Investors are now cottoning onto this reflation trade, and no more so that the world’s maestro hedge fund manager, John Paulson, who has placed a $5bn-plus bet that gold will continue its upward March. He is not alone, with both Chinese and Russian governments building up stock piles of the commodity.
At the end of April, China owned 1,054 tonnes of gold, up from 600 tonnes in 2003. This reflects a move that started four years ago to diversify their holdings away from the dollar, when China broke its currency's peg to the US currency and officially marked it to a basket of currencies. So, while the country continues to be a significant buyer of US Treasury bonds, it has also been raising the proportion of purchases of other currencies and of gold.
This is sensible as gold, priced in dollars, is a natural hedge against weakness in the greenback – which has fallen by 8 per cent on a trade-weighted basis in the past five weeks. Investor demand for the commodity is also being supported by concerns that other large economies could follow the UK and see their top-notch ratings for sovereign debt under review. And remember that economic recoveries are rarely smooth (, 28 April 2009), so it is reasonable to expect periodic bouts of inflationary worries given the reflationary economic policies being pursued.
Investors in the options market have clearly taken note and have been betting that gold will glisten brightly later this year with traders reporting higher-than-usual activity on call options with an exercise price of $1100 an ounce for December 2009 expiry.
The charts also tell a story as gold climbs back towards its record high. More often than not the final leg of a bull market is characterised by acceleration in price. This is exactly what happened in the oil market last summer, and if gold heads above the psychological $1,000 barrier – as I suspect it will do sooner rather than later – it would be reasonable to expect increased buying activity from that point onwards.
One way to try and earn magnified profits from the gold price is through a contract-for-difference (CFD) on an ETF such as ETF Securities' Physical Gold (TIDM: PHAU) and Gold Bullion Securities (TIDM: GBS) products (www.etfsecurities.com). With all the ingredients in place – concerted central bank policy of quantitative easing, reflationary global economic policy, Chinese and Russian buying – gold could prove a sparkling investment. The smartest hedge fund manager certainly thinks so.
