Will a Rising Dollar Hammer Down Gold?

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gold barsA rapidly growing list of reports shows a U.S. economic recovery that's far stronger than most had anticipated just months ago. Weekly jobless claims came in less than expected, manufacturing is surging and even the housing sector is showing some signs of life.

High-profile bears have been throwing in the towel on pessimistic forecasts, and safe-haven assets like government bonds have sold off sharply in recent days.

But the growing optimism could prove catastrophic for another investment that has seen a tremendous pile-on over the last few years: gold.

Since it generates no income and is impossible to value, gold bugs have considerable leeway in justifying their perpetually bullish stance on the precious metal. Whether inflationary or deflationary times are ahead, for example, gold prices can only go up, according to their theory.

A Global Flight From Safety

And yet recent data suggest that neither of these contrary scenarios is materializing, and a happy middle might lie ahead instead. November's consumer price index data released this week, for example, showed that inflation remains modest. And rapidly climbing Treasury yields signal that the deflationary fears paraded over the summer are fading fast as investors become less willing to accept meager yields in anticipation of declining prices.

Some commentators have chalked up rising yields to the market's growing dissatisfaction with U.S. government debt rather than investors' increasing risk appetite. But investors have been leaving safe-haven assets all over the world, including German bunds and Japanese government bonds.

Investors would be wise to recognize that the rising but still manageable Treasury yields are instead a signal of a growing normalization for the U.S. economy. And even as the contradictory long-term cases for gold recede, a rallying U.S. dollar could be the catalyst for a near-term correction. Indeed, gold prices took a hit this week amid predictions of a rising dollar, closing on Thursday at $1,370, down $15, or 1.1%.

Not Much Industrial Value


That trend could be just getting started. As interest rates in the U.S. rise more quickly than elsewhere, the dollar could be poised for a bounce. Like other commodities, gold tends to see its price move inverse to the greenback.

But unlike other commodities -- for example, oil -- gold has little industrial use. That means economic growth doesn't result in extra demand to offset a rising dollar.

An entire cottage industry ranging from shady cable personalities with questionable endorsements to companies pushing gold coins of dubious quality has profited handsomely by presenting gold as a solid investment. Investors, though, should realize that it has actually performed horribly compared with income-generating investments like stocks over time and tends to be highly volatile. Gold prices have fluctuated wildly over decades.

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That volatility could get even more extreme as new instruments like exchange-traded funds have made piling in even easier. But the vast numbers of first-time buyers who have gotten in knowing only big gains could quickly head for the door when things turn, adding to the sharpness of a sell-off.

The big downside risks and potential volatility should be particular warnings to investors who, unlike speculators in hedge funds, might need their cash to pay expenses at some point.

As the U.S. economic picture continues to brighten, inflationary and deflationary scenarios lose their grip, and the market increasingly anticipates a resurgent dollar. As the country's fortunes finally rise, gold bugs could finally see theirs dim.
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