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Stronger Dollar Pushes Down Oil and Gold?

by: Tim Iacono September 07, 2008 | about stocks: GLD / OIL / UUP    

Tim Iacono

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Time and again you hear things like, "In commodity markets today, a stronger dollar pushed oil and gold lower...", and everyone seems to accept that relationship as if it were somehow a law of nature. As if it were causation rather than correlation.

But does it make any sense?

The commonly heard explanation is that commodities such as crude oil and gold are denominated in dollars on commodity exchanges around the world, so when the dollar strengthens against other paper money, these commodities become more expensive in terms of other paper money, making them less appealing.

But does this even make any sense?

While it may be true over a period of hours or days, over weeks or months, it is certainly not true. For example, if you bought an ounce of gold on August 1st using euros, this would have cost you 590 euros, since gold sold at about $915 per ounce and one euro could be exchanged for $1.55.

At the moment, that same ounce of gold would cost just 560 euros ($800 per ounce with the euro at $1.42) meaning that since the time that European traders sold gold because it was getting too expensive, it has actually become five percent cheaper.

Looked at another way using the PowerShares US Dollar Index ETF (UUP) along with the iPath Crude Oil ETN (OIL) and the SPDR Gold Shares ETF (GLD) in the chart below, in the last seven weeks, the trade weighted dollar has gained about eight percent versus other freely traded currencies while the price of oil and gold have fallen more than double that amount.
IMAGE NAMEA one-to-one relationship might make sense, but to say that the dollar rose by x percent and, as a result, oil and gold fell by 2x or 3x percent doesn't make sense.

The idea that the dollar is strengthening against the euro, the pound, and other currencies because their economies now look to be getting much weaker, much faster than the U.S. economy, which will result in lower demand for commodities makes a lot of sense. However, only the brighter reporters in the mainstream financial media seem to make this connection with the regularity of the dollar up/commodities down meme.

But even this argument works only when economies, in general, are weakening.

If, for example, the global economy was booming and growth in the U.S. surged, this would cause the dollar to rise against other currencies, but would this be a signal for commodity prices to be pushed lower?

Perhaps someone could enlighten me on the relationship between the dollar and commodity prices which, in the past, I've referred to as nothing more than a "Pavlovian" response by traders which, incidentally, didn't work out so well in 2005 when both the dollar and commodity prices rose.

Importantly, note that 2005 was the only year of the last six when the dollar rose.

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This article has 7 comments:

  •  
    Sep 07 02:30 PM
    Isn't the demand for oil considered inelastic? People can cut consumption to a point, but no matter what it is still a necessity. Thus even if the dollar rises there is a limit to how far oil consumption can be cut back. The other issue is supply and demand. Is that not the ultimate regulator of price (provided it is not artifically controlled)?
    Reply
  •  
    Sep 07 04:03 PM
    2005 is an excellent example that gold can rise whether rates are being increased or decreased. And, with the bailout of fanny and freddie this weekend, I think gold is going to resume its bull market regardless of the direction of the dollar.
    Reply
  •  
    Sep 08 09:08 AM
    I would tend to agree with bold4gold, but I would hold any positions on gold before I would buy. The pricing trend for gold is just now reversing upwards from its support price. Hopefully this is your bull and not a bounce.
    Reply
  •  
    Sep 08 12:52 PM
    In general, saying that the dollar is (really) going up is like saying that your house is increasing in value because it isn't falling apart as fast as your neighbor's houses.

    With the massive 'printing' of new dollars over the time of this financial crisis, it would seem that the dollar should be rapidly dropping in value, not increasing.

