Gold and the Australian Dollar

Since November 2004 when the GLD gold ETF was introduced gold has had a beta of 0.92 to the Australian Dollar (not including interest) and an annual alpha of 18%. This is based on a regression on monthly data. In other words a 1% rise in the Aussie is associated with a 0.92% rise in gold. I was under the impression from looking at the charts that gold was more volatile than the Aussie. It is more volatile - the standard deviation is 4.58% vs. 2.87% but it isn't exaggerating the moves in the Australian Dollar. Rather the excess volatility is idiosyncratic to gold. On the other hand it has averaged a 1.84% a month return vs. 0.47% for the Aussie in USD terms. Interest would have almost doubled that monthly return for the currency though. So holding gold was a bit less than twice as good as holding the Australian Dollar. The MSCI returned 1.06% with a similar volatility to the AUD. For a US investor, Australian Dollars were about a wash with investing in a globally diversified stock portfolio during this period. Gold and the AUD had a negative correlation with stocks.

What this analysis means is that going forward this relationship between gold and the Aussie could be maintained without the Aussie appreciating and with gold rising at 18% per year. I think the Australian Dollar will remain strong in the near future, but it is hard to see it rising much more given purchasing power parity considerations and the fact that the Reserve Bank of Australia's next move is likely to be an interest rate cut. The Fed is likely near completion of its interest rate cuts. The recent rise in the Aussie has been driven both by Australia's strongly improving terms of trade and the rise in the interest rate differential between Australia and the US as the RBA raised rates and the Fed cut them. Coal and iron ore prices have recently jumped tremendously, but this move is not just due to demand growth in China and elsewhere but supply constraints in Australia and elsewhere (limited port facilities, floods in Queensland). David Uren wrote an interesting article yesterday in the Australian. The print version has charts of the marginal cost curve for iron ore supply to China. Even a small drop in demand would lower marginal cost and spot price radically. And supply is likely to increase. So the record prices for these two resources are not sustainable. Oil and gold are a different matter. High oil prices make gold more expensive to mine and I haven't heard of a lot of new mining capacity coming on. The same for oil despite the huge new oil field discovery in Brazil - it is only about one year's global oil consumption.

Disclosure: Short gold, long AUD, long stocks (especially Australian ones) :)