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[ThatHawaiiGuy]

Rising gold price outshines its world economic influence
By Kevin Morrison
Published: September 11 2003 5:00 / Last Updated: September 11 2003 5:00

Gold has traditionally been regarded as a safe haven in times of global uncertainty. The approach of today's second anniversary of the September 11 attacks on the US has triggered a rally in the gold price as fears of more terror attacks take hold. Bullion's price closed at a seven-year high of $381.05 in London earlier this week.


Gold's role in the world economy has been in decline over the past two decades. The gold standard was abolished as a currency peg in 1968. Its biggest user, the jewellery market, has remained static for years and there has been no new industrial use for the metal in decades. Central banks have also been reducing their holdings.

The financial importance of the metal has fallen with the growth of fixed interest, equities and derivative products. Annual gold production is worth about $24bn (£15bn) a year, which is dwarfed by the moneychanging hands in the foreign exchange, bond and equity markets. But changes to the structure of the gold market are helping to fuel price rises.

Many view the gold price as a barometer of international confidence. It rises in times of war: it hit its highest level in more than six years in February just ahead of the war in Iraq and has held its ground in the run-up to the anniversary of the terror attacks.

Gold mining shares are likewise enjoying a revival. A benchmark gold share indicator, the Gold Bugs index on the American Stock Exchange, hit its highest point since June 1996 this week. But even though gold shares are doing well, they have still been outperformed this year by the technology-laden Nasdaq index.

The gold price has risen 10 per cent since the start of August, outperforming other commodities such as oil, the price of which also reflects geopolitical fears.

Analysts are pointing to market fundamentals. One reason for gold's gain is the 41 per cent fall in the US dollar against the euro since mid-2001. The dollar's fall was counterbalanced by a similar rise in the gold price. But the relationship between the dollar and gold has diverged over the past three months. Gold was about $40 lower from its current level when the dollar hit its record low against the single currency in June.

Another reason is the buoying effect of large investment inflows into gold futures and options traded on the New York Mercantile Exchange, the world's biggest commodities futures exchange. Investors have bought gold derivatives that account for more than a quarter of the world's annual production.

Inflation may play a part in the current rise. Alan Greenspan, the Federal Reserve chairman, signalled that the pruning of US central bank rates was near an end when the Fed cut rates to 1 per cent on June 25. Since then metals prices have risen strongly. Platinum touched a fresh 23-year high this week. Silver hit a three-year peak on Tuesday, copper last week reached its highest point since March 2001 and nickel has not been higher since May 2000.

Central bank gold sales were until four years ago viewed as a big threat to the gold market.When Gordon Brown, the British finance minister, announced the proposed sale of more than half of the Bank of England's 715-tonne holding in 1999, he provoked outcry among gold producing countries. The gold price fell to a 20-year low of $252. Mr Brown's move led to the Central Bank Gold Agreement in September 1999 under which 15 European central banks agreed to conduct orderly sales of 400 tonnes a year for four years. This agreement expires in a year's time and a new pact is expected to be signed before the September 2004 deadline.

But one of the biggest influences on lifting the gold price is the move by gold producers to buy back long-term gold sale contracts, which is akin to miners buying gold. This is in response to the demands of institutional investors who are averse to the price-warping effect of gold hedging. Hedging typically takes the form of forward sales that enable the producer to lock in a price in the future. The effect is unlikely to be enough to bring back the golden days of the late 1970s when the price soared to $800 an ounce.

"Producers have been the biggest single buyers of gold in the past 18 months, this cannot go on for ever," says Andy Smith, an analyst at Mitsui Global Precious Metals. "Soon the price will have to adjust to reflect the underlying supply and customer demand."

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As gold, so silver...