Want to Capture the Timing of Gold’s Ups and Downs? What Signals are Being Sent by the Dollar Index and Inflation?

TradingKey - The U.S. dollar and gold are a natural “teeter-totter” duo.

You can imagine the dollar and gold as two children sitting at either end of a seesaw.

When the dollar rises (appreciates), it pushes gold (XAUUSD) down (causing prices to decline); conversely, when the dollar dips (depreciates), gold bounces up (resulting in price increases).

(Source: Shutterstock)

The U.S. dollar index exerts a significant influence on gold prices, acting as a hidden force.

But what exactly is this index?

In simple terms, the dollar index measures the exchange rate of the U.S. dollar against a basket of currencies—specifically the euro, yen, pound, Canadian dollar, Swedish krona, and Swiss franc—reflecting its strength in the international foreign exchange market.

To illustrate, envision the global currency market as a vast fruit market where the U.S. dollar is akin to an apple—the most common and frequently traded fruit.

Other currencies represent various other fruits: for example, euros are likened to oranges, and yen are likened to bananas.

The dollar index functions like a “fruit price composite index,” which shows changes in apple (dollar) prices relative to other fruits (currencies).

When the dollar index rises, it indicates that apples (the U.S. dollar) are becoming more expensive compared to other fruits (currencies), reflecting dollar appreciation. Conversely, when it falls, apples become relatively cheaper—indicating a depreciation of the U.S. dollar.

(Source: Freepik)

Why Does Gold Get a Cold When the Dollar Sneezes?

Three key factors underpin this relationship:

Natural Currency Binding

Around 80% of global gold transactions settle in dollars; thus fluctuations in its strength directly impact your shopping expenses.

For instance, if you’re a European investor looking to buy gold with euros:

When the dollar index rises (indicating appreciation), each euro exchanges for fewer dollars; consequently, gold appears more expensive in euros—you might hesitate: “Maybe I should wait?”

Conversely, when the index drops (indicating depreciation), each euro buys more dollars; hence gold feels discounted against euros which may prompt you to think: “I should stock up while it’s cheap!”

Competitive Relationship with Safe-Haven Assets

Both the dollar and gold are regarded as safe-haven assets, but investors tend to be like fickle diners, rarely favoring both dishes at the same time.

During periods of economic stability (such as strong U.S. employment data), one might think, “Why buy gold when I can store money in dollar assets (like government bonds) that guarantee principal protection and earn interest?” At such times, gold is often overlooked, leading to a decline in its price.

However, during times of crisis, concerns may arise regarding the safety of dollar assets.

Consequently, investors may pivot and rush to purchase gold; during these moments, both assets might experience a short-term upturn. Nevertheless, in the long run, a stronger dollar continues to exert downward pressure on gold prices.

Federal Reserve's Policy as a "Conducting Stick"

When the Federal Reserve raises interest rates, yields on dollar deposits rise. Investors become more inclined to hold dollars for interest earnings, causing gold—known as a “non-yielding asset”—to be discarded.

Alternatively, when interest rates fall and the expense of maintaining dollars decreases, gold gains greater appeal.

Investors might reason: “With interest rates so low, it makes sense to buy some gold instead for preservation of value.”

In addition to the dollar index, inflation plays a significant behind-the-scenes role in influencing gold prices.

It resembles a fickle weather forecaster, at times sending gold prices soaring like a hot air balloon, while other times it quietly supports prices as if covered by an insulating blanket.

So, what exactly is inflation?

From a practical perspective, inflation is commonly expressed as “money becoming less valuable.”

For instance, if you could buy 5 apples for $10 last year. However, this year, the same amount of money only buys you 3 apples—demonstrating the effects of inflation.

From a more technical definition, inflation refers to a period where the supply of money exceeds its actual demand within circulation conditions.

This occurs when current purchasing power surpasses production supply, leading to currency devaluation and consequently resulting in widespread and sustained price increases.

If the money in your pocket keeps shrinking—say yesterday you could buy 10 pounds of rice, but today you can only buy 9—what would you do?

Astute individuals would quickly convert their cash into “things that don’t depreciate,” with gold being the most traditional choice.

Given that global gold reserves are finite, mining one ton of gold ore is certainly more challenging than printing a hundred million banknotes.

Therefore, when paper currency floods the market, gold shines through like an oasis in the desert.

For instance, in 2021 U.S. Consumer Price Index (CPI) rose by 5.4% compared to last year, marking the highest increase in three decades.

Although gold prices did not breach the highs of 2020, they still rose by 7% throughout the year—outpacing most other assets.

Here we see that investors are not merely “buying gold,” but rather “purchasing an insurance policy against currency devaluation.”

However, the relationship between inflation and gold prices isn't always as straightforward as it seems; it comes with complexity.

Mild Inflation (2%-3%): The market may find this “tolerable,” leading central banks to refrain from hastily raising interest rates. In this scenario, gold prices might experience slight fluctuations.

