Competitive devaluations gain acceptance as justification for higher gold

Section:

Few Obstacles in Path of Bullion Bulls

By Jack Farchy and Sam Jones
Financial Times, London
Friday, September 24, 2010

http://www.ft.com/cms/s/0/16f72c6c-c73d-11df-aeb1-00144feab49a.html

You can't earn interest on it, you can't eat it ... but you can certainly trade it. Gold is more expensive than it has ever been but investors cannot get enough of it.

Fears that renewed monetary easing by the Federal Reserve could lead to sharp falls in the US dollar and, eventually, a jump in inflation have sent the gold price to a string of record highs this week. The precious metal was on Thursday trading just shy of $1,300 an ounce, with analysts predicting it could surpass this level within days.

The hedge funds and commodity traders that snapped up gold earlier this year, betting on its traditional status as a store of value at times of turmoil and as a hedge against possible future inflation, are already sitting on healthy profits following a spectacular rally.

... Dispatch continues below ...



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That might be a signal to sell. But even among those who believe the market is now in bubble territory, there is little conviction prices are about to fall. "There is little sign of anyone going short gold," says Kamal Naqvi, head of commodity sales at Credit Suisse.

That view is almost universal among bankers who advise and trade with hedge funds, private banks, and other gold investors. Several bankers contacted by the Financial Times this week said none of their clients were looking to bet against the yellow metal. In the past six trading days gold has written five new records.

The precious metal, already in a 10-year bull market, has been driven higher by a combination of factors.

One of the biggest influences on the price has been the behaviour of central banks. The Fed's efforts to pump money into the economy to revive lending and growth have already raised fears of a surge in inflation later. That has made gold an attractive bet for some.

Moreover, after selling gold from their reserves at a rate equivalent to 10 per cent of annual demand for two decades, central banks have now turned buyers.

In the last two weeks, action by some central banks has also raised the prospect of a round of competitive devaluation of paper currencies, which has been supportive for gold.

First, the Bank of Japan last week intervened to weaken the yen for the first time in six years. Then the Fed on Tuesday signalled it was prepared to initiate a second round of quantitative easing. Its statement drove the dollar sharply lower.

"Lately the thesis of competitive devaluation as a driver for gold has become much more accepted by the mainstream," Mr Naqvi says. "There is not a country in the world that wants a firmer domestic currency. The result is devaluing currencies against hard assets, and gold is the obvious barometer of that."

Some of the most influential speculators in the gold market are hedge funds -- many of which have been taking unusually large positions in the precious metal. Traders say the latest leg of the rally, which has lifted gold 12 per cent from below $1,160 in late July to its peak of $1,296.10 on Wednesday, has been driven more by hedge funds and other money managers than by small-scale retail investors.

The most prominent hedge fund in the gold market is Paulson & Co, which is renowned for correctly calling the collapse of the US subprime housing market. Paulson & Co denominates a third of its $33 billion in assets in a special "gold" share class.

In fact, gold is the group's largest single position. The $3.4 billion stake in the SPDR Gold Trust, a listed US instrument backed by physical gold, equates to a greater tonnage of the metal than Australia holds.

Even funds that have historically shied away from the metal are now laying on positions designed to profit from a further rally. One large multi-billion dollar fund manager recently laid on a trade designed to profit from a rise in the price of gold to about $1,500 an ounce.

"Lots of hedge funds have been buying even during the past few days," said one trader. "A lot of what is driving it is technical rather than fundamental."

Mr Naqvi adds that many managers are under pressure to find a profitable investment after a punishing summer. "Clients are under some pressure to put money to work and the gold story remains a good one," he said.

For many hedge fund managers trading in gold can not only be profitable but can help to lower the risk profile of their portfolios by diversifying them away from dollar currency risks. "Playing gold as a currency trade is much more straightforward than trying to mess about trading the dollar versus the yen or the euro," says one.

For now, the physical market is providing further support. The supply of scrap gold, which usually rises when prices hit records, has remained surprisingly slow. Afshin Nabavi, head of trading and physical sales at MKS Finance, a gold refiner, says: "With these prices we had expected to see much more."

Analysts, therefore, believe there is plenty of scope for further short term gains in the gold price. Adjusted by inflation, current record prices are far below the levels touched in 1980, about $2,300 in today's money.

The market, though, is divided on bullion's longer-term prospects. George Soros has described the metal as the "ultimate bubble."

"It may go higher," the legendary investor said last week. "But it's certainly not safe and it's not going to last forever."


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