No end in sight to the rising price of gold

The reason for the metal's decade-long rally is simple - it is a haven in uncertain times. And economic optimism at the start of the year has now evaporated. Jonathan Spall writes
The yellow metal's price has hit record after record in recents months as economic uncertainty drives more investors to seek a safe haven.
The yellow metal's price has hit record after record in recents months as economic uncertainty drives more investors to seek a safe haven.

Many commentators started the year feeling that the rally in gold had run its course as Europe would get to grips with its debt crisis, inflation would be politically unpalatable in the euro zone leading the European Central Bank to raise rates and there were few signs of inflation in the US.

Consequently, so the argument from some ran, there was no reason to own gold. Indeed there were a number of high-profile exits from the metal at the start of the year and subsequently gold dropped to a little above US$1,300 towards the end of January.

However, such optimism was to be short-lived.

First there was the global political upheaval engendered by the Arab Spring.

The rise in the gold price that followed these momentous events was not simply investors fleeing to a haven; exposure to the oil price might have been the more logical choice.

It was simply a reminder that matters were not as straightforward as some had imagined at the start of the year and the retreat to gold was only reflecting the uncertainty that many felt.

Inflation may well be politically unacceptable in Europe and the European Central Bank has raised rates. However, far from choking off interest in gold, the market's attention has been far more focused on the health and durability of the single currency.

The seeming continual lurch from one crisis to another as the baton was passed from Ireland to Greece to Portugal in an ongoing merry-go-round and now dragging in Spain and Italy as the costs for them to raise debt soars to new highs has obviously been another major blow to investor confidence.

Despite the best efforts of the politicians and central bankers there is little sense that matters have been resolved, or are close to being resolved.

Instead there is an uncomfortable feeling that a series of short-term fixes are being applied to a patient that needs a major operation rather than a series of sticking plasters.

Those looking for some good news might be tempted to point out the US has not had to raise rates as there has been no sign of inflation. Unfortunately the latest economic releases suggest there is scant sign of growth either.

So the market has switched in focus to the potential for a further round of quantitative easing as the administration of Barack Obama looks to kick start the economy.

Obviously poor US economic data is not the only issue that will have concerned investors.

Clearly the debt-ceiling controversy was resolved but not without plenty of brinkmanship and a deal that was signed only with a great deal of nose-holding from the politicians.

Markets dislike uncertainty and that these debt-ceiling extensions, which had previously been passed with a minimum of fuss, could cause America to be downgraded from its top-tier "AAA" status was yet another blow to a market looking for stability.

So in the midst of all the uncertainty the US has lost some of its credential as a haven.

The Swiss franc, which for many has been the escape route of choice, has been declared "massively overvalued" by the Swiss National Bank. Whether the market takes much notice of this over the longer term is a different matter though.

Realistically the US treasury market will remain the bulwark for many against financial meltdown not least because there is no other market able to accommodate the massive flows that constitute the global markets.

Here lies both the advantage and disadvantage for gold.

It has none of the baggage that either the US dollar or Swiss franc have; unfortunately it is a very small market and as such even relatively modest inflow from global investment funds will have a major impact on the price. Hence the sharp moves that we have seen since the lows of the year and even over the course of the past month.

Gold is about 28 per cent up from its price in January.

In the short term the recent sharp rises in its price probably mean the rally is a little overstretched.

However, the recent purchases of gold by the central banks of Thailand, South Korea, Russia and Mexico will have served only to highlight the attractions of gold when added to a balanced portfolio. Doubtless other central banks, sovereign wealth funds, money managers and private individuals are looking at ways to buy the metal.

So despite the fact that gold has enjoyed a near 11-year run where the price has increased more than six-and-a-half times, its outlook continues to look positive.

After all, what are the alternatives?

Jonathan Spall is director, commodities distribution at Barclays Capital and is the author of How to Profit in Gold. He is based in London

Published: August 8, 2011 04:00 AM


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