How the Currency Market affects the Price of Gold and Silver

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.

This post was published at GoldSilverWorlds on July 27, 2016.