What really drives the price of gold? Some say it’s a fear gauge. Others prefer to look at the demand coming from the Indian wedding season. But the silliest of all conclusions to reach is that the dollar price of gold should be determined solely by its value vis-à-vis another fiat currency.

The truth is the primary driver of gold is the intrinsic value of the dollar itself, not its value on the Dollar Index (DXY). The intrinsic value of the dollar can be determined by the level of real interest rates. Real interest rates are calculated by subtracting the rate of inflation from a country’s “risk free” sovereign yield. Right now the level of real interest rates in the U.S. is a negative 1.55%.

A key factor is to then determine the future direction of real interest rates. The more positive real rates become, the less incentivized investors are to hold gold. And the opposite is also true. The more negative real rates become, the more necessary it is to own an asset that is proven to keep pace with inflation. The Fed has threatened to begin lift off from its zero interest rate policy in the middle of next year. However, the Fed has made it clear that it will only raise nominal yields if inflation is rising as well. Therefore, there is no reason to believe real interest rates will rise anytime in the near future.

The intrinsic value of the dollar is not rising; and most likely will not increase for the foreseeable future. The dollar is only rising against other currencies because the value of those currencies are being pummeled by their central banks to a greater extent than our Fed.  The weightings in the DXY favor the performance of the dollar against the euro and the yen. Therefore, just because the nations of Europe and Japan are determined to completely wreck their currencies does not mean that the intrinsic value of the dollar is improving or that the dollar price of gold must go down. In fact, holders of the euro and yen should be more compelled to own gold than ever before.