As more and more liquidity is pumped into the global financial system, so gold bugs have become increasingly vocal about the precious metals monetary properties and the importance of hard assets.

And, for good reason, they argue, the metal has been used as a monetary asset for centuries.  But, while it remains a medium of exchange in some places, currently world’s reserve currency is the US dollar. And, any view of gold’s long-term prospects must take account of the outlook for the US dollar.

As the World Gold Council notes, “Gold’s strong inverse relationship to the US dollar – the strongest of all commodities  – is in part driven by a large portion of demand (c. 90%) coming from outside the US, but also by its use as an alternative currency and a US dollar hedge.”

Regarded in this light,  the graph below, from the WGC’s latest Gold Investor publication makes for very interesting reading.

US$ allocations in reserve portfolios have fallen

As is evidenced above, the purchasing power of US investors has eroded over the past four decades, the WGC notes.

“In fact, they lost almost 80% of their purchasing power to inflation and another 30% to a protracted devaluation of the US dollar.”

And, it is expected that this devaluation will continue, the Council goes on, it says that, while the dollar will remain a very relevant currency to the functioning of the global economy, “Market consensus forecasts indicate US-dollar depreciation against 14 out of the 27 major currencies including the Chinese yuan, Australian dollar, Mexican peso, Singapore dollar and Korean won by 2016.”

Importantly, it notes, “these bearish views are firmly supported by weak fundamentals…relative GDP growth, current account deficits and short- and long-term interest rates suggest that the dollar is poised for a decline.”

As a result of these developments, it adds, “reserve asset managers have decreased their US dollar allocation considerably, from 63% in 1999 to 53% in 2012.”

The implications for gold

As the US dollar declines in influence, it is expected that, over time, the basket of currencies employed as reserve assets will expand and, it is thought by gold bugs, the yellow metal will have a much more prominent place in the new basket.

This is very much what the WGC argues, saying, “As the world moves towards a multi-currency reserve system, gold will play an important role as a foundation asset that diversifies risk.

“As more currencies are included in the reserve system, gold’s relationship with other currencies will likely evolve. It is likely that gold will retain its generally negative relationship with the US dollar, but it will also serve as a hedge against all fiat currencies.”

As a result of this, the WGC concludes, “As the monetary system evolves to make room for alternative reserve currencies, gold will have a growing prominence as a balancing mechanism against the risks inherent in fiat currencies.”