Gold Outlook: Dollar Strength, QE, and Deflationary Concerns
TOM BUTCHER: Hello and welcome to Van Eck Outlook. I'm your host, Tom Butcher. I have with me today Joe Foster, Portfolio Manager for Van Eck's active gold strategies and the firm's Senior Gold Analyst. Joe is an acknowledged authority on gold, with over ten years' dedicated experience in geology and mining with some of that time spent as a gold geologist in Nevada. Joe, welcome.
JOE FOSTER: Thank you.
BUTCHER: Today we're going to look at gold and the changing economic landscape. First, why is there a negative correlation between the U.S. dollar and the price of gold?
FOSTER: To understand the negative correlation between gold and the dollar, you have to look at gold's role in the financial system. Gold serves as a sound currency. It has intrinsic value. In other words, it has unique physical properties as a metal that people value. It exists in limited supply. It's very hard to find and very rare. It's widely accepted as a medium of exchange. Since gold was first coined back in 600 B.C., it has been used all over the world in varying quantities as a medium of exchange. Finally, it should have no counterparty risk or risk of default*. Gold qualifies as a sound currency. The dollar, on the other hand, only meets one of those qualifications. It has no intrinsic value— it is made of paper. It is not limited in supply because the Fed can print as many dollars as it wants. It has counterparty risk, i.e., it only has value as long as investors have faith and trust in the U.S. government. The one attribute it does have is that it is accepted as a medium of exchange all over the world. Therefore the dollar, as the world's reserve currency, typically experiences strength when nobody is worried about the U.S. economy or the financial system. When people start to worry about the economy or see cracks in the financial system, they lose faith in the dollar and they turn to gold as a sound currency. When the dollar is strong, as it has been recently, we tend to see weakness in gold; when people lose faith in the dollar, then vice versa, we see strength in the gold market.
BUTCHER: Thank you. What do you consider the risks of ending crisis-era monetary policies? For example, qualitative easing and zero rates?
FOSTER: It is going to take years to unwind the extreme monetary policies that we've seen over the past five-plus years. There are several risks that come with the unwinding of those policies. One is that we could see an unwanted rise in interest rates. That could be difficult for the economy. Secondly, with the withdrawal of liquidity, we could see the weak economies move into recession. Finally, we could see unintended consequences brought on by investments during this period. With ultra-low interest rates, people have been going out on the risk curve to achieve yield, and by unwinding these monetary policies, riskier activities could bring unintended consequences.
BUTCHER: Thank you. One final question, Joe: how do deflationary concerns affect the gold market?
FOSTER: Generally, deflation increases the risk to the financial system. It can increase the probability of banking failures and it also causes central banks to implement inflationary monetary policies via quantitative easing and negative real interest rates. Gold benefits as a store of wealth and a sound currency in that type of an environment. Recently we have seen deflationary concerns in Japan and Europe. However, gold hasn't reacted to them. The beneficiary would likely be the dollar. The dollar is currently the safe haven of choice. If those deflationary concerns ever creep into the U.S. economy, I think you would see the dollar weaken and gold strengthen.
BUTCHER: With Joe's views on how deflationary concerns affect the gold market, we come to the end of this edition of Van Eck Outlook. Should you wish to read Joe's monthly commentary, please visit the Van Eck website at www.vaneck.com.
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