Gold Hits $1800: Watch Volatility, Not Only Price

Fear about the turmoil in global financial markets and the fragile world economy could drive the price of gold to record levels last seen in 1980.

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The CME Group raised gold margins by 22 percent after the close of regular trading hours in the U.S. Wednesday. Gold prices continued to soar in evening trade, moving above $1810 per ounce.

Gold rallied above $1800 for the first time Wednesday morning, and closed at an all-time nominal high, after trading with record volume and record volatility this week. The price of the precious metal has risen 20 percent since the beginning of July and is now only 25 percent shy of its inflation-adjusted record price of $2395, reached in January 1980.

Gold has spiked 8 percent over 3 days – the biggest 3-day advance since November 2008. Trading volume in gold futures and options was at an all-time high at the CME Group Tuesday, topping 500,000 contracts and was expected to post another record Wednesday.

Traders and strategists say the main catalyst behind the move is fear, but the continuous climb in the price of gold , itself on increasingly higher volumes, is also attracting buyers.

“People rush to buy and rush to sell based on headlines and make price decisions instead of investment decisions,” says RBC Capital Markets precious metals strategist George Gero. “It’s the fear factor.”

For a great gauge of that fear — look at the volatility.

“This has been the single, most volatile period of trading I’ve seen in my entire career,” says commodities and currencies trader John Netto of M3 Capital. The rise in implied volatility – over the future trading range for gold – “not only portends the fear associated with the stability of the U.S. financial system, but also a global debasement in a basket of currencies. Gold is sitting at all-time highs, priced in dollars, Euros, Pounds , and even commodity currencies like Aussie Dollar."

“There has been a significant and extremely important regime shift toward higher volatility in the gold market this week,” says Colin Fenton, chief commodities strategist at JP Morgan Chase, who raised his price target on gold from $1,800 to $2,500 an ounce on Monday.

Fenton says rather than focus on high valuation or price levels, traders should look at the volatility in the gold market, which is rising for fundamental reasons. The “Gold VIX” (GVZ) – which calculates implied volatility on options on the SPDR Gold Trust ETF –spiked to over 30 percent on Wednesday, the highest level since November 2010.

Higher volatility is an indicative of the perceived risk in the markets of the ability of the U.S. to deal with mounting debt issues, Fenton says. Certainly, Europe’s unfunded liabilities are a contributing factor. But he sees the gold market as the “benchmark barometer of the U.S. Debt Super Committee perceived chances of making a historic grand bargain on reining in the entitlement problem.” The Group of 12 named in the past 24 hours may come up with a solution, Fenton says, “but gold is going to call their bluff until they do.”