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blew past $1,500 an ounce.
At the heart of it, is fear. Gold is possibly the best fear gauge there is. When investors are scared over inflation, civil war, earthquakes, nuclear reactor meltdowns and debt defaults, they run to gold. Here are the top 5 reasons why gold is popping.
5. Price Manipulation
Price manipulation is the most controversial theory that has circulated among gold bugs for 20 years. Some argue that gold prices have been illegally suppressed over the last two decades by central banks and governments. The Gold Anti-Trust Action Committee, or GATA, is the biggest complainant.
According to the
World Gold Council
, central banks reportedly hold 30,534.5 tons of gold, with the International Monetary Fund accounting for 2,814 tons. GATA argues that central banks actually have less than 15,000 tons of gold, and that the missing gold has been secretly sold or leased into the market to prevent gold prices from rising to their actual value, which should be between $3,000 to $5,000 an ounce.
"The reasoning for the suppression is governments/bankers
look at gold to be a barometer of the health of economies and countries. These suppressors want to kill or at the very least, greatly slow the messenger," argues Peter Grandich, editor of Grandich Publications. The suppression theory means that global economies are in worse financial shape than investors think and that gold should be bought as the ultimate safe haven.
The gold manipulation theory has been gaining traction of late after trader Brian Beatty filed lawsuits at the end of October against
for conspiring to "suppress and manipulate" silver prices on the Comex.
A Chicago law firm, Cafferty Faucher, filed a lawsuit at the end of December against HSBC and JPMorgan accusing the two of using their positions as silver holders to purposefully suppress the silver price so they could profit from their short positions.
The Commodity Futures Trading Commission is now investigating the possibility of criminal activity in manipulating the silver futures market, particularly at JPMorgan.
The belief is that as investors realize that the precious metals market is manipulated, gold and silver prices will rise exponentially, but until then prices will suffer. "Our complaint is that more often now they're doing it surreptitiously as a mechanism of supporting their currencies, supporting government bonds and suppressing interest rates," says Chris Powell, secretary and treasurer of GATA.
The opposition, however, believes that claims of price suppression are completely unfounded. "If this is suppression," says Jon Nadler, senior analyst at Kitco.com. "I think it's completely ineffectual, and let me have more of it."
4. Supply and Demand
The supply and demand factor is pivotal in determining the price of gold. From 2005 to 2009, the gold industry received 59% of its supply from mining production, 31% from recycled or scrap gold and 10% from central bank sales. Many analysts argue there isn't enough gold being produced to satisfy rising demand.
In the World Gold Council's recent Gold Demand Trend report for 2010, gold mine supply rose 3% for the year to 2,659 tons as gold miners hustle to produce gold at record high prices. The above ground supply is estimated to be around 165,600 metric tons and for now, heavy demand has sopped up the extra supply.
But the wild card in the supply and demand thesis is the end of producer de-hedging
Miners had been buying gold from the open market to eliminate hedging positions, where they had previously locked in gold sales at a certain, lower, price. Now, all the big hedges have been eliminated. The move in of itself is a bullish indicator but the role of producer de-hedging had been instrumental in pushing gold prices higher and without it the market loses a key driver.
Matthew Piggott, metals analyst, GFMS says the end of de-hedging will force "the
to look to other areas of demand to make up the difference in the absence of price support from de-hedging activity."
One factor that could perpetuate a supply and demand imbalance and higher gold prices is the advent of physically backed gold ETFs. Along with the GLD, the
iShares Comex Gold Trust
ETFS Physical Swiss Gold Shares
hold more than 1,300 tons of gold, about half of annual gold production.
Over the past three years, cumulative supply has grown 59% while demand has surged 62%. This upward trend is expected to continue as investors seek ways to diversify their portfolio with this supply and demand dance being pivotal to prices.
3. Safe Haven and Peer Pressure Buying
Traditionally, gold investing was reserved for
-- those who thought global wealth would be eradicated and gold would be the only currency left standing.
However, as the financial crisis rocked global markets at the end of 2008, a trend started to develop of regular investors allocating a certain amount of their portfolios into gold. The GLD held 614 tons the Friday before
declared bankruptcy and how holds 1,213 tons.
The recommended percentage is typically between 5%-20% depending on how aggressive the investor wants to be or just how much he needs to diversify against other assets. Most retail investors still don't own gold, which is one of the fundamental reasons gold bulls think the price will skyrocket.
"We're going to go into a period like the high tech market where there is a mania," says Rob McEwen, CEO of
, who thinks the market is about half of the way there.
"Your curve is like any other area of the market that suddenly people wake up to and say I have to have it and it goes parabolic ... at some point up there gold is going to achieve a point where its relative purchasing power relative to other assets is going to be at its zenith and that's when you want to start thinking about trading out."
This recent shift of gold as a trading tool as well as an investment was underscored by gold purchases from big-name investors who had profited off of the subprime crisis by betting against mortgage-backed securities.
