US Dollar Correlation to Gold Signals Risk to Longer-Term Trend

The correlation between the US Dollar and Gold prices has picked up considerably as of late, as a fear of excessive US fiscal and monetary stimuli have increased the lure of gold as a hedge against dollar weakness. In fact, the 20-day rolling correlation between the Euro/US Dollar and COMEX Gold futures now stands near record-highs after having fallen near all-time lows earlier this year.

Though any statistician can tell you that correlation does not imply causality, the strong link can hardly be cast away as a spurious coincidence. The earlier breakdown in the Euro/US Dollar-Gold correlation was arguably a function of the resurgence in the US Dollar as a safe-haven currency. As markets back away from excessive US fiscal deficits and oversupply of US Treasury bonds, the US Dollar could potentially suffer over the medium-to-long term.

On a shorter-term basis, risk-averse investors have kept short-term US Treasury rates at incredible historic lows. 1-Month Treasury Bills now yield an absolutely miniscule 0.06% annual return. Investors are sure enough that the US Treasury can meet its obligations through the very near-term, but ballooning yields (and dropping prices) on 10 and 30-year bonds emphasize investors’ shaken confidence in Treasuries and the US Dollar.

Markets typically view the steepness of the yield curve (spread between short and longer-dated interest rates) as a sign of market growth expectations. The yield curve is typically at its steepest when short-term interest rates are low but markets expect economies and yields to return to their longer-term potential. In 2003 we saw the 2-10 Treasury yield spread hit its highest in at least three decades. Such a steep yield curve signaled that markets expected the US economy to recover and that the US Federal Reserve would need to raise short-term rates.

Yet the more recent steepening of the yield curve has been far from what we saw from 2001-2003. In this case, we believe such steepening is driven more by fear than by medium-to-long-term growth expectations.

US Treasury Yield Spread: 10-Year Bond vs 2-Year Note Monthly Chart

Such dynamics may not be especially market-moving on a shorter-term basis, but it is a key US Dollar risk to keep in mind in the coming months and years of forex trading. In other words, other more market-moving factors are likely to hold greater influence over the Euro/US Dollar exchange rate through the coming days and weeks of trading.

Forex Correlations Summary

Forex correlations against Oil, Gold, and the Dow Jones Industrials Average for the past 30 calendar days:

Written by David Rodriguez, Quantitative Strategist for
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