signing of the Bretton Woods Accords (1945) until the early 1970s.

The XAU/USD

So where can you see how the value of Gold is changing in comparison to the USD? It’s pretty simple: the XAU/USD. The XAU/USD is a very special forex currency pair that compares gold (XAU) to the US dollar (USD). Thus, the pair is called the XAU/USD.

The XAU/USD tells traders how many US dollars it costs to purchase one ounce of gold. Although all national currencies may be paired to gold, the XAU/USD is the most frequently referenced. Why? Because the USD is the world’s leading reserve currency that is held by central banks. So, gold prices are commonly denominated in USD on the global currency markets.

The XAU/USD is an interesting currency pair to trade! Ask any trader and they’ll tell you about the massive liquidity of XAU/USD. It’s not unreasonable to call the XAU/USD the gold standard of the forex! (Excuse the pun…)

Now, how does gold affect major currency pairs in Forex? Let’s explore. 

Gold vs AUD/USD

Australia has a strong reputation as being one of the world’s largest producers of bullion. This means that the Australian economy relies heavily on how it exports gold to the rest of the world. So, it’s not a quantum leap to understand that Australia’s domestic currency (AUD) is impacted by the nation’s commitment to export gold.

A picture is worth 1000 words. Let’s place gold and AUD/USD side by side on the same chart and see if there are any correlations.

gold, forex market, currencies

Can you see how they move together? That’s because gold has a positive correlation with the AUD/USD. So, if the value of gold goes up, so does AUD/USD; if the value of gold goes down, so does the AUD/USD. While this relationship isn’t the product of a central bank peg, it is at least an informal gold standard.

Remember, this correlation is due to various factors, namely Australia being the third biggest gold producer worldwide. Each year, AUS miners dig out more than $5 billion worth of bullion. This is a staggering valuation and one that impacts the country’s currency on an ongoing basis.

Historically, the AUD/USD has had a massive correlation of 80% to the price of Gold!

80%!!! 

That’s too big of a percentage for it to be a coincidence… 

However, for the skeptics out there (and we love you for that), let’s compare gold to another major currency pair… Perhaps the Swissy? 

Gold vs USD/CHF

Yup, that’s right. There’s a correlation between the Swiss franc (CHF) and gold. But, it’s not free sailing like AUD/USD. In fact, gold has a negative correlation with USD/CHF.

A negative correlation in asset pricing alludes to two (or more) assets having an inverse relationship. In the case of gold and the CHF, it means that if gold prices go up, the value of USD/CHF moves down. And, if gold prices fall down, the value of USD/CHF goes up. Think of this relationship as sort of an “inverse gold standard.”

Again, USD/CHF/XAU relationship may be due to a number of different reasons. One worth mentioning, however, would be the fact that over 25% of the Swiss franc is backed by gold reserves. So, the CHF fiat currency is in part on a version of the gold standard.

One could say that Switzerland is the global hub for the gold industry and most of the gold in the world passes through Switzerland. So, the country imports gold and 1/4 of the country’s currency is backed by gold. Isn’t that amazing?

How Gold Affects Currencies

Even if you do not want to trade or purchase gold, it might be worth keeping an eye on it from time to time. You can check its movements against the world’s fiat currency here.

In the meantime, just remember that the price of gold is negatively correlated to the USD and positively correlated to the CHF and AUD. And, the relationship between gold and major currency pairs is just one of the many that we will tackle throughout this level. 

Summary

If you’re trading currencies, don’t forget about gold! It’s a barometer of economic performance, as well as being a bonafide safe-haven asset. Bullion’s impact on the forex is profound, especially upon countries that import, export and stockpile the yellow metal.

As we said earlier, gold has never been worthless! Be sure to keep an eye on this exciting market as you trade forex.