USD and Gold Move in Tandem, Signalling Risk Aversion

By Roger Baettig | February 23 2011 6:50 AM

Gold price remained firm in European session but failed to exceed yesterday's high. Despite traditional negative correlation, gold and USD has been moving in tandem since the outbreak of the anti-government unrest in Egypt. The situation indicates risk aversion in the market and investors seek for safe-haven assets. Protests were also seen in Algeria although the government said that 'domino effect' would not apply to the country. Indeed, should Egypt-styled tensions eventually spread to Algeria, European markets will be more affected since the country is a large source of the continent's gas imports.

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The chart below shows the correlation between gold and the US dollar index. Note the 30-day correlation has shifted to positive territory since mind January. Anti-government protests in the Middle East and North Africa have escalated. While oil prices have jumped amid worries over oil supply disruption, precious metals also strengthened. We noticed that short-covering in gold futures began 2 weeks ago. The same unwinding should happen in USD futures which have been sold down excessively.

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Apart from geopolitical tensions, gold prices were also supported by news of strong physical demand. According to Hong Kong Census and Statistics Department, outflows of gold from Hong Kong to China doubled to 118.904 metric tons in 2010. Separately, a senior industrial official in China said that gold imports jumped almost 6 times to 200.72 metric tons in the first 10 months of 2010.

BOE's minutes for the February meeting unveiled one more policymakers voted for a rate hike in the midst of elevated inflation. The vote remained to be 3-split with the majority (5,compared with 6 in the prior meeting) voting for maintaining the status quo, Adam Posen favoring addition of +50B pound to the 200B-pound asset purchase plan and Spencer Dale, Andrew Sentance and Martin Weale preferring a rate hike. The minutes indicate that policymakers are facing higher pressure to tightening monetary policy even though growth in the UK remained subdued.