Understanding Gold Prices and the U.S. Dollar
Why, when you trade spot gold using an online forex trading platform, do you trade gold in a pair with the U.S. dollar?
As you may recall from “How to Trade Spot Gold,” when trading spot gold, the quote is represented in the form of XAU/USD. The first symbol listed represents one troy ounce of gold. So the price quote—which may look something like 800 XAU/USD—simply means that one ounce of gold is equal to $800 U.S. dollars. (The dollar amount fluctuates, of course.)
Perhaps you noticed that reading a spot gold quote is similar to reading a forex quote. That is because trading spot gold is much like trading forex. Forex is the simultaneous buying of one currency and selling of another. One example of a forex pair is the EUR/USD, which refers to the euro and the U.S. dollar. Another pair is the USD/JPY, which refers to the U.S. dollar and the Japanese yen. With each pair, a trader oncurrently buys one currency and sells the other. With spot gold, you simply trade gold and the U.S. dollar instead of two currencies. (The same is true of spot silver and spot oil; you simply trade silver or oil and the U.S. dollar instead of two currencies.)
So, essentially, when gold traders buy a spot gold contract, they are buying gold and selling the U.S. dollar. When gold traders sell a spot gold contract, they are selling gold and buying the U.S. dollar. That is because—as you might have guessed—gold prices normally rise with a fall in the U.S. dollar, and fall with a rise in the U.S. dollar.
Because of this, many gold traders buy gold to hedge against a fall in the U.S. dollar
—which is happening in our current market environment.
When the U.S. Federal Reserve Board is concerned about the economy, it inflates
the U.S. money supply by lowering interest rates and selling U.S. government securities.
All of that extra liquidity tends to dilute, and thus lower the value of, the U.S. dollar.
Currently, gold traders—and thus the gold market—seem to think the Fed will stop
at nothing to try to boost the housing and financial markets—which could bode poorly for the U.S. dollar and well for the price of gold.