Gold and the Forex Market

But gold exchange pattern started showing its weaknesses at the same time as the economy strengthened and increased its imports of services and products from abroad. This caused the necessary gold reserves to guarantee the money to become extinct, reducing the monetary mass, with the subsequent increase of interest rates and reduction of economic activity down to recession. Then, the low prices of merchandises brought about massive buys from abroad, inverting all the processes. Those oscillating rise and fall patterns continued until World War I, when commerce flows and free movement of gold were interrupted.

After the Wars, Bretton Woods Convention was celebrated in 1944, as a product of the resolutions of the Monetary and Financial Conference of the United Nations, where rules were established for commercial and financial relationships between the most industrialized countries of the world. The creation of the World Bank and the International Monetary Fund were decided as well as the use of the dollar as an international currency, and its value in terms of gold was set at 35 dollars per ounce (the United States was the owner at that time of more than 60% of the world’s gold reserves). The Convention was abandoned in 1971, and in 1973, the currencies of the most important industrialized countries started to float more freely, controlled by the forces of supply and demand that were acting in the exchange markets. New financial instruments were created, the market was unregulated and commerce was freed up.

In the eighties, technology opened the frontiers and the circulation of capital among the countries accelerated, extending the continuity of the market through Asia, Europe and America. Transactions in currencies exploded from around 70 thousand million dollars daily in the mid-eighties to more than 2,5 trillion daily, 20 years later. The combination of a low margin and a high leverage has changed the way in which the interbank currency market performs its transactions. The exchange market, formerly only reserved to big investors and financial institutions, is nowadays available to any individual investor and for smaller institutions thanks to the Internet and online brokers, with quotes and charts in real time.

Gold in the Forex market

In Forex, the symbol for Gold is XAU. Gold price is measured by its weight, and refers to the value of one ounce in dollars. Transactions with gold prices are realized in the same way as transactions with currencies, in a parallel way, on OTC (Over the Counter) markets. That is, there is no need for third parties intervening to consolidate the transactions. These are performed virtually, as the physical exchange of the traded merchandise is not required, as gold is considered as “XAU”, just as any other currency. But trades are only bought and sold in respect to the American dollar (USD).

In general, when gold prices increase, the US dollar falls. For this reason, investors trade gold to balance their profits and losses against the dollar. Furthermore, as gold is prone to keep its value stability over time, investors usually buy this “currency” to counteract the effects of inflation and variations in the value of currencies. The buying power of many currencies has been decreasing as a consequence of the impact of the price surge in commodities and services.

In the exchange market, some investors also buy and sell gold for speculation trying to get some profits on small price fluctuations. However, the price of gold is very difficult to predict, as it is primarily used as a reserve for buying power, and thus is affected by many monetary and psychological factors. Investing short term to earn more than with other types of investment can be very risky.

Given its use as a reserve, the price of gold is very much related to the behavior of other investment alternatives, as currencies, bonds and stocks. The price of gold will tend to rise in the middle of monetary instability and falling capital markets. Wars and natural disasters also have an influence on its price. Gold has been rising due to the dollar weakness and the instability of stock markets. However, its real price, adjusted to the inflation, is today much lower than what it was at the beginning of the eighties. In any case, the actual trend is bullish, as in the last 7 years the nominal price of gold rised from US$330 per ounce in April 2003 to US$900 at the beginning of April 2008, and is now trading above US$1300.

Gold rising prices can have an influence on other currencies, especially those of the countries that have a greater production of this metal. For example, Australia is the third greater gold exporter, and Canada the third greater producer. Therefore, we could speculate with trades on Australian (AUD) or Canadian (CAD) dollars waiting the currency to become stronger meanwhile gold price increases.

In the Forex market, gold is neutral, this means it is not linked to any particular country, thus its price increases affect the transactions in several currencies. Gold prices are an important element that gives impulse to the Forex market.

There are presently five main gold markets, located in New York, London, Zurich, Hong Kong and Sidney. Contrarily to stock markets, gold price depends on the perception of some important middle men who communicate with each other and “set up” the price several times per day. This procedure gives more stability to the given price as it offers reference points that are being updated according to supply and demand movements.

The fact that the markets are located in different time zones, allows to perform transactions 24 hours round. The main currencies employed in the transactions are the US dollar and the Euro. At a certain point in time the Pound Sterling was a dominating currency but not any more now.

Gold has also an additional role, as it is employed as a reserve for buying power. Although it can also be used in
production processes, the biggest part of Gold demand comes from its use as a reserve.

Reasons to invest in Gold

1. Gold is not affected by inflation nor by devaluation. Therefore, it doesn’t lose value daily as paper money does.
2. Gold is considered a safe haven investment. Gold has proven to ameliorate its results in years of crisis or wars, when other investment alternatives often fail.
3. Gold is NOT placed under political control. No government can have any influence on its price.
4. Presently, Gold reserves are limited. This has a positive influence on its price, as it will tend to rise when the resource is limited.
5. Gold is an easy investment. It is an internationally accepted currency and doesn’t bear any great difficulties for its exchange, nor is it extravagantly taxed.
6. Gold is a secure and profitable investment. From January 2010, Gold has profited up to now around 25%.
7. The main use of Gold is as a reserve. There is very little gold for sale as it is being accumulated as a reserve, for this reason an increase in its price is expected.
8. Gold allows several ways of investment. Gold Bullions, certificates of deposit, futures and options on Gold, investment funds.
9. Gold is considered as the best investment in times of crisis. Gold is considered as a liquid asset and its value always increases over time.
10. There are no sales taxes on Gold.