What gold prices say

Gold has been the conventional hedge against uncertainty and risk. At the first sign of a crisis, investors flock to gold, forsaking paper assets. And there's little doubt that at present there's no shortage of risk in the global markets, ranging from concerns about the massive US current account deficit, inflated markets, a housing bubble in the US, growth in China and India putting pressure on raw material prices, and the steep rise in crude oil prices to fears about the next terrorist attack.

Given all these uncertainties, it's no surprise that international gold prices seem to be headed for 17-year highs. Last week, it was the rise in the June US current account deficit which was the reason for the yellow metal's rise, because this was expected to put pressure on the dollar, and gold prices have traditionally moved inversely to the dollar.

With the dollar weakening once again, gold prices are expected to move up. Note, however, that gold prices rose not only against the dollar, but also against the euro.

That's interesting, because the usual inverse relationship between gold and the dollar was weakened in the past few months, with gold rallying together with a stronger dollar. That's because of the lack of confidence in the euro.

For several years, investors who wanted to hedge against dollar weakness bought the euro. But with the vote against the European constitution and with all the talk about countries pulling out of the euro, it now appears that the euro is no hedge at all. Where else do investors turn, so goes the theory, than to tried-and-tested gold?

Ironically, for those concerned about the long-term prospects of both the dollar and the euro, gold""Lord Keynes' "barbarous relic"""has emerged as an alternative.

Of course, there are other triggers as well, one of them being the runaway rise in the price of crude oil. The apprehension is that high oil prices could cool global growth while stoking inflation, and if that happens investors in gold could benefit.

Analysts point out that during the 1979 oil crisis, the price of gold more than doubled over the course of the year. Gold bulls are also keen to establish a link between the hot new emerging markets of India and China, on the one hand, and gold, on the other.

A Merrill Lynch gold analyst has forecast, for example, that the price of gold could go up to $725 an ounce by 2010, thanks to burgeoning demand from India and China. India is the world's largest gold consumer, accounting for almost a fifth of world demand, and demand surged by 17 per cent last year. In China, demand for gold is expected to rise as its new middle class samples the joys of capitalism. And in both countries, as living standards go up rapidly, the demand for gold jewellery will rise.

Of course, many of these arguments could be self-serving, and perhaps the real reason for the rise in gold prices is global liquidity. After all, fund buying reportedly provided the push to the recent rise in gold prices.

If that is true, then higher gold prices are part and parcel of the rise in asset prices across the globe, thanks to excess liquidity. However, the difference may be that while the price of gold is relatively insulated from a withdrawal of liquidity, the price of paper assets could plummet.