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Thursday, May 13, 2010

How to invest in gold and key price drivers

LONDON (Reuters) - Gold prices surged to record highs above $1,230 an ounce on Tuesday, as concerns over the potential for Greece's sovereign risk issues to spread through the euro zone sparked buying of the precious metal as a haven from risk.

Bullion prices have already reached new highs in sterling, euro and Swiss franc terms this week, but strength in the dollar camouflaged spot gold's strength, analysts said.

Gold broke its usual strong inverse correlation with the dollar to rally in line with the U.S. currency this month, as investors sought refuge from other markets in both assets.

Following are key facts about the market and different ways to invest in the precious metal.



Large buyers and institutional investors generally buy the metal from big banks.

London is the hub of the global spot gold market, with some $18 billion in trades passing through London's clearing system each day. To avoid cost and security risks, bullion is not usually physically moved and deals are cleared through paper transfers.

Other significant markets for physical gold are India, China, the Middle East, Singapore, Turkey, Italy and the United States.


Investors can also enter the market via futures exchanges, where people trade in contracts to buy or sell a particular commodity at a fixed price on a certain future date.

The COMEX division of the New York Mercantile Exchange is the world's largest gold futures market in terms of trading volume. The Tokyo Commodity exchange, popularly known as TOCOM, is the most important futures market in Asia.

China launched its first gold futures contract on January 9, 2008. Several other countries, including India, Dubai and Turkey, have also launched futures exchanges.


The wider media coverage of high gold prices has also attracted investments into exchange-traded funds (ETFs), which issue securities backed by physical metal and allow people to gain exposure to the underlying gold prices without taking delivery of the metal itself.

Gold held in New York's SPDR Gold Trust , largest gold-backed ETF, rose to a record high of 1,192.150 tonnes as of May 10, from 1,188.498 tonnes in the previous business day.

The ETF's holdings are equivalent to nearly half global annual mine supply, and are worth more than $53 billion at today's prices.

Other gold ETFs include iShares COMEX Gold Trust , ETF Securities' Gold Bullion Securities and ETFS Physical Gold, and Zurich Cantonal Bank's Physical Gold.


Retail investors can buy gold from metals traders selling bars and coins in specialist shops or on the Internet. They pay a small premium for investment products, of between 5-20 percent above spot price depending on the size of the product and the weight of demand.



Rising interest in commodities, including gold, from investment funds in recent years has been a major factor behind bullion's rally to historic highs. Gold's strong performance since the beginning of the 21st century has attracted more players and increased inflows of money into the overall market.


Despite the recent drop in the usual strong correlation between gold and the euro-dollar exchange rate, the currency market still plays a major long-term role in setting the direction of gold.

Bullion prices typically move in the opposite direction to the U.S. dollar both because dollar-priced assets become nominally more expensive as the U.S. currency strengthens, and because gold is a popular hedge against currency weakness.


Gold has historically had a strong correlation with crude oil prices, as the metal can be used as a hedge against oil-led inflation. Strength in crude prices also boosts interest in commodities as an asset class.


The precious metal is widely considered a "safe haven," bought in a flight to quality during uncertain times.

Financial market shocks, as seen in the aftermath of the collapse of Lehman Brothers in 2009 and more recently in the case of Greece's debt problems, tend to boost inflows to gold.

Major geopolitical events including bomb blasts, terror attacks and assassinations can also induce price rises.


Central banks hold gold as part of their reserves. Buying or selling of the metal by the banks can influence prices. On Aug. 7, 2009, a group of 19 European central banks agreed to renew a pact to limit gold sales, originally signed in 1999 and renewed for a further five years in 2004.

Annual sales under the pact are limited to 400 tonnes, down from 500 tonnes in the second agreement, which expired in late September.

Sales under the agreement have been low under the new pact, however.


Several years ago when gold prices were languishing around $300 an ounce, gold producers sold a part of their expected output with a promise to deliver the metal at a future date.

But when prices started rising, they suffered losses and there was a move to buy back their hedging positions to fully gain from higher market prices -- a practice known as de-hedging.

Significant producer de-hedging can boost market sentiment and support gold prices. However, the rate of de-hedging has slowed markedly in recent years as the outstanding global hedgebook shrank.


Supply and demand fundamentals generally do not play a big role in determining gold prices because of huge above-ground stocks, now estimated at around 160,000 tonnes -- more than 60 times annual mine production.

Gold is not consumed like other commodities.

Peak buying seasons in major consuming countries such as India and China exert some influence on the market, but others factors such as the dollar and oil prices carry more weight.

(Compiled by Atul Prakash, Jan Harvey and Frank Tang; Editing by Veronica Brown, Chris Johnson, Clarence Fernandez, and Rebekah Kebede)

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