Investing in Gold – Prices Up Due to Crisis

Investing in Gold - Prices Up Due to Crisis

by David Redmond on 31 Mar, 2011

Gold has been on the rise both in terms of popularity and price per ounce since the banking crisis began in 2007, and in the face of political crises in the Middle East and natural disaster in Japan, prices are soaring yet again.

By its very nature gold is an insurance investment. It hedges against collapse of commodities and currency markets, is not shocked by most political upheavals and is truly international. Its movement in and out of favour is therefore decided by the relative risk-reward balance of the rest of the market. And right now, the market is a very risky place.

A couple of months ago gold was beginning to lose its edge in the market. An increasing appetite for risk coupled with lesser worries of inflation was leading investors back towards pre-crash behaviour. Yet just as investors were beginning to take on fresh risk, the markets were rocked by the tsunami in Japan which has pushed worry around the world and with it sent the price of gold up once more.

Central banks, who tend to take more long term position on the markets, are in a similar position. With the US dollar weakening and facing continued devaluation through quantitative easing many central banks who bought big on the dollar are having to reallocate risk. China is one of these nations holding as it does around $892bn of US bonds. In response the rising power will no doubt look to boost its relatively weak position in gold which currently stands at 1.7% of its total forex reserves.

And it’s not just the West who are looking to diversify. Emerging economies who characteristically fail to back their economies with gold are now looking to add some support to their currencies. A prime example being Russia who purchased 135 tonnes of the precious metal in 2010.

The question for market players and central banks is how far above its current position of $1,405 will gold continue to climb, and when will it come down?

Market followers generally see gold moving above $1,500 at some point in 2011 before going on to $2,000 by year-end 2012. Yet this position is always subject to general market performance. If the global financial system is able to operate for a year without any major external shocks then it is unlikely gold will achieve these values. Quite simply the gains available in the open market and the focus of most investment banks on short-term currency, commodity and derivative markets mean that gold’s value will only continue to rise if other markets fail.

So whilst it is understandable that central banks who must focus on a far longer-term and less risk-positive portfolio have been net-buying gold for the first time since 1988, the rest of the market should not be so bullish.

Short term shocks will indeed push the price of gold northwards but in the medium term there is increasingly less reason to be averse to currency dependant portfolios in the year ahead and the markets should begin to truly return to business as it was before the credit crisis; in particular in the lending markets. The result should be gold should beginning to level out. Until then, hawkish investors can as also hope to cash in on gold during a crisis.

About the Author

David Redmond

David Redmond is a Partner of Don Gilliard Finance Group. He is a fee-only, independent financial advisor and financial planner. For over 15 years, he has been helping individual investors and their families realize their investment goals.