Three Reasons for Record Gold Prices

Another record high for gold prices today and everybody wants to know why. The yellow metal has repeatedly been rallying to higher highs on strong volume, attracting the attention of traders, investors and yes, even economists.

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And the move has gone well beyond the standard arguments: cheap dollar, “safe haven” in times of inflation; in fact, there are probably more conversations about deflationthese days. So what’s going on?

Three reasons: fear, low interest rates and China.

The euro crisis fed fear that paper currencies could become worthless, and increased the demand for physical gold.

Brian Hicks co-manages a resources fund for U.S. Global Investors. He says, “Strong gold prices are a threat to the fiat paper money system and confidence that central bankers can maintain the value of their currencies."

Hicks adds, "The central banks are in an all out way against debt deflation and they will use extreme measures such as quantitative easing (money printing) in order to escape the debilitating clutches of deflation, all of which serves to weaken our currency.”

Adrian Day, CEO of Adrian Day Asset Management agrees. “Gold's record prices have very little, indeed, to do with inflation. Gold is sending the signal that paper money, and the people that control paper money, can't be trusted.”

And, low interest rates make gold more attractive. Gold does not pay a dividend and unless the price goes up, there is no real return. In fact, if you are holding the gold, you may have to pay storage costs.

“There is a ‘perfect storm’ for gold, says Bill O’Neill, of LOGIC Advisors. “The metal has become the ultimate currency as few want to commit to the Euro, Pound or Yen. And while the U.S. dollar may be the best of a weak lot, it also holds little appeal. Central banks are lessening currency reserves within their asset portfolio mix and that seems likely to continue. Central banks will actually be net buyers of gold in calendar 2010 and I suspect 2011 as well.”

Which leads us to reason three: China.

According to data from the IMF and World Gold Council, as of January, 2010 10 percent of all foreign currency reserves were invested in gold. China had just 1.6 percent of its foreign currency reserves in gold.

While China’s appetite for all commodities is well known, Mr. Day cites a report this week that a Chinese official indicated China is looking to increase its reserves of precious metal, adding to the bullish sentiment in the market.

Man Financial trader Kevin Grady says, “The key to gold right now is the fact that there are value investors waiting for the sell-offs to buy. Our most recent sell-offs have been met with tremendous buying and the fact that we keep making higher lows on these sell-offs means that investors are getting more aggressive.”

And it’s not greed but fear driving these investors suggests Adrian Day. Gold is acting as an insurance policy, investors that have bought are generally not selling and, “they will continue holding their gold until they don’t need it anymore.”