How Gold Affects the Forex Market

Gold and other precious metals like silver, platinum and palladium have intrinsic value as hard physical assets with important industrial applications. They also have value due to their ability to store a considerable amount of wealth in a rather small space.

As a result, many people keep gold to protect against inflationary pressures and to provide a means of exchange in tumultuous times that may depreciate the value of paper fiat currencies. Furthermore, many currencies were at one time or another pegged to gold or the so-called "gold standard."

For example, from the mid-1940s to the early 1970s, gold determined the value of most major currencies in the global forex markets under the Bretton Woods system of exchange rates. This post-WWII system of fixed exchange rates broke down in the early 1970s as then-president Richard Nixon ordered the U.S. Dollar removed from the gold standard.

The following sections describe some of the more recent trading links between gold and several major currencies.

The Euro and Gold

Since 1980, when gold hit its former record high of $850 an ounce, the price of gold had declined gradually until 1999 when it had fallen to a low of $257 an ounce. Interestingly, the low in the price of gold coincided roughly with the introduction of the Euro in January of 1999.

Furthermore, until the recent Greek debt crisis at least, the E.U.'s Euro has generally risen in value versus the U.S. Dollar due in part to a relatively modest currency printing program overseen by the European Central Bank. This contrasts with the more active paper money printing program overseen by the Federal Reserve in the United States.

The Australian Dollar and Gold

Another interesting link between gold and currencies involves the value of the Australian Dollar. Since as gold rises in value, so generally does the Australian Dollar.

Basically, this link has to do with the fact that Australia has considerable gold reserves. Also, Australia is a net exporter of gold, and the precious metal makes up a significant percentage of its national exports.

These factors make the value of the Australian Dollar especially susceptible to fluctuations in gold prices, although its value is also affected by the price of oil and other key raw materials. As a result, the Aussie is often referred to as a commodity currency by forex traders.

The Swiss Franc and Gold

In 2000, the Swiss Franc became the last of the national paper currencies to be taken off the time-honored gold standard. Before that time, the Swiss Franc had the status of being a safe haven currency that maintained intrinsic value when times became difficult since it was freely convertible into gold.

The Swiss currency still benefits from safe haven buying to a lesser extend due to its long history of political stability, neutrality and abstention from conflict. Nevertheless, the currency's former close relationship to the value of gold has declined considerably.

The U.S. Dollar and Gold

Recently, as the U.S. government continues to overspend its income by a considerable margin, under the guise of stimulating the country's failing credit-driven economy, investors increasingly look to gold as a way of hedging against the almost inevitable inflationary implications of increasing government borrowing to print more paper money. This has resulted in a recent inverse relationship between the value of the U.S. Dollar and gold.

Furthermore, as post-WWI Germany learned during its devastating hyper-inflationary period in the early 1920s, this sort of irresponsible fiscal policy can be a recipe for a currency's downfall and eventual replacement by a currency linked to gold - the forex market's standard of real value.