Is Gold the Ultimate Currency?

A Safe-Haven Asset that Many Consider the World's Currency

Long before the U.S. dollar or the British pound or any other present major currency of the world was in circulation, gold was the currency of choice. Old habits die hard, as the precious yellow metal is still perceived by much of the world’s population as the ultimate currency and is one of the most popular traded markets.

Indeed, gold futures on the COMEX division of CME Group rank right up there with the major U.S. stock indexes, grains and U.S. Treasury futures as being among the most popularly traded futures markets worldwide. During times of increased investor anxiety and/or geopolitical uncertainty gold is sought out by traders and investors as a safe-haven asset. In recent years it seems those times of higher anxiety in the market place are occurring with more frequency—to the benefit of gold.

Gold is a “hard asset” that is also used by investors as a hedge against price inflation. Gold bulls have benefited in recent years by the very easy monetary policies of the major central banks of the world--implemented to resurrect businesses and spending during the recent worldwide economic recession. History shows that when central banks start printing money, inflationary price pressures start to increase. During the past five years the printing presses of the world’s major central banks have been working very hard.

Interest in gold futures among individual traders has increased markedly in recent years as the daily price volatility in gold futures has increased. Twenty years ago the weekly trading range in gold futures was many times under $10.00, as gold prices were then valued at well below $1,000 an ounce. Today, with gold trading well above $1,000 and with frequent world political or economic developments that rattle the market place, gold’s weekly trading range is much higher—sometimes as high as $25.00 or more in a single day.

India and China are two of the world’s most populous nations whose appetite for gold is very strong and getting stronger. Both are major fundamental factors in the gold market. China is presently the world’s largest consumer of gold, while India is second. The peoples of both nations consider gold a major cultural element as well as an investment asset. During India’s Diwali festival season, which occurs in the last quarter of the year, demand for gold increases significantly from the Indian consumers. Gold is traditionally a favorite gift given by the peoples of China and India.

Gold futures prices track the daily value of the U.S. dollar versus the other major currencies on the world foreign exchange market. Recent history shows gold tends to trade in an inverse relationship with the value of the U.S. dollar. In addition, gold generally trades in a positive correlation with the Euro currency. Should the U.S. dollar see a significant appreciation in value against the other major currencies, upside potential in gold would likely be limited. However, history does show that gold and the U.S. dollar can both appreciate during times of keener investor uncertainty in the market place.

The daily price action in gold is determined to a large degree by the level of risk aversion in the market place on that given day. Therefore, the “risk-on” and “risk-off” trading days that occur frequently in the market place are critical indicators.

The terms “risk-on” and “risk-off” in the daily market place have been commonly used (or some believe abused) for at least the past few years to describe the general tenor of the investing market place. Most individual markets’ daily price movements are inter-related to at least some degree, and more sessions than not they are influenced by a handful of markets—gold being one.

These key markets are also called “outside markets” by many. They include the U.S. dollar, U.S. Treasury bond and note futures, crude oil, the U.S. stock indexes, and gold.

For example, if a major overnight development occurred in the Middle East, such as a military conflict, it’s likely the U.S. dollar, crude oil, U.S. T-Bond and T-Note futures, as well as gold, prices would be significantly higher due to increased safe-haven investment demand. U.S. stock indexes would likely trade lower. This would also be a “risk-off” trading day, whereby investor risk appetite has shrunk due to higher uncertainty in the market place.

A “risk-on” trading day in the market place may occur if there were a stronger-than-expected major U.S., China or European Union economic report that buoyed the world stock and commodity markets. Gold would typically at least see buying interest limited on a risk-on trading day, if not outright downside price readings.

Importantly, the general correlations among individual markets, the outside markets, and their price movements is not at all constant and can turn 180 degrees from normal during unusual circumstances. Still, a daily examination of the above outside markets provides a good, general view of the mentality and “riskiness” of the market place on that given day—and the potential price trend for gold on that day.