Gold's chances of reaching $1000

By Neil Behrmann

January 2008:- The momentum in the gold market has driven gold past the 1980 high of US$850 an ounce.  If the dollar remains weak, the market could drive it to $1,000.

These are no longer the predictions of gold bugs who forecast economic apocalypses, but main stream analysts and economists. The prime reason why gold has soared 31 per cent since the middle of last year to around $870 an ounce is that the US Federal Reserve and European central banks have pumped money into the system to counter a credit contraction. Worried investors bought gold as a safe haven on fears that banks would collapse and that the increase in liquidity and lower interest rates would lead to inflation. The surge in oil prices accentuated those fears. Indeed, gold has not only soared in US dollars but in euros, sterling and other currencies (see table).

Rising prices caused hedge and managed futures funds to build up net bull positions of more than 22 million ounces of gold on New York's COMEX, according to the Commodity Futures Trading Commission. The open trading positions on the exchange have reached record levels of around 64 million ounces, equivalent to more than half of annual world supplies. At these levels gold is volatile and risks have increased.  The sharp decline in recent days is one such example

Gold ETF's role in bull market

A major boost for gold has been the advent of gold exchange traded funds (ETFs) in the past four years. The growth of this gold product has been extraordinary. It is arguably the most significant gold investment development since gold futures and options trade began on New York's COMEX in the early 1970s.

Gold ETFs were launched in Australia and London, but the listing of StreetTracks Gold Shares (GLD) on the New York Stock Exchange in October 2004 set the pace for the surge in gold ETF and general gold demand. By the second quarter of 2005, bullion holdings of Gold ETFs had jumped from 2 million ounces in 2004 to 8 million ounces. Bullion inventories of GLD, the market leader by far, and other gold ETFs have since reached around 27 million ounces worth around $23 billion.

Gold ETFs are popular because large and small investors and speculators can buy them easily on stock exchanges. Each gold ETF share comprises one tenth of an ounce of gold. An investor who buys 1000 shares in a gold ETF, for example, is buying 100 ounces of gold.

Gold ETFs such as StreetTracks which is listed in New York and other parts of the world, including Singapore, are trustees on behalf of investors for physical gold bullion deposited in dedicated banks.

The gold is held in 'allocated accounts'. This means that the gold is held on behalf of gold ETF investors. They are the sole owners. The gold bars that are deposited in the banks' vaults, are numbered and placed on shelves.

They are labelled and are the property of the individual gold ETF owner. Even though the gold is held on the bank's premises, it is neither the property of the bank nor the liability of the bank. The bank is the safe keeper.

Thus if the bank fails, its creditors cannot claim the gold as part of the bank's assets. Ordinary bank deposits, unallocated gold, which is kept in a pool on the bank's premises and gold futures and options derivatives, do not have this security. Gold ETFs are thus a safe haven.

Prior to the arrival of gold ETFs, investors who feared a systemic financial collapse and possible bank failures, had to pay higher storage and insurance fees of allocated bank accounts.

The fees vary according to the amount of gold that the bank stores, but are obviously higher for medium and smaller holdings.

In contrast, gold ETFs charge only 0.4 per cent annual management fees. They include storage and other expenses and are the same for big or small investors.

Golden Risks

The gold bull market has been in force since 2001 when September 11 precipitated a flight into bullion. Wealthy US, European, Middle Eastern, Asian, South American and other investors, who have been concerned about a weak greenback, credit binge, excess speculation, inflation and a potential financial and economic crisis built up holdings of physical gold in bullion and private banks.

At some point the golden party will end, but it is difficult to determine at what price. Jewellery and physical demand has declined because of high prices. But the main risk is recession and a fall in prices of shares, property and other assets.

Gold enthusiasts claim that bullion will not fall in a general stock market downturn. History shows that indeed it does. The direct risk to gold is the possibility that hedge funds and other speculators are forced to dump overvalued copper, zinc, lead and other commodities. Losses on these commodities would force the speculators to sell gold.

The dollar is a key factor. When markets become excessively bearish about currencies, they can turn unexpectedly.

The dollar and dollar linked currencies, such as China and other Asian exchange rates have become increasingly undervalued relative to the euro, sterling and other European currencies. History shows that gold tends to fall in most currencies during a US dollar upturn.

 

Gold's performance in various currencies

Currency

2000/2001 low

January 2008

Gain

US dollar

255

873

+242%

Yen

3000

9450

+215%

Indian Rupee

12,000

34000

+183%

Sterling

180

443

+146%

Euro

280

594

+112%

Australian dollar

480

1000

+108%

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