Solid gold as a hedge against the greenback

As Charles de Gaulle put, gold does not change its nature. And with global economies in confusion, it is as every bit as reliable toda.

A miner walks several kilometres below ground in a gold mine in South Africa.

Over the past few weeks gold has hit yet another record high against the dollar, stopping just shy of US$1,390 before falling back slightly. It has appreciated by 20 per cent against the greenback and 25 per cent against the euro this year.

It therefore makes sense that gold mining companies are entering into hedges ("accelerated selling") that will guarantee cash flow and allow them to secure financing as they seek to bring new production onstream.

Concurrently, European central banks are taking the opportunity to reweight their foreign exchange reserves to redress historic imbalances that have resulted in them holding more than 60 per cent of their assets in gold. This is a clearly unsustainable amountsince there is little yield to be earned. After all, any constituent of reserves that comprises such a high percentage is clearly not optimal and is also a source of unwelcome risk concentration.

Equally, as gold prices recently hit a record high in Indian rupees, demand from India has evaporated. There is evidence of large quantities of scrap gold coming on to the market as people look to cash in on their gains, particularly at a time of such global economic uncertainty.

At least that would be the logical analysis.

Instead, on October 7 and with gold trading at $1,360, AngloGold Ashanti - the world's second-largest gold mining company - announced it had "completed the elimination of its gold hedgebook". In other words, it has bought back gold that it had previously sold but not mined.

A few days later, Resolute Mining issued a press release that stated it was now an "unhedged gold producer". These statements were the culmination of events that started as the amount of gold sold forward by miners, metal that they anticipated producing but was still in the ground, was just 4.8 million ounces down from a peak a decade ago of 111 million ounces.

In 1999, market fears that central banks were about to offload much of the gold they held led to 15 European institutions entering into an agreement to have a timetable for sales. This established a maximum of 400 tonnes that could be sold in any "quota year" to prevent a collapse in value.

In this they succeeded admirably, with the price of gold stabilising and the UK managing to offload half of its gold reserves at an average price of about $275 per ounce. The UK was not alone, with the Belgians, Spanish, French, Swedes, Dutch, Swiss and the European Central Bank also reducing their gold holdings. Why wouldn't they when Gordon Brown, the UK's chancellor of the exchequer at the time, could claim in his pre-budget report of November 1999 that "under this government, Britain will not return to the boom and bust of the past"?.

These institutions filled their quota of 400 tonnes a year for five years. The ongoing enthusiasm for gold sales resulted in this self-imposed limit increasing to 500 tonnes a year from 2004. Once more the ceiling was hit - at least initially. In latter years, against a background of rising gold prices, the desire to sell gold began to pall rapidly and recently it has dwindled to virtually nothing.

Instead central bank activity in the gold market is all about buying gold. China, Russia and Saudi Arabia are among the larger purchasers who have used their rising wealth to diversify their country's assets, with India paying $1,045 an ounce for 200 tonnes a year ago - almost four times the price that the UK sales managed to achieve. Gold imports are buoyant and there is far less of it being sold back to the merchants and banks than had been anticipated.

In effect, we have seen pretty much the reverse of "logical analysis". To further emphasise the irrationality, gold is trading about five times higher today than it was 10 years ago, when there were only 140,000 tonnes of gold in above-ground stocks, compared with today's figure of 165,000.

It has, however, always been an unconventional asset. True, the growth of gold exchange-traded funds (GETF), most notably SPDR gold shares, the most popular GETF, uncovered a whole new class of investors in precious metals. The total assets under management in these products is some 2,130 tonnes of metal worth more than $92 billion - twice as much gold as China's central bank has. While we can see where demand has grown, this still does not tell us why.

For that we have to look at the ongoing concerns about the global economy.

There are claims that Europe needs to raise interest rates to curb Germany's strengthening growthand yet must cut them to help the fragile Portuguese, Greek and Irish economies. Some analysts are accusing the US of being disingenuous as it attempts competitive devaluation of its currency while claiming it is doing no such thing. Others blame China.

Calls to impose tariffs and protect domestic employment as well as the revival of economies come against a background of fear over immigration. Certainly, European government approval ratings are slumping as many leaders struggle to manage expectations in the face of raising retirement ages, austerity packages and social unrest.

Gold is not a perfect asset but it may be the closest thing to one that we have. Charles de Gaulle, the former French president, described the metal in 1965 thus: "Gold, which does not change its nature, which has no nationality, which is eternally and universally accepted as the unalterable fiduciary value par excellence."

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