In the fourth-quarter of 2010, legendary investor
added 24,800 shares of the GLD making him the seventh largest holder behind
currently owns 31.5 million shares.
Soros also owns 5 million shares of the less expensive IAU.
Large investment banks are loading up on gold too.
Bank of America
added 1.3 million shares of the GLD.
dumped large positions, however, in the fourth quarter by selling 4.5 million shares of both IAU and GLD, combined, but the bank did create a small position in
ETFS Physical Gold
Big-name buyers like Soros and Paulson and big banks are significant as they can trigger peer pressure buying. When gold prices pop double digits on high volume, retail investors typically will jump into the trade for fear of missing the opportunity.
On the flip side, when profit-takers sell gold for cash or the crisis premium decreases, momentum buying also slows as investors don't want to be left holding "cheap" gold.
Large swings in the gold price can also point to buy orders or sell stops. When the gold price sinks to or rises to a certain level, a trader will be forced to sell or buy gold. This trading restriction is set up to protect the trader from losses and to protect gains, but often can accelerate sell-offs and rallies.
2. Currency Debasement
The most popular reason to own gold is as a form of money. The theory is as paper currency loses value, gold will retain its purchasing power, making it a safe place to preserve one's wealth.
Historically, gold has traded in opposition to the dollar 32% of the time, according to data from
Standard and Poor's
. A weaker dollar makes dollar-backed commodities like gold cheaper to buy in other currencies, which strengthens demand.
As central banks dealt with the financial crisis by pumping lots of cheap money into the system, they created a nasty side effect: inflation.
China's inflation is at 5.4%, India's is almost 9%, the Eurozone is dealing with 2.7% as is the U.S. and the U.K. is at 4.4%.
The only tool central banks have to fight inflation is to rate key interest rates, something they have to do very carefully in order to not choke off growth. But here's the rub: inflation is rising faster than interest rates creating a perpetual negative real interest rate environment (interest rate minus inflation), which means your dollar in the bank is worth less. As paper currencies lose value, gold shines as a store of wealth.
The U.S. is currently more than $14.2 trillion in debt with $191 billion in interest payments due in fiscal year 2011 fueling rumors among doomsayers that the dollar will eventually be worth zero.
"Intrinsically, the dollar is worth nothing. It's a dream painted on a piece of paper," says Rick Rule founder of Global Resource Investments. Rule predicts higher gold prices in the future because the U.S. dollar will eventually depreciate in value. "There's no particular reason why you, despite the fact that you live in the U.S., need to be a prisoner of the dollar ... use gold money, export your capital."
Despite Washington's promise to tackle the deficit, it has a long way to go to strengthen the fiscal health of the country.
The dollar is also losing its mojo as the world's top currency. BRICS countries -- Brazil, Russia, India, China and South Africa -- have said that they are looking for a broader international reserve currency structure not so heavily reliant on the U.S. dollar. Making matters worse, the countries will now do credit business in local currencies. Lack of love will push the dollar lower and send gold higher.
1. Central Bank Buying
Huge double-digit price movements in gold could mean that there are big players in the market like central banks.
"There has been a fundamental shift in the behavior of central banks over the past few quarters," says Natalie Dempster, head of investment for the World Gold Council. "Central banks on the whole have been net sellers of gold for the past two decades."
Since the second quarter of 2009, however, central banks from emerging market countries have transitioned into net buyers. The
. India now holds 7.9% in gold reserves, which is still considerably lower than the 20% of gold reserves it held in 1994.
One of the biggest buyers is China. Over the past five years, the country secretly increased its gold holdings from 600 tons to 1,054 tons. China currently holds only 1.6% of its reserves in gold. Dempster says that if the continent were to reallocate its holdings to 3%, it would need to buy 1,000 tons of gold. Compare this with the U.S. and Portugal, which hold 70% and 80% of their reserves in gold, respectively.
China is the world's largest gold producer and vies with India for title of largest gold consumer.
Nigel Moffett, head of Treasury at Gold Corp. says, "
China is the world's number one producer, producing 340 tons of gold a year. You don't see any of that coming out of China. You see a lot of gold going into China." Moffatt believes that its central bank is a prominent buyer.
The rumor is that China is trying to beef up its currency, the yuan, to make it a more viable player on the international stage. Not a
, but a gold kicker.
"Some banks," says Dempster, "have been rebalancing as the percentage of gold in total reserves has fallen over time. Others are looking to diversify away from dollar-based assets, and with sovereign debt concerns continuing to grow around the world, gold's attractiveness as a reserve asset that bears no credit risk continues to grow."
In 2010, net central bank purchases totaled 87 tons, according to the World Gold Council, led by Russia, Thailand and Venezuela.
Central banks, in general, regard reserve allocation as an ongoing government policy. Although the governments consider fundamentals like dollar weakness and the sustainability of gold as money, they don't trade gold; they buy it as an investment. They will buy gold when they feel gold reserves are too low when compared to its other holdings.
Central banks tend to be price agnostic, but are heavy buyers and sellers.
Written by Alix Steel in
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