Equity Research

During the first nine years of this gold bull market, gold prices moved with a near perfect inverse relationship to the US dollar. Indeed, in the early years gold was only really moving up against the greenback, it was only after a few years that it began to appreciate against all currencies. The game plan was simple; the dollar is going down, so gold in USD terms is going up with some leverage factor. Gold worked well as both a USD hedge and as a tool to speculate on a USD decline. This is no longer the case.

Nothing lasts forever and over the past two years or so this inverse relationship has broken down significantly. The gold story is no longer simply a USD devaluation play. Relationship remains intact, there are long periods where gold and the USD move together.

The most significant reason for this is that the Euros are a lot less desirable than they were a few years ago. Since all currencies trade on a relative basis, it doesn't matter if the USD has poor fundamentals; if the picture for the Euro is worse relative to the USD, then the greenback will make gains against the Euro. During periods where the Euro zone debt crisis has been the focus of market attention, gold and US dollars have been bought since both are preferable to Euros and provided a safe haven.

Gold Price ?

The key point of this article is not to say that gold will not rise is if the US dollar falls it is to point out that gold is no longer as effective as a USD hedge. In conclusion we hope to have shown that gold simply isn't a clean hedge against the USD any more. When trading one should aim to tailor positions to match your view and optimize the risk/reward dynamics. If we think that the USD is going to fall, short it. If we think gold is going to rise, then buy gold. Taking a long position on gold purely since we think the USD index is going to fall is not really statistically justifiable due to the weakness of the relationship between the two.

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