On yesterday I mentioned once again that gold is inversely related to the dollar. Since I keep harping on this point, I thought an example might be helpful to illustrate the relationship. This may bring back some bad flashbacks from math class, so if you really don’t care of the “why” – just remember that gold and the dollar move inversely to each other and that will put money in your pocket.
Gold is priced in US Dollars (USD). So, if it is currently selling at 640 USD/oz – it requires the exchange of 640 USD for 1 ounce of gold anywhere in the world. Thus owners of non US Dollars must exchange their currency for USD to purchase gold. This happens behind the scene and is transparent to the purchaser. Therefore by definition the price of gold is linked to foreign exchange rates.
So, if the current USD to Euro exchange rate is
1 Euro equals 1.32 USD
10,000 Euro equals 13,200 USD
If Gold sells for $640/oz a person with 10,000 Euro would be able to purchase 20.625 ounces of gold.
If the dollar weakens its purchasing power decreases. In other words, a candy bar in Europe that cost 1.32 USD may now cost 1.50 USD. So, let’s assume the dollar weakens
1 Euro equals 1.50 USD
10,000 Euro equals 15,000 USD
If the price of gold remains 640 USD/oz – investors holding Euro can purchase more ounces for the same amount of money.
10,000 Euro can now purchase 23.4375 ounces of gold. (15,000E / 640 USD/Oz)
So, investors holding Euros receive a gift simply by the dollar weakening. Just like any savvy consumer, they would recognize a bargain and buy more. This buying activity drives the price of gold back to its equilibrium point 10,000 Euros buying 20.625 ounces.
That translates into a price of 727.27 USD/oz
(1.50 USD / 1 Euro * 10,000 Euro) / 20.625 oz
The price moving back to its equilibrium point happens almost instantaneously. There are some people out there known as arbitragers that try to take advantage of the discrepancy. Most without sophisticated computer set-ups don’t have a chance.
That’s the math behind the relationship. The inverse is also true. I will leave the proof to you. The question to ask yourself – Will Congress continue to spend more money than it brings in? Their reckless spending puts downward pressure on the dollar. Dollar goes down – price of gold goes up. Now let’s make some money!