Gold prices look set for a spiral

Hedge funds selling energy stocks, buying gold.

Gold prices are set to rise further as hedge funds have started liquidating their exposure to energy stocks and getting into gold. They are selling energy stocks as international crude oil prices are going down.

This also establishes a new linkage between crude oil and gold in the commodity market.

Traditionally, there is a negative correlation between the greenback and gold and a positive correlation between the euro and gold. This means, gold prices go up whenever the dollar is under pressure. Similarly, gold prices and the euro move in tandem.

So, whenever the euro is invested in gold, there is no appreciation. The trend has now been reversed. Between September and now, gold has appreciated substantially even though the euro has weakened against the dollar "" from $1.2325 a euro on September to $1.1718 a euro on September 18. This signals that the greenback-gold link has been broken and the euro-gold relationship has turned inverse.

"Traditionally, gold is a proxy for currency and has been a perfect hedging instrument. This is why whenever the dollar fell, investors got out of the greenback and took positions in gold. Now, gold has become an independent investment by itself and not a proxy for currency," a commodity trader said.

In fact, the commodity market is discovering a new correlation between crude and gold. "Gold prices are moving up when crude prices are down, "said a source in a foreign institutional investor.

One of the reasons for gold prices going up is the increasing weighting being given to gold by big funds in their investment portfolios. From 5 per cent, the weighting is being doubled to 10 per cent and funds are heavily investing in gold, copper and coffee.

Another factor that has been pushing gold prices northwards is the growing physical demand from India and West Asia..

"Investors in Bahrain and Kuwait are shifting their focus from stocks to commodities as the markets have been over-stretched there. Besides, they are sitting on piles of oil money. Gold, for them, is emerging as a new asset class," said a fund manager.

Spot gold hit yet another high yesterday, touching Rs 7,265 per 10 grams of standard gold. Analysts are predicting that the bull run for the yellow metal will continue and gold may touch Rs 10,000 over the next few months.

The bullishness on gold prices will continue at least till 2007 as capacity expansion for the yellow metal takes longer than other commodities. Gold refineries across the world are running zero hedge positions.

This means the refineries have unbound all forward contracts as the outlook on gold prices is very bullish. Traditionally, 30-40 per cent of refining capacities are sold in forward deals.

However, refineries do cancel these contracts when they are sure that prices will rise further than what has been envisaged in forward deals.

GOLD RUSH: THE INSIDE STORY

Hedge funds selling energy stocks, buying gold

Traditional gold-dollar linkage broken

Gold, euro moving in different directions

Gold, crude prices, too, moving in different ways

Gold refineries running zero-hedge positions