Investor Confidence Increases: Gold and Dollar Up on Risk Aversion

Investor Confidence Increases: Gold and Dollar Up on Risk Aversion

The onset of risk aversion usually props the dollar initially followed by the Yen. However, once the sense of insecurity amongst investors increases, gold catches their attention and also begins to rise. While there are no hard and fast rules, this is the usual trend. With the deepening of the Greek crisis and worries on the Euro zone debt, investors seem to have shed riskier assets and taken a cover under the dollar's shelter initially. This made the dollar rise. The Yen is also a natural choice for investors in times of risk aversion and the Yen also rose.However, beyond a point, investors need to feel even more secure and want to get into something that has intrinsic value. Gold becomes their natural choice. With risk aversion setting in due to the Euro zone debt problems, gold also rose. However, investors, while moving under the shelter of safe instruments, are also looking for opportunities for profit taking. As investors try to cash in on profit taking opportunities, the hedge currencies including the Yen and the dollar and gold can move up and down.Thus, in the case of the current Greek debt crisis, the dollar moved up followed by the Yen and gold. However, prices of gold underwent some correction after their initial rise. The onset of risk aversion arising from the Greek crisis propelled the price of gold to a five month, with Nymex June delivery rising $2.60 to $1,183.30 per ounce. However, gold's record high of US$1,227 set in December 2009, due to the prevalent risk aversion at that point of time is yet to be met. The differential in the current price of gold and the December 2009 gold price also indicate the level of risk aversion prevalent as well the condition of the economies.The rise in the price of gold can actually be viewed as a fall in the value of currencies due to new inherent risks being factored into them. If the price of gold were to rise, it should rise uniformly against various currencies. However, it may be noted that in the last six months, while gold was up about 5% in Canadian dollar terms, it rose 23% in Euro terms and 19% in terms of the British pound. This uneven change in the price of gold relative to other currencies clearly shows the quantum of risk being factored into the Euro and the pound, with Europe being the closest to the Greek crisis and taking most of the responsibility to bail out the nation. Under normal circumstances, the price of gold and the US dollar move in opposite directions. However, once economic uncertainty sets in, the two tend to move in tandem. As of now, the US dollar is the main reserve as well as the key hedge currency. Risky economic developments lead the US dollar to come in greater demand. However, if the US economy were to be hit by a Greek kind of debt crisis, with its fiscal deficit and current account deficits being unreasonably high, gold could become a primary store of value and its importance will start reflecting in the rise in its value vis--vis other currencies, which in effect would actually be declining versus gold. But, until such an eventuality, the dollar continues to be the king of currencies.

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