Myth: US Dollar is money. Fact: Gold & Silver are money. US Dollar is legal tender/debt brought down to low parcels for spending purposes.” – Ziad K. Abdelnour, Economic Warfare: Secrets of Wealth Creation in the Age of Welfare Politics.
Like it or not, the US dollar remains the world’s reserve currency. Just as significantly though, from our perspective, which is a resource angle, the dollar remains the benchmark pricing mechanism for virtually all commodities.
What is also fact is that there is a strong negative correlation between the prices of commodities and the value of the dollar. When the US dollar moves lower, commodities prices tend to gravitate to higher levels – and vice versa.
Simultaneously, some commodities are more sensitive to currency moves than others. For example, gold is both a commodity and a currency – as it has a very strong history as a store of value and as a means of exchange. The yellow metal’s important role in the international economy is underlined by the fact that central banks around the world hold gold as part of their foreign exchange reserves.
As both a commodity and de facto currency, gold is highly sensitive to the value of the US dollar. Over recent weeks, we have witnessed a recovery in the US dollar, with the price of gold moving in the other direction. However there are signs that the dollar could run out of steam sooner, rather than later.
Dollar’s Recent History
The dollar index traded to what became a significant high during January 2016 – however the bullish trend in the dollar and bearish path of the euro came to an end. Instead, as the dollar index highlights, the dollar fell steadily against other world currencies throughout 2017. A period of price consolidation then followed, before it broke out to the upside during April in a long-overdue recovery.
This shouldn’t be too surprising, as currency values are often significantly influenced by interest rate differentials. In the US, the gap between euro and US rates has been widening since December 2015. At the end of 2015, the Fed Funds rate was at the zero percent level, and short-term European rates were at negative forty basis points. Since then, a total of six rate hikes brought the Fed Funds rate to the 1.5% level, while European rates have not budged.
Dollar Headwinds
But what we saw during 2017 was that even as US rates were rising and the gap between euro and US rates was growing, the US dollar actually weakened – which runs contrary to popular logic. So, further gains in the US dollar are far from assured on the basis of the interest rate scenario alone.
And there are other economic and political factors that could impact upon the path of the US currency in the near-term. The US domestic and international political landscapes continue to pose potential problems for the US dollar. President Trump has backed away from the Iran nuclear non-proliferation agreement, which from a perception perspective heightens the potential for hostilities in the Middle East.
Simultaneously, the upcoming summit between the US President and North Korean leader Kim Jong Un will create an environment of uncertainty, which could lead to a peaceful resolution of the Korean War and the nuclear aspirations of North Korea. At the same time, trade issues that include tariffs and retaliation by China, could impact the value of the dollar. Finally, on the domestic political scene in the US, upcoming mid-term elections and a continuation of investigations by the special prosecutor could lead to price volatility in foreign exchange markets.
Summary
Even though the dollar index has recovered from its lows, the longer-term prospects for the dollar remain cloudy in my view. As we’ve discussed previously, significantly higher rates and a significantly higher dollar would likely prove disastrous for the US economy. President Trump is on the record stating that he doesn’t want a strong currency, because of the trade implications. Higher rates would also mean a blow-out in the cost of servicing the massive debt that the US has built up since the GFC.
I am therefore of the opinion that we are close to a peak in the US dollar, which in turn will provide the next catalyst for a run in commodity prices. Gold, which has suffered over recent months as a result of US strength, will likely be one of the biggest beneficiaries. Accordingly, prices should push past the US$1,350/oz mark during H2 2018.
