(MENAFN - Arab News) Gold prices have been one of the strongest performing investments this decade, rising from 282 per ounce at the beginning of 2000 to their current level of 1,648 per ounce.
This equates to total annual returns of around 14 percent compared with around 2 percent for the S&P 500 and around 7 percent for 10-year US Treasury bonds.
Gold prices spiked to an all-time high closing price of 1,895 per ounce on Sept. 6, 2011. Investors were attracted to gold as a relative safe haven amidst dual sovereign crises in the US and Europe. These crises began to emerge in 2010 when gold prices rose 28 percent from 1,101 at the beginning of the year to 1,406 by year-end.
There are differing explanations as to what caused the large increase in gold prices. Firstly, the crises increased the appeal of traditional safe haven assets, such as gold and US Treasuries. Demand for US Treasuries has driven up their prices, driving down yields to the extent that real returns have turned negative. This increased the safe haven appeal of gold relative to US Treasuries.
Furthermore, gold is often perceived as a hedge against inflation as its value tends to increase with the general price level. The risk to economic growth posed by the crises may have led to expectations for looser monetary policies from central banks, particularly quantitative easing. In turn, this would be expected to lead to higher prices, attracting investors to gold.
Additionally, the heightened risk and volatility in financial markets and concerns about the depreciation of currencies, particularly the Euro, also increased the appeal of gold as a more reliable store of absolute long-term value.
Furthermore, demand for gold rose 7 percent in Q3, 2011 versus Q2 alone, providing strong support to prices. The largest component of global demand for gold is for jewellery manufacturing, accounting for around 40 percent. However, most of the Q3, 2011 increase in demand came from private sector purchases of bars and coins, reflecting gold's appeal at the time as a store of value rather than demand for making jewellery or industrial use. Purchases of gold by central banks also rose significantly in Q3, 2011 as gold became more attractive to this sector versus Euro and US Dollar denominated assets.
Finally, the spike was also partially driven by a speculative bubble with prices overextending themselves before the bubble burst. Gold prices collapsed 16 percent from their highs of 1,895 to 1,598 in just under three weeks.
Since Q3, 2011, gold prices have remained bound in a range from 1,530 to 1,800 and are currently close to the middle of this range at 1,648.
Many of the market risks that led to the spike in prices in September 2011 are now largely thought to have dissipated. Real interest rates are starting to edge up and the economic growth outlook has improved, lowering expectations for quantitative easing. The balance sheet of the ECB has declined from 3.1 trillion euros in mid 2012 to 2.8 trillion currently although the Federal Reserve has continued to expand its balance sheet, leaving purchases of Treasury and mortgage-backed securities unchanged at 85 billion per month at its last monetary policy meeting.
Total demand for gold has fallen by 2 percent to 1,188 tons in Q3, 2012 from Q3, 2011. In this timeframe, demand for gold, mainly for investment purposes, from the financial sector, excluding central banks, has picked up sharply while demand for gold as a store of value has fallen around 30 percent (we assume that demand from central banks and purchases of gold bar and coins represent demand for gold as a store of value). Meanwhile, demand for gold for use in industry and jewelry manufacturing has remained flat.
Another factor keeping a lid on gold prices, as expressed in US dollars, is a slight appreciation of the dollar since Q3, 2011. All other things being equal, the gold price tends to fall to compensate for an increase in the value of the US dollar.
Since peaking in early September 2011 at 1,895, gold's performance has been unimpressive, suggesting that gold may have lost some of its appeal. According to QNB Group, the main downside risks to the price include central banks tightening up monetary policy by cutting back on quantitative easing and raising interest rates.