    There is one cavaet, however; with the new dollars the Fed is printing for the financial institutions, if they are not passing them along in the form of new loans, is there really an actual increase in outstanding (inflationary) dollars? It looks to me like most all of those newly printed dollars are being stuffed into financial institutions 'mattresses' rather than being passed on as loans to stimulate the economy.
    Reply
  •  
    Sep 08 05:29 PM
    the dollar is a commodity also. it responds to supply/demand dynamics. if there is oversupply with falling value--demand falls; if value is rising with supply decreasing--demand rises. every commodity reacts to its next best replacement. the dollar is just one of many fiat currencies. it responds to its use/demand/value compared with its competitio[ala oil vs NG as fuel alternatives]. to date the dollar has been the preferred fiat, what would happen were it not?
    Reply
  •  
    Sep 08 07:11 PM
    if we have a financial recovery then the commodities bull resumes as the party restarts so we need the drinks and the trifles again.what can we do but what can restart it.we are intoxicated with debt and bloated with financial fodder.our rivals and enemies have cleared our table and just started there party they will be needing our food and drink but there coffers are full ours are bare..the hangover will persist the pain blinding.wait and see.i hope you did not drink and left before midnight
    Reply
  •  
    Sep 13 10:12 AM
    There is nothing complicated about this. The price of a barrel of oil has remainded approximately the same for decades (and it will continue to do so) when gold itself, or a gold backed currency is used to purchase the oil. But the U.S. dollar has not been a gold backed currency since August 1971, because when it was, the U.S. Congress was forced to restrain it's spending. They didn't like that. Could just spend, spend, spend. Had to frugal like the rest of us. And, more importantly, the people had control of the currency when it was backed by a commodity, like gold. On the other hand, the government has control of the currency when it's NOT backed by a commodity, as it has not been since August 1971. And, just look at how many U.S. dollars that your Congresses have printed up and dumped on the nation since then! When the currency is NOT backed by a commodity, like gold, the U.S. Congress can print up (and they do so, on a daily basis now) as much as they like and spend as much as they like. The Federal Reserve Bank (FED) does the actual printing, but Congress and the big banks are the first to get their greedy little hands on it and spend it, and BEFORE it begins to lose value as it spreads into the market and private sector. Because there is more currency in circulation each time they print up more, the value of the currency eventually sinks after they spend it first.

    Learn to think about it this way: it's not that the price of things are always going up, but rather that the value of your currency (dollars) is continually going down. This printing up of more and more currency by and for the U.S. Congress to spend is called debasement or devaluation. It's a scheme they use to get more money (currency) to spend. In fact, it's the biggest swindle that has ever been foisted off on the American citizen. It started with Franklin D. Roosevelt and went into high gear during Richard M. Nixon's presidency. It's been going on ever since, and getting worse and worse. No president, Republican or Democrat, since the Nixon days has ever made any serious attempt to stop printing up more and more currency to spend. Why? Because it's an easy way to get more and more money to spend without actually having to go out and earn it, like you and I are forced to do. Elected officials like to spend like sailors, (makes them feel important) but they don't like to work hard for the money they want to spend. So they just print it up. Don't you wish you could do that? But, if you did it would be counterfeiting, and you'd go to jail. Nope, the elected officials in Congress have given themselves the best of it, ie, the right to print up all the money they could ever need to spend on just about anything they want.

    There are charts, graphs and tables to unequivocally prove this.

    It must stop! But, getting the majority of the people to understand this is the greatest challenge, because the U.S. Congress has gone to great lengths to confuse and mislead the people about what's really happening to their dollars and therefore, their purchasing power. Why? Because it's not their advantage. They'd have to start watching their spending very closely. And, that's something they don't want to do. Spend, spend and spend some more is Congress' motto. They love to spend -- after all it's not their money that's getting spent and ruined, it's yours. Big joke on you and me. Huh?

    So, what can you do about it? Contact your Congressman or Congresswoman and demand that the U.S. dollar be put back on a commodity backed basis, like gold. Expect them to try to confuse you about it, or present some fear filled reasons why it's not possible to do that. But don't fooled, they are smooth talkin' ya, like they always do. Just press your Congressman or Congresswoman about this. Just say, you won't vote for him or her anymore, if they don't do as you have instructed. That will get their attention!

    If and when your currency does get backed by a commodity, like gold, a wonder thing will happen -- you will see an immediate halt to the increase in prices (in terms of the U.S. dollar) and your dollars will begin to buy as much or more of the products or services you need at the SAME price, ALL OF THE TIME! And, most importantly, as long as the U.S. dollar is on that commodity backed basis, it will continue to have that wonderful purchasing power that the people of this country used to enjoy before the times of Nixon, and FDR. And, no more of this constant and exasperating creeping upwards of prices every time you go to the gas pump or the grocery store --- when the U.S. dollar is linked to a commodity, like gold. The people will love it, but the big spenders in Congress will hate it. Many of them will quit Congress and go home because they were there just to spend mostly.

    But, that's Ok, because new men and women, of a much finer and honest character will be drawn to public service and get elected as our representatives. You and I will like that a lot too. But, again, this will only happen if we make it an iron clad law that no one in the Congress, nor anyone in government can debase the currency (our dollars) anymore.

    Reply
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