THERE’S SCOPE FOR GOLD TO RISE FURTHER

SENIOR ANALYST, ETF SECURITIES

THE allure of gold is unmistakable in the current economic environment. Its attributes as a store of value have historically attracted investors during times of financial and economic uncertainty, and as a counter to inflation and sovereign risk.

While inflation still appears a long way off, gold is being viewed as an alternative to paper currency as central banks around the world flood financial markets with cheap liquidity. And it is not just the Federal Reserve. There is still the possibility that the Bank of Japan and the Bank of England will increase their monetary stimulus and a number of other developed economy central banks could follow.

The outlook for gold must also be viewed in the context of a struggling global economy that faces an overhang of consumer and mortgage debt, high inventories of unsold homes, high unemployment levels and governments that need to tighten public purse strings to stabilise government debt. As a fresh wave of sovereign risk threatens the Eurozone, investors are looking for hard assets to buffer portfolios against the growing risks of currency debasement and possible government defaults. Government debt and budget problems cannot be fixed overnight, but instead take years to be resolved and investor concerns are therefore unlikely to subside anytime soon.

It’s not just private investors that are diversifying portfolios with gold. Even the official sector is diversifying its foreign reserves holdings into gold, with central banks turning net buyers of gold in the second quarter of 2009, driven mainly by the reserve-rich emerging markets such as China, Russia and India.

With gold still around 70 per cent below its all-time highs in real terms, if current macro trends continue, there would seem to be substantial scope for further appreciation. How high the gold price can go will be determined by how well governments are able to manage the dilemma of needing to control rapidly rising government debt while trying to stimulate structurally weak domestic economies. To paraphrase George Bernard Shaw: if you have to choose between trusting the natural stability of gold or the natural stability of the honesty and intelligence of the members of the government, vote for gold.