High Inflation + Central Bank Rate Hikes: When central banks implement tight monetary policies such as interest rate hikes to combat inflation—this may effectively lower inflation rates but simultaneously raise the opportunity cost of holding gold. Since gold does not generate interest income depositing money in banks or investing in other yielding assets can reap some return. In such a scenario, some investors may cut back on their gold investments, putting downward pressure on its price.

(Source: Freepik)

To better understand the intriguing “teeter-totter” relationship between the dollar and gold, let's take a closer look at their trends over the past decade.

Over the last ten years, movements in the dollar index and gold prices have predominantly exhibited an inverse correlation—when one rises, the other tends to fall.

(Source: TradingView)

Key Milestones

• 2014: Conclusion of Quantitative Easing Marks a Revival for the Dollar

Do you remember when the Federal Reserve announced it was ending Quantitative Easing (QE)?

It was akin to turning off a monetary faucet. The dollar index surged from 80 to 100—a remarkable 25% rise—marking its fastest appreciation in nearly a decade.

During this period, gold prices fell from 1,300 per ounce to 1,100—a decline of 15%. Observers likely noted that every time a Federal Reserve official mentioned “ending QE," gold appeared to deflate like a punctured balloon.

• 2018: The Quartet of Rate Hikes Pressures Gold Prices

In this year, the Federal Reserve raised rates four times, pushing them from 1.5% to 2.5%. The dollar index climbed to 97 amid growing market sentiment favoring “dollar dominance.”

As a result, gold retreated from 1,350 at the beginning of the year to 1,200 by year-end—a decrease of 11%. Most dramatically in December during the last hike announcement, gold briefly dipped below $1,200.

• 2020: Unforeseen Pandemic Triggers “Dollar Decline and Gold Ascendancy”

As COVID-19 swept across the globe, the Federal Reserve rapidly cut interest rates to zero while initiating unlimited Quantitative Easing (QE).

This caused the dollar index to plummet from 103 down to 92—the largest annual decline since 2008.

Consequently, gold prices soared from 1,500 up to an all-time high of 2075—representing an extraordinary annual increase of 38%.

Gold price charts displayed consistent upward trends during this time, whether day or night. As global investors pondered one crucial question: “With so much currency being printed, what can retain its value?”The unmistakable answer was—gold.

• 2022: A Year of Aggressive Rate Hikes with Gold's "Resilient Comeback"

The Federal Reserve executed a combination of “rate hikes plus balance sheet reductions,” driving interest rates up sharply until they reached 4.5%.

The dollar index soared as high as 114 (the highest level in 20 years), prompting many market participants to speculate that gold prices would drastically decline.

Gold initially fell to 1,610, experiencing 1,800, resulting in a slight overall decline of just 0.4% for the year.

• 2025: Trump's Tariff Turmoil Fuels Gold's Meteoric Rise 

In 2025, the Trump administration implemented a "reciprocal tariffs" policy, imposing matching duties on major trading partners starting April 2.

During this tariff crisis, the DXY (US Dollar Index) experienced significant fluctuations, frequently dropping below the critical 100-point level.

The turmoil bolstered gold's safe-haven appeal, driving prices to surge beyond market expectations during this period.

(Source: Freepik)

With this in mind, we should keep a close watch on three key economic indicators to help predict gold price movements in advance.

Dollar Index

You may recall the relationship between the dollar and gold that we discussed earlier, likened to a teeter-totter.

When the dollar index starts to surge, it’s akin to one end of the seesaw suddenly becoming heavier, which is likely to depress gold prices.

In such a scenario, if you already hold gold, it may be wise to consider reducing your position to lock in profits.

Conversely, when the dollar index begins its decline, it could signal a springtime for gold; this might be an opportune moment to increase your holdings at favorable prices.

Inflation Rate (CPI Data)

Should inflation rates start climbing higher, it indicates that inflation is quietly on the rise.

At this juncture, gold's inflation-hedging attributes come into play and prices often follow suit upward.

If you notice that CPI has been rising for several consecutive months, it may be a good idea to invest in some gold funds or physical gold—to armor your assets against inflation.

Federal Reserve Rate Decision

Whenever the Federal Reserve meets to decide on interest rate hikes or cuts, financial markets invariably "quake."

During interest rate hikes, yields on dollar deposits increase as everyone rushes for dollar assets; naturally, this leads to neglect of gold.

At times like these, it's prudent to cut losses on any positions you hold in gold without hesitation. Conversely, should a rate cut occur and reduce the attractiveness of the dollar, demand for gold will rise significantly.

What's more critical is paying attention to any signals regarding future policy from the Fed—if they indicate continued monetary easing ahead, good times for gold may still be forthcoming.

However, if hawkish signals emerge it would be wise to tighten your purse strings and proceed with caution!