Falling Gold Prices and the Forex Market

Back in January, I shared 3 reasons why gold prices could slide for the rest of 2013. Since then, the precious metal has tumbled roughly 25% from the $1,500/ounce level to test its yearly lows near $1,200/ounce. Is gold in for more losses for the last stretch of the year? More importantly, how can forex traders like you and me profit from all this?

Before we start talking about catching pips, let’s take a quick walk down memory lane to understand the correlation between the U.S. dollar (blue) and the price of gold (green).

As you can see from the chart above, the U.S. dollar typically has an inverse relationship with gold. During the second quarter of this year, the prospect of the Fed tapering its bond purchases came up and led to a strong dollar rally. However, when U.S. economic data failed to show enough momentum, the dollar erased its gains in the following months.

However, the correlation seemed to go haywire in the third quarter of the year, as FOMC officials and U.S. reports gave mixed signals on the Fed taper. This month though, it appears that gold and the U.S. dollar are headed in opposite directions once again since markets seem to be more convinced that the U.S. central bank is ready to reduce bond purchases sooner or later.

Another intermarket relationship that’s worth taking note of is the one between gold and the Australian dollar. In our School of Pipsology lesson on gold, we demonstrated how the precious metal has a positive correlation with AUD. This is because Australia is one of the world’s top gold producers and stands to gain some serious moolah when gold prices rise.

Lastly, with Switzerland having 25% of its money backed by gold reserves, it might be worth paying attention to the franc’s reaction to gold price action.

There you have it, ladies and gents! If you think that the gold selloff is likely to carry on for the rest of the year, then you could consider a long-term short AUD/USD or long USD/CHF position. On the flip side, if you think that a bounce is in the cards once gold tests the $1,200/ounce levels, you could wait for a reversal on these pairs.