Gold Increasingly Used As Hedge Against Currencies; Gold ETFs Growing

From Exchange Traded Gold: Most commentators have concluded that dollar weakness has been the main factor for the sharp revival in the spot gold price since its mid September low of $574 an ounce.

Yet, as the table to the right shows, gold itself is being used as a hedge against general uncertainty in the currency markets.

Gold, as a store of value and effective currency, has risen by around 11 percent against both the US dollar and yen and has outperformed major currencies such as the Euro, Sterling and Swiss franc. At a spot gold price of $645 an ounce, the US dollar gold price is hovering near a key resistance level of $640 and technical analysts contend that the momentum of a decisive breakabove this level could push the spot gold price towards its May peak of $731 an ounce.

Several factors have precipitated the latest upward trend. When volatility and prices subsided in recent months, physical demand increased once again in the Indian subcontinent, Middle East and Asia. India's gold consumption in the month leading to the Diwali festival season in October rose to 156 tonnes from 70 tonnes, according to Suresh Hundia, president of the Bombay Bullion Association. After de-stocking when prices were soaring earlier in the year, jewelers and other fabricators in Italy and elsewhere began purchasing ahead of Christmas.

Bank For International Settlements, Organization For Cooperation and Development and European Central Bank economists fear that a global excess of liquidity has caused either excessive valuations or bubbles in asset markets, including some equity markets, real estate, private equity and junk bonds. So far there hasn’t been a marked increase in general global inflation, but with energy and other raw material prices still at high levels, there are fears of acceleration.

The dollar is currently weakening with markets expecting US interest rates to either stabilize or slip in a slower US economy. But the appreciation of the Euro, Sterling and other European currencies against the US dollar, Yen and other Asian currencies put pressure on the region’s exporters and economies. European central bankers are threatening more interest rate rises, but some time in 2007, they may well be forced to cut rates. This in turn could lead to a setback in those currencies.

Finally, although there are overtures towards peace between Israel and the Palestinians, the region remains extremely unstable. North Korea and fears about Russia’s power in energy markets and elsewhere are also worrying. All these concerns are encouraging investors to hedge using gold.

Investment in Exchange Traded Gold funds exceed analyst expectations

Gold Bullion Securities [GOLD] was the pioneer and began trading in Australia in March 2003. By the time LyxOR Gold Bullion Securities [GBS] listed in London during March 2004, it held only a few hundred thousand ounces in trust on behalf of investors. When StreetTRACKS GoldShares (GLD) was ready for launch mid December 2004, the amount of GBS gold holdings had risen to almost 2 million ounces worth around $900 million.

The listing of GLD on the New York Stock Exchange in December 2004, defied the negative expectations of some analysts, who did not believe that ETFs would have much impact on gold investment demand. The product took off and by the second quarter of 2005, bullion holdings of gold ETFs had jumped to 8 million ounces. Investment in gold ETFs surged further during the next stage of the gold bull market. As the spot gold price soared from around $425 an ounce in the second quarter of 2005 to a peak of $731 an ounce early May 2006, total global gold ETF holdings rose to around 15 million ounces and are currently around 19 million.

“StreetTRACKS gold has proved to be one of the fastest growing ETFs in the history of the product,” says Dodd Kittsley, director of ETF research at State Street Global Advisors.

The growth in ETF gold holdings, however, has not been strictly correlated to movements in the bullion price. Indeed, during the extensive speculation which drove spot bullion by 33 percent from around $550 late March, towards the May top of $731, gold ETF holdings rose by only a few hundred thousand ounces. This contrasted with a surge in the open interest on Comex, the New York futures and options exchange. The small increase at the time illustrated that gold ETFs attracted medium and long term gold investors. They were wary of the speculative run and were not prepared to chase prices.

When gold tumbled in volatile conditions in May and June, gold ETF investors didn't dump their gold and holdings fell back by less than 5 percent. Moreover as gold had another leg downwards to around $560 during the Northern hemisphere summer months, purchases by investors caused Exchange Traded Gold holdings to rise to around 16 million ounces and by the early winter they were above 17 million ounces. These bargain hunters have been proved correct as the spot gold price has since recovered by 13 percent to around $635 an ounce.

Following that revival, the growth in bullion holdings had again flattened indicating that Exchange Traded Gold investors have once again become cautious. By the end of November Exchange Traded Gold ETFs, notably GLD in New York and Singapore, GBS in London and Paris, GOLD in Australia and New Gold Debentures in Johannesburg held in trust 17.3 million ounces worth $11 billion. Including Barclay’s Gold Trust and products in Switzerland and Turkey, all gold ETFs hold around 19 million ounces worth some $12 billion. The GLD [13.7 million ounces] accounts for 72 percent of the total and the 3.2 million ounces in Gold Bullion Securities products, 17 percent.

The market is now exceedingly liquid. The GLD, for example, averaged a turnover of $217 million a day in October, says Kittsley. Institutions, individual investors and hedge funds are all active users of the product. Morgan Stanley predicts that total global exchange traded fund assets under management will soar to $2 trillion in 2011 compared with $532 billion currently. Kittsley has a more conservative estimate of $1 trillion to $2 trillion in five years time. Growing numbers of institutional and retail investors are investing in Exchange Traded Gold ETFs following positive regulatory changes, and new ETFs are being launched on exchanges around the world. This indicates that the gold ETF share of the global gold investment pool will continue to increase.