Gold reaches new highs amidst dollar and euro worries

Posted on : Thu, 28 July 2011

Gold has risen to over US$1,600 per ounce, up 30% on the average price in 2010. QNB Capital argues that this rise is a consequence of gold being seen as a safe haven while uncertainties hang over the major currencies.

The value of gold reached new heights in July 2011 against the US dollar, euro, Japanese yen and British pound. These are the four most heavily traded currencies, involved in over three quarters of all foreign exchange transactions.

The gold price has been rising strongly over the last two years owing to demand from private investors and some central banks. This has partly been in response to the US, Eurozone and UK expanding the supply of their currencies to help revive their economies from the 2009 recession.
The gold supply, on the other hand, increases at a slow and predictable level through mining, growing by about 1.5% a year.

Many central banks hold large amounts of gold in their reserves, equal to 18% of the global above ground gold stock of around 168,000 tonnes (now valued at over US$8trn). A similar amount of gold is held by private investors in the form of gold bars and coins, who often view it as a hedge against inflation.

The majority of global gold, about 51%, is in the form of jewellery, much of it used to store wealth. Gold also has direct uses in industry, electronics and dentistry. This wide range of uses—as a currency, asset or commodity—complicates assessments of gold’s fair value.

Although gold has reached historical highs in nominal terms, it is still well below its all-time-peak in January 1980, if adjusted for inflation. Its price at the peak was equivalent to about US$2,400 in current prices. Bullish traders also argue that if gold is compared to commodities and assets, such as oil and equities, rather than currencies, it may not yet be overpriced.

In any case, the jump in gold over the last month has been driven by the serious concerns weighting down on the US dollar and euro. This has intensified the focus on gold as a safe haven from the risk of currency devaluation.

Debt crises in certain European countries, particularly Greece, have weakened the euro. Meanwhile, the dollar is suffering from the failure of the US government to agree on raising its borrowing ceiling, which needs to happen to avoid the US defaulting on its debt service obligations for the first time.

The crisis in the US could yet be resolved by a last minute deal between Republicans and Democrats. It might also be delayed by a decision to prioritise debt interest payments over other government obligations, such as salaries.

According to QNB Capital, a delay would probably boost gold further, while a deal might lead to a partial recovery in the US dollar against gold, depending on its terms.