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Gold - It Is Still All About The US Dollar Part II

In my original article I made the following statements:

"It means that holders of any non-USD currency who want to exchange it for gold, must first exchange it for US dollars and then exchange the US dollars for gold.

When anyone is selling gold, the proceeds are always paid in US dollars. The dollars can be held as such, or they can be exchanged for other currency."

Another professional labeled the above statements as "fiction".

I do not agree. But I do see the possibility for others to infer something other than what was intended. Therefore, I apologize. And I have replaced the statements in question with the following:

When someone in Switzerland, for example, exchanges Swiss Francs for gold, they are quoted a price in Swiss Francs. That seems pretty straight-forward. But how is the price for gold in Swiss Francs calculated when the international market for gold is priced in US dollars?

The amount that someone pays in Swiss Francs (or any other non-USD currency) is determined by calculating the exchange rate between the US dollar and the specific non-USD currency involved. Based on that calculation, it is then known how many Swiss Francs are needed to equal the transaction amount in US dollars.

My original statements were intended to draw attention to the role of the US dollar in all transactions involving gold. I am aware that the statements above were not 'technically' correct. And so some further clarification is in order.

When someone pays Euros, Yen, or Swiss Francs for gold, the amount they pay is calculated and based on two specific things, BOTH of which involve the US dollar.

The first is the US dollar price of gold:

"Gold is priced in US dollars and trades in gold are settled in US dollars because of the hegemony of the dollar and its role as the world's reserve currency."

The second is the exchange rate between the US dollar and the other currency used:

"On December 31, 2013, gold traded at $1210 per ounce. And on that day one euro could be exchanged for 1.3776 USD. Hence, 842 euros ($1210 USD divided by 1.3776 = 842) could be exchanged for $1210 USD which could then subsequently be exchanged for one ounce of gold."

When you see the price of an ounce of gold quoted in any non-USD currency, it already includes the above two factors. There is no direct floating day-to-day market price for gold in any non-USD currency.

Quotes in other currencies that are posted in the Wall Street Journal, or on Kitco, or anywhere else, are based on 1) the US dollar price for gold and 2) the exchange rate between the US dollar and the respective non-USD currency.

I hope that is clear. And the statements above were intended to draw attention to the issue.

It was also pointed out that the market for gold in China is quoted in Yuan and trades in Yuan. Which is true. But that market is an experiment that is still in its infancy. And the participants are continually monitoring and hedging any consequential variance between the US dollar price for gold and the Yuan price for gold.

You don't 'need' US dollars to pay for gold, and you certainly can use other currencies, but you are still paying the US dollar price for gold. And the amount you pay in any other currency is determined via the exchange rate formula above.

On to other things...

Within the past couple of weeks, there have been several articles attempting to analyze gold or explain various ways to analyze and measure gold. It seems as if the focus on gold is heightened. And yet, the price of gold (to some) appears to be 'stuck'.

Let me propose a solution to all of the confusion. What if we applied all of the time, attention, and expertise that is spent on gold to analysis of the US dollar. Put another way, "how many different ways can you value the US dollar"? How many different ways can you value 'money'? Said that way, it almost seems non-sensical.

Gold is real money. The US dollar is a substitute for real money. Over time, the price of gold reflects inversely - and proportionately - the decline in value of the US dollar.

There is an initial 'shock' factor that seems to encourage traders to buy gold when an international event of consequence takes place. These could be terrorist actions, political elections, assassinations, even natural calamities. But the effect on the gold market is short-lived.

This is because any consequential and lasting impact on the price of gold is determined by what is happening to the US dollar, not the event itself.

A stable or stronger US dollar translates to a stable or lower US dollar gold price. A weaker or declining US dollar translates to higher gold prices.

We are currently in a period of dollar strength which dates back to 2011, which, not just coincidentally, happens to be when gold peaked in US dollars.

And from 1999 to 2011 gold increased from $275 per ounce to $1900 per ounce while the US dollar went into free fall.

Part of the confusion surrounding gold is due to the fact that the effects of inflation created by the Federal Reserve are lagging and difficult to quantify. And price action in gold trading is often based on expectations which are unrealistic.

There are many different 'investment products' which purport to represent positions in gold for trading purposes, and the trading activity can have a considerable effect on gold prices, regardless of faulty logic or unrealistic expectations. Volatility can be extreme in the short term but the effects are muted over time.

And again, there is no correlation between interest rates and gold. Any effect that interest rates seem to have on the price of gold is the result of what is happening to the US dollar. (see: Gold And Interest Rates - A Mass Of Confusion)

There are seemingly unlimited variations to the game of analyzing and interpreting, identifying and labeling, looking for correlations and chart patterns, combinations of events, etc.

But when it comes to gold, only one things matters. The US dollar.

Irrespective of investment considerations, interest rates, or world events, it is STILL ALL ABOUT THE US DOLLAR.

 

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