The US dollar’s status as the primary reserve currency is as strong as ever. Global uncertainty and lasting economic disruptions from the Covid-19 pandemic and Russia-Ukraine War alongside the Federal Reserve’s aggressive monetary policy have reinforced the advantages the US dollar offers compared to other established reserve currencies in 2022, as well as newer options like cryptocurrencies.
Without suitable alternatives, demand for the US dollar can be seen in currency markets as the greenback has risen over 13% in 2022 while other major currencies have seen comparative drops (see Figure 1a).
Gold has characteristics similar to currencies while also serving as a reserve asset for many central banks. As such, it is important to take a global view of gold against multiple currencies to see the range of performance. As seen in Figure 1b, the gold price in US dollar (USD) terms has been significantly weaker versus gold priced in Japanese yen (JPY), British pounds (GBP), and euros (EUR). Based on historical relationships, this disparity in performance — driven by a strong US dollar — would imply a tepid outlook for gold.
However, gold demand globally has seen renewed interest this year, especially outside the US. This may suggest that global investors, like their US counterparts, are concerned about local economic uncertainty, and the potential for monetary and fiscal policies in response to slowing growth and high inflation, pushing up the appeal of holding gold as both a potential store of value and a source of diversification against US dollar strength and local currency weakness.
US dollar strength has not scared away gold demand
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In 2021, the USD gold price fell by 3.5%, and global gold ETFs saw net outflows of US$9B. Lackluster returns (in USD) and the impact of year-to-date USD strength have not dissuaded investors from purchasing gold. In fact, while the price of gold in USD terms year to date has seen a comparative drop from 2021, gold ETFs have posted US$14B in inflows globally, indicating that investors likely have purchased gold for portfolio diversification.
US investors have added the most capital into gold-backed ETFs, equating to 83.7 metric tons (t) followed by the UK with 47.6t, Germany with 28.2t, France with 9.5t, and Japan with 0.8t. Geopolitical instability, high inflation, and economic uncertainty continued to support gold across Europe and Asia. Strong demand from those regions where the local currency continues to reach decade lows versus the US dollar reaffirms gold’s potential function as a wealth-preservation vehicle and a “currency of last resort” globally.
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While gold ETFs can be a valuable indication of investment demand in the short term, gold ETF daily trading volume accounts for less than 2% of aggregate volume in the global gold bullion market. Physical bar and coin demand make up the majority of annual gold investment demand (approximately 80% on average).
In Q1 and Q2, global demand for bars and coins generated 246t and 245t, respectively. This is slightly below the quarterly 10-year average of 284t and on par with the 5-year average of 254t. Yet the recent weakness is not the result of a strong dollar and pullback from US investors. The US dollar appreciated 6.4% in 2021 while bar and coin purchases from US investors posted a decade high of 130t. This trend continued into the first half of 2022 as the US dollar appreciated 9.4%.
US investors bought 31t and 29t of gold bars and coins in Q1 and Q2, respectively, which is significantly higher than the quarterly 10-year average of 15t and the 5-year average of 13t. Despite a strong US dollar, current bar and coin demand may surpass last year’s total. If that happens, it would be the strongest year of sales since 1999, when the price of gold closed at US$290/oz, and would indicate a long-term positive view of gold.
Flight to quality: US dollar, gold and recessions
Since 2000, the National Bureau of Economic Research (NBER) has announced three recessions. Each time, the US dollar found a new cycle high and gold, another perceived safe haven, appreciated on average 9.03% (see figure 3). Positive returns from the US dollar and gold can both occur during extreme downturns. But a strong US dollar can put an artificial ceiling on how much gold might appreciate in the middle of an actual recession since it has an average monthly correlation of -0.36 to the USD since 1971.
Figure 3: US Dollar and Gold Cement Roles During Recessions
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When each recessionary period ended, the US dollar retreated. Yet gold saw continued support as recessionary concerns lingered. In fact, gold saw a bull run in the aftermath of each of the last three recessions, as shown in Figure 4. The COVID-19-led recession ended on April 30, 2020, with the price of gold closing at US$1,687/oz. Gold appreciated to US$1,769/oz by April 2021 and to US$1,897/oz by April 2022. A weakening dollar initially following recent recessions has had a positive impact on the price of gold since investors around the world can buy it at a cheaper price.
Opportunities remain in gold over longer term
The potential for a recession is front of mind for investors, after two consecutive negative GDP prints, heighten geopolitical tensions, and aggressive rate hikes from the Fed and other global central banks as they attempt to fight off the highest inflation in over 40 years. If the Fed decides inflation is too entrench in the system and it continues to increase rates higher than the market is currently expecting, the US dollar could reach a new cycle high.
As a result, gold’s performance in USD will continue to look weak compared to JPY, GBP, and EUR. If the US dollar continues to appreciate, having an allocation to gold could be beneficial for investors over the next 12, 24, or 36 months, in a manner similar to the three most recent recessions.
While a stronger US dollar may continue to act as a headwind for gold in the short term, in the longer term it may prove favorable, as seen in gold’s historical performance after the most recent three recessions. Current circumstances may ultimately represent an opportunity for gold investors, both in the near term and long term, despite the dollar’s strength year to date.
Diego Andrade is senior gold strategist, and Maxwell Gold, head of gold strategy, State Street Global Advisors
