It's been a record breaking week for gold prices and with the US dollar looking weak, things haven't looked this good for the yellow metal in a long time.
So what's driving the run up that we've seen in prices and is it likely to continue?
In many ways the spike in gold prices makes little sense.
We dig gold out of the ground only to put the majority of it back into the ground in a vault!
In addition to using gold for investment purposes, there is also obviously strong demand for gold as jewellery. It's also used in electronics because its characteristics have an efficient conductor that does not corrode.
But can you guess the proportions for gold use?
(Source: www.gold.org)
Gold made sense when countries used the gold standard. This was where currency was guaranteed by a holding in gold.
Now, instead of having currency being guaranteed by a physical holding of gold, it is backed by government under a fiat currency.
So, while there's not enough gold in supply to see a return to the gold standard, countries around the world hold significant holdings of gold in reserve.
That's because gold acts as a hedge against the US dollar.
Since gold is traded in US dollars, when the US dollar falls, gold prices generally rise.
This relationship means that if the market thinks that the US dollar is going to fall further, gold is going to see more demand since when the US dollar falls, gold prices generally rise.
At a time when governments around the world are printing money, one thing that gold has in its favour is that gold cannot be printed. There is a limited supply.
Gold has now traded over $1000 US ounce for the last 6 weeks with no signs that it is going under $1000 any time soon.
Anything that China is buying is rising at the moment...and China is buying gold.
While gold prices have been hitting record levels, gold miners in Australia haven't been doing so well.
Our two largest gold miners are:
Both have underperformed in 2009.
When looking at investing in gold miners in Australia, you need to take into account the effect of currency.
While gold prices have been rising in US dollar terms with a rise of 20% in the year to date so far, in Australian dollar terms, gold hasn't really moved in 2009.
That means that the rise in Australian dollar has all but erased the gain that we've seen in gold prices and that has been bad news for Australian miners.
The good news is that we are now seeing gold rising in Australian dollar terms and that should be good news for our miners.
When choosing a miner to invest in, consider the cost of getting gold out of the ground. Generally the larger miners have cheaper costs.
When gold prices are this high it can become feasible for the smaller, lower quality deposits to be mined at a higher price per ounce. Hence, smaller, junior gold miners generally do quite well in this climate even in relation to the larger gold miners such as Lihir Gold and Newcrest Mining.
So all in all, the outlook for gold is looking bright. Keep in mind the currency effect and the cost of getting the yellow metal out of the ground.
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Happy investing!
Julia Lee Equities Analyst Bell Direct
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