First, on the commodities markets, gold is traded in U.S. dollars (USD). With a constant gold price in USD, a rise of the Australian Dollar (AUD) against the US Dollar (AUD/USD) makes gold cheaper for Aussie investors.
Symmetrically, a decline of the AUD/USD makes gold more expensive for them. This foreign currency (FX) effect (also known by traders as currency risk) is a real matter for local investors.
FX markets in general and the Australian Dollar in particular had impressive volatility in 2008, especially during the second half of the year. If it continues in 2009, you’ll want to understand the relationship in order to devise your own gold strategy.
On the chart above, the black line represents gold in Australian dollars (we called this composite “Aussie gold”), while the green bars represent the currency pair AUD/USD. There are three different phases that are distinct.
1) Phase 1 from August 2007 to March 2008 where “Aussie Gold” climbed sharply despite the fact that the AUD/USD exchange rate was rising too. It means that at the same time, gold prices in USD were rising faster than the AUD/USD.
In details, it means that, the AUD/USD ( how many US Dollars for ONE Australian Dollar) rose by 11% roughly between September 2007 and March 2008. For the same period, gold (therefore how many US Dollars for ONE ounce of Gold) rose by 31%
As a result, both the AUD and gold appreciated against the USD, but gold appreciated much faster. That’s why the Aussie gold price (how many Australian Dollars for ONE ounce of gold) also climbed sharply. What does it all mean? It means that gold appreciated against AUD!
The Aussie gold price is a function of the velocity of the AUD/USD compared to the velocity of gold. If AUD/USD appreciates faster than gold, then the Aussie gold price declines. If gold appreciates faster than AUD/USD, then the Aussie gold price rises.
2) Phase 2 from March 2008 to September 2008 where the “Aussie gold” was cheaper as gold in USD was correcting while the local currency jumped to historical highs until July, then crashed.
3) Phase 3 from September until now where gold prices on the international markets are consolidating and rising again whereas the AUD/USD has been falling to low levels not seen since 2003. As a result, the “Aussie gold” is soaring.
Since last October, we can see that the Aussie gold price is reaching historic highs. Because of the crash of his currency on the FX markets, a local must pay today $1,250 AUD to buy an ounce of gold. At mid-August last year, the cost for the same ounce was only $917 AUD. It’s a 36% increase in 5 months!
What is the conclusion of that?
Well, we have calculated the correlation between gold and the Australian currency, both the strength of their relationship and the degree of their relationship. From 1991 to date, this correlation is equal to 81%. Gold and the Aussie are positively correlated, as they typically move in the same direction because they are both traded against the US Dollar. But they don’t move at the same pace. And this is that difference of pace or velocity that drives the Aussie gold price.
On a historical basis, a strong Australian dollar is NOT a 100% guarantee of a cheaper gold for local investors, but it is clearly often the case.
That’s why if you want to buy gold, I would suggest you to wait for the Aussie gold price to correct. Currently these are the historical highs. If we have a look at the Aussie gold itself on a weekly chart (above), the MACD shows that the bullish momentum is likely to be over. It has peaked at unprecedented high levels on early January and has already started to curve downward.
Historically a similar configuration happened twice, in May 2006 and March 2008 (circled on the chart). If the MACD crosses below its signal line, it would be a clear signal of trend reversal, and would drive the Aussie Gold much cheaper. We will keep an eye on that in the coming weeks!
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