Traditionally gold is supposed to perform well whenever political risks are high, trade tensions are escalated, or economic growth is threatened, but that has not been the case in 2018. Between rising U.S. interest rates and the strengthening dollar, the bear market for gold could be here to stay.

Relationships Matter

Currencies and gold have an intimate relationship and you rarely see the price of gold and the value of the U.S. dollar move in the same direction. That's because gold is priced in dollars and when investors are worried about the outlook for the U.S. economy, they like to park their money in gold.

The U.S. economy, however, is doing well right now and the prospect of further rate hikes makes gold a less attractive investment. Younger investors also don't share their parents or grandparents' love for the commodity. If they are skeptical about fiat currencies or think governments will collapse, their first thought is often to buy cryptocurrencies. Regardless, if you are trading gold and want to understand if the bear market is here to stay, you've got to be watching the dollar and the path of U.S. interest rates.

Currency Watch List

There are three currencies that will be on the move if gold prices continue to fall. They are the Australian dollar, South African rand and Russian ruble. Although China is the world's top producer of gold, its currency is less sensitive to gold volatility because China decides where the yuan goes, and the economy is large enough that its dependency on gold is minimal. But if gold prices continue to fall it could be very bad news for other gold producers such as Australia, South Africa and Russia.

Gold is down 8.6 percent since the beginning of 2018 and during this time, the South African rand fell 15 percent, the Russian ruble dropped 14 percent and the Australian dollar declined 6.5 percent.

South African Rand

Of all these countries, South Africa is in the most trouble. Its economy is tiny, less than a quarter the size of Australia's, which makes it particularly sensitive to the price fluctuations of a commodity that accounts for one-third of exports. The decline in the price of gold hit South Africa's economy so hard that it contracted at the sharpest rate in nine years in Q1. President Cyril Ramaphosa's growth plans are also overly ambitious and the twin deficits continue to grow. The more persistent the decline in gold prices, the more difficult it will be for South Africa to boost investor and business confidence. Just as it has depreciated the most this year on the back of falling gold prices, a bear market for gold means more losses for the rand.

Australian Dollar

Australia is the world's second biggest producer of gold but compared to South Africa and Russia, a bear market in gold won't hit its currency as hard. The economy is better diversified, and the central bank expects growth to stay on course, which is a rare sign of optimism in today's markets. They've done a great job diversifying away from a mining dependent economy which means if gold prices continue to fall and you don't want to be exposed to the U.S. dollar, an AUD/ZAR spread may be an interesting trade.

Russian Ruble

The most gold-backed currency in the world is the Russian ruble. And like China, there's been a strong effort by Russia to diversify out of U.S. dollars. They've been doubling down on gold and could buy even more if prices continue to tumble. Russia's economy is less sensitive to the price of gold than South Africa's because they import more than they export but whenever there's a sharp selloff in gold, a short-term impact on the ruble is unavoidable.

Written by Kathy Lien. Read more from the author here.

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