Sunday, March 19, 2023

When USD Is Up, The Price Of Gold Goes Down…

And vice versa.

This was one of my first financial advice dished out by my father while I was young. Somehow this sticks in my mind for a long time, like those childhood experiences, good and bad, where it remains with you forever.


When I started to know more of economics, finances and investing, it was obvious that this was a result of one of the most important attributes in an investment portfolio: correlation.


The current times are challenging due to rapid inflation followed by increasing interest rates, macroeconomic factors that had not been seen in at least a decade and a half. Major asset classes fell, yet there are some still holding, or even profiting, from the prevailing economic environment. Drilling down further, some regions/countries’ asset classes may have performed better than others; and going down even further, some sectors/industries of some places may be better than other sectors/industries of other places.


Such is the levels of diversification, another important aspect of portfolio management. It is not advisable to concentrate all into one asset class, region/country or sector/industry, for one big bang will bring massive pain to an investment portfolio (afterthoughts on SVB’s client base). Diversification is designed for two things: to prevent greater than normal losses in down times, and to let you sleep somewhat better at night.


Going back to the assumption in this blog post’s title, there is truth to it, to a certain extent.


Since gold is priced in USD, the argument for this assumption is that a weakened USD makes the price of gold cheaper, hence the latter’s higher demand, and the reverse, i.e., stronger USD, would make gold more costly, thus lowering its demand. However, there are other reasons, too, such as periods of inflation where gold is favoured due to its deemed hedging properties. Sometimes in moments of economic crises, USD and gold had shown some positive correlation. 


As with most relationships in the intricate world of economics, finance and investments, there is no single absolute link between the various asset classes, sub-asset classes, etc., let alone the one between USD and the price of gold. And these links may be positive or negative. In short, correlation does not imply causation, and all assumptions are made on certeris paribus (assume all things equal).


It is precisely this correlation, positive and negative, that brings variation in protecting an investment portfolio, and this variation is important in navigating the not-so-smooth path of investing and building the retirement pot.


Hence, this is why most in the investment circles would say that diversification is probably the only free lunch around.

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