Saturday, May 15, 2010

Forex Trading Insight. Using Gold to Identify Currency Leaders and Laggards.

Assessing the performance of currencies against the value of gold enables a transparent examination of the strength of a nation's currency, without the influence of dynamics in other currencies and their economies. A rising euro against the U.S. dollar, for instance, may not necessarily be a reflection of improved fundamentals in the Eurozone but of deteriorating fundamentals, technicals, and/or sentiment in the U.S. dollar. Meanwhile, the euro could be selling off against the Japanese yen and be little changed against the British pound—a different performance from that against the dollar. Charting the euro against gold would allow for a secular view of the euro, which is not influenced by factors specific to individual currencies. Unlike currencies, which are largely influenced by interest rate movements resulting from economic policies and capital flows, gold is mainly a reflection of supply and demand, and not a direct result of any particular central bank actions.
Charting several currencies against the price of gold presents a broader view of currencies against a neutral asset such as gold, enabling a less biased look at the currency in question. There are percentage increase in the value of gold against the aussie (Australian dollar, AUD), loonie (Canadian dollar, CAD), euro (EUR), and kiwi (New Zealand dollar, NZD) from January 2001 to May 2008. All charts show an uptrend, reflecting gold's appreciation against all currencies since 2001. The graph with the least appreciation throughout most of the eight-year period is against the loonie, showing that gold grew the least against the Canadian currency. Nonetheless, at the end of the period, gold ended up 90.5 percent against the aussie versus 123 percent against the loonie, meaning gold's appreciation was the least against the Australian dollar. This suggests that the Aussie was the best-performing currency in the group. The weaker increase in gold against the AUD, CAD, and NZD reflected the broad rally in those currencies due to their dependence on rising commodities as well as high interest rates prevailing throughout the period.
Similarly, we measures gold against the U.S. dollar, Swiss franc (CHF), Japanese yen (JPY), and British pound (GBP) over the same period. Note how gold's performance against these currencies was mostly higher than its performance January 2001 to May 2008, suggesting these currencies have underperformed the AUD, CAD, EUR, and NZD. Thus, with gold showing the highest percentage increase against the USD and the lowest percentage increase against the AUD, we can conclude that playing the AUD/USD currency pair (buying AUD and selling USD) would have produced the highest rate of return if held between January 2001 and May 2008. Indeed, opportunities in foreign exchange markets are not limited solely to trading currencies against the USD, but also in those pairs involving non-USD currencies. Charting gold against different currencies over a three- or six-month period enables a truer assessment of individual currencies than comparing them against the dollar or the euro. This way, traders can not only determine the secular performance of currencies but may also rank them in order of strength and be better able to buy the strongest against the weakest.



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