Precious metal's golden future seems assured

Saudi Arabia joins Russia, China and India in purchasing large amounts of gold.

A large part of gold trading is about psychology.

According to statistics compiled by the World Gold Council and released this week, the Saudi Arabian Monetary Agency (SAMA) has increased the amount of gold it owns from 143 tonnes to 322.90 tonnes, making it the 16th largest holder of gold in the world. In buying this metal, Saudi Arabia has aligned itself with China, Russia and India as the biggest purchasers who have made their transactions public but they join a whole host of smaller names that have also elected to put more of their assets into precious metals. The kingdom has declined to reveal more details and rumours naturally swirled as to where the gold might have come from, with the IMF being a prime candidate.

In the end though, it matters very little whether SAMA bought from the IMF or in the open market. The result is simply that another central bank has added to its gold reserves. More tellingly, central banks in European countries, which were forced to timetable their selling back in 1999 as the market dropped as low as US$250 an ounce, have sold less than 2 tonnes of the precious metals in a period where their agreement allows for 300 tonnes of sales - not exactly indicative of a desire to lighten up on their holdings of this metal despite the price being some five times higher than that achieved on some of their sales.

However, these types of transactions are about both economics and politics. The first part of this would make it logical that with the gold price having soared, we could see more selling from central banks. However, the political element of this means it is far less likely the institutions holding almost 20 per cent of all the gold that has ever been mined are interested in disposing of it; it is not an easy transaction selling gold when the population is buying it and is liable to criticise an institution selling the country's "heirloom". As we have seen, there are more countries looking to add to their stocks of this metal than looking to sell, despite current levels hitting record highs.

This strikes at the very essence of gold: it is just as much a psychological trade as an economic one. Hence an asset that was languishing at $250 just 10 years ago and was largely forgotten is now trading five times higher and is confidently cited by many as having considerably higher to go as investors look for an asset that cannot be debased or devalued by the actions of others. Sigmund Freud, the founder of the psychoanalytical method of psychiatry, once said: "Our fascination of gold is related to the fantasies of early childhood."

While I am not sure I would endorse that, there is little doubt that advertisers look to tempt us into buying their products by associating it with gold - think about credit cards, chocolate and even make-up. It is a hook that is meant to make us feel the product is special and appeals to our basic values. While it may seem like a stretch of the imagination, this is also much of the rationale behind the way gold trades. When monetary authorities are seen as being strong and having achieved the perfect balance between growth and low inflation, there is little need for an investment that has no yield, at least for small holdings. However, when those same authorities are attempting to steer a perilous course between the dangers of runaway inflation and deflation and there is a perception that the outcome is uncertain, then the outlook for gold changes dramatically.

It is at this point we find ourselves now. Investors are concerned about the state of the world and looking for the reassurance that an investment in gold can bring. Hence, we are likely to see new buyers of gold as the price goes higher but these will be from non-traditional gold-buying areas of the world with different motivations to the usual purchasers. However, while many of the new investors will see gold simply as a currency, it is also a commodity and while the market's attention is fixed firmly on the attributes of gold as a hedge against uncertainties in the global economy, it must never be forgotten that there are those who also buy gold for uncertainty of a very different type - for example the estimated 10,000 to 15,000 tonnes of the metal being held within the Indian rural economy as a form of savings. If they should decide to divest, then their collective holdings dwarf even the recent purchase by the Saudi Arabian central bank.

Jonathan Spall is a director of commodities at Barclays Capital and is based in London