Please ensure Javascript is enabled for purposes of website accessibility

How a Strong Dollar Affects Gold Stocks

By Sam Mattera - May 30, 2015 at 4:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

As a unique commodity, the price of gold fluctuates with the value of the U.S. dollar.

"If you own one ounce of gold for an eternity, you will still own one ounce at its end." -- Warren Buffett

Warren Buffett has never been a fan of gold. The Oracle of Omaha has often derided the precious metal, as it offers no productivity. If you purchase shares of a successful company, that company can provide a steady stream of income, which, compounded over many years, will generate significant additional wealth. Gold, in contrast, simply sits there.

That's fair criticism -- on the other hand, the consistent value of gold is also its greatest attribute. An ounce of gold never changes. For investors interested in gold, that means keeping a close eye on the value of other things -- in particular, the value of paper money and the U.S. dollar.

A unique commodity
For most of history, gold has anchored the global money supply. From 1900 to 1933, the value of the U.S. dollar was derived from gold directly: a U.S. dollar was legally defined as just over 1.5 grams of the precious metal.

But the U.S. ended gold convertibility during the Great Depression, and abandoned the gold standard entirely in 1971. From then on, gold has simply been another commodity, albeit one with a few unique properties.

The value of oil or lumber or coal may shift with the global economy, as demand for those commodities depends on their popularity within the larger economic chain. In the 1850s, whale oil was a valuable commodity, but its relevancy receded with the emergence of fossil fuels and electricity. If solar energy and electric cars eventually become standard, the value of crude oil could likewise plummet, as demand slowly falls by the wayside.

Gold, in contrast, has no real industrial use. Gold's value rises and falls not in relation to its demand, but in relation to the value of the currency it's valued in. When a currency weakens, gold's price goes up. When a currency strengthens, gold's price goes down. Although the price of gold appears to rise or fall, it isn't the value of gold that has changed -- it's the value of the currency.

A bet against the U.S. dollar
In essence, buying gold amounts to a bet against the value of the U.S. dollar.

Over short periods -- months, years, or even a few decades -- the price of gold can fall if the U.S. dollar experiences a bull market. From 1980 to 1999, gold prices fell significantly as the relative value of the U.S. dollar surged. The same has been true in recent years: Consider the price of the popular ETF SPDR Gold Shares (GLD 0.92%) relative to the U.S. dollar index over the last five years:

GLD Chart

GLD data by YCharts

The U.S. dollar index compares the value of the U.S. dollar to a basket of foreign currencies, while the SPDR Gold Shares derives its value directly from the price of gold bullion. When the U.S. dollar was at its weakest, SPDR Gold Shares traded near its height. As the dollar has been strengthening over the last two years, the price of SPDR Gold Shares has fallen.

For gold stocks, the story is much the same -- the recent rise in the relative value of the U.S. dollar has proven to be devastating for shareholders. Although buying shares of a gold miner is quite different than buying the commodity itself, the financial performance of these firms depends on the price of gold. These companies generally derive their profit by taking advantage of the spread between gold prices and the cost of mining. When gold prices tumble, gold stocks almost always decline in tandem. Consider the recent performance of Goldcorp (GG), one of the largest and best-known pure gold miners. Like SPDR Gold Shares, its share price has fluctuated in inverse relation to the U.S. dollar index.

Real Trade Weighted US Dollar Index: Major Currencies Chart

Real Trade Weighted US Dollar Index: Major Currencies data by YCharts

Gold miners can mitigate their exposure to the dollar by engaging in a variety of different strategies. Some firms, such as Newmont Mining (NEM 2.76%) mine other metals in addition to gold (in Newmont's case, copper). Newmont hasn't been a great stock to own over the last two years, but it's certainly outperformed Goldcorp.

NEM Chart

NEM data by YCharts

Another option is to engage in hedging, establishing contracts to sell gold at a fixed price at some point in the future. If the dollar strengthens and the price of gold falls, these contracts can protect a company's bottom line. However, many gold firms -- particularly pure-play gold firms -- intentionally avoid hedging. Goldcorp proudly boasts that it is "100% unhedged," for example. Rival Barrick Gold spent almost $3 billion in 2009 to rid itself of its gold hedges. Given gold's unique status, investors are often interested in using gold stocks as a way to hedge their portfolio against dollar weakness (or to bet against the strength of the dollar explicitly). Hedging limits a company's downside, but also caps its potential upside.

If a significant percentage of your portfolio is in gold stocks, you should hope that the value of the U.S. dollar falls (and by extension, the price of gold rises). A strong dollar can wreak havoc on gold prices, and, by extension, gold stocks.

Sam Mattera has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

SPDR Gold Trust Stock Quote
SPDR Gold Trust
GLD
$167.87 (0.92%) $1.53
Goldcorp Inc. Stock Quote
Goldcorp Inc.
GG
Barrick Gold Corporation Stock Quote
Barrick Gold Corporation
GOLD
$16.74 (2.07%) $0.34
Newmont Mining Corporation Stock Quote
Newmont Mining Corporation
NEM
$46.55 (2.76%) $1.25

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
389%
 
S&P 500 Returns
125%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/13/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.