The Relation of the US Dollar with Oil Prices, Gold Prices, and the US Stock Market

Abstract

The purpose of this paper is to study the relation of US stocks, gold, and oil with the US dollar foreign exchange rate. First it is demonstrated that the law of one price holds for US stocks, gold, and oil. This law specifies that a 1% appreciation of the US dollar leads to a 1% fall in the price of stocks, gold, and oil. This is true for the simple reason that stocks, gold and oil are denominated in US dollars. Next intrinsic returns are calculated. Intrinsic returns are defined as those asset returns that treat the US dollar unchanged. Although raw returns are marginally negatively correlated with the US dollar, intrinsic returns and the US dollar are essentially independent. Nevertheless the paper uncovers a calendar break in September 2002. Before this date raw and intrinsic returns of US stocks are positively correlated with the US dollar, while they are negatively correlated afterwards. The implications for portfolio analysis are clear-cut: investors should hold a portfolio that is long in equity, gold and oil, although oil has on average a zero return and suffers from excess volatility. It may seem that foreigners benefit additionally from a stronger dollar. However the US dollar has itself a zero average return.