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Gold's Recent Rise Tied to Euro's Decline

  • Michael Bowman

While a falling euro has grabbed financial headlines, the price of gold reached a record-high last week and has since hovered around $1,200 an ounce, that is up from $930 a year ago and $270 a decade ago. Analysts say a worsening debt picture among industrialized nations has reduced confidence in the world's major currencies and made precious metals more attractive to investors.

It has been treasured since the earliest civilizations, led nations to conquer and colonize, sparked frantic rushes to remote lands, and inspired some of the world's best-known poetry. A versatile metal, gold is used for currency, jewelry, awards and medals, industrial applications, and as a safe haven for wealth in uncertain times.

Nations began issuing paper money centuries ago as a substitute for precious metal coins. But when faith in national currencies declines, many people still turn to gold to preserve their financial worth and, they hope, turn a profit.

Bank of America analyst Mary Ann Bartels on Bloomberg Television:

"People concerned about inflation like gold," she noted. "And it is a store of value. So it really answers a lot for a broad investor base."

A surge in demand for gold recently pushed its price to an all-time high. And buyers are not limited to wealthy investors. Earlier this month, Beijing policeman Ding Jingshan showed up at a gold market to make a purchase.

"I think investing in gold bullion is very good. The price of gold has been going up and I think it will rise even more," said Ding.

Ding is not alone in believing that gold will rise above the current $1,200-an-ounce range. Again, Bank of America's Mary Ann Bartels:

"We have had a target for some time on gold of $1,500 to $1,600 [an ounce], and we are still very comfortable with that target," added Bartels.

Fear of inflation often heightens gold's appeal. But analysts see low short-term inflation risks in the United States and other major industrialized nations as a fledgling global economic recovery takes shape.

But for the long term, things look murkier in Europe and elsewhere, with massive fiscal imbalances and staggering debt forcing governments to scramble and make painful decisions. The Greek debt crisis has weighed heavily on the euro and boosted gold's appeal, according to Rachel Benepe, portfolio manager of First Eagle's Gold Fund.

"The risks are out there," said Benepe. "With the European zone having issues, people are worried about currencies. It is not really surprising that gold has become a substitute currency, and that more investors are moving into it. When you look at gold, it is a scarce asset. If people are hoarding and buying, the price of gold is going to move up."

Some analysts foresee a scenario where unsustainable debt in the United States and Europe eventually forces central banks to devalue their currencies. Such moves can spark gut-wrenching hyperinflation, as seen in Zimbabwe in recent years, in much of Latin America in the 1970s and 1980s, and in Germany between the First and Second World Wars.

A major currency devaluation today would almost certainly unleash global panic-buying of precious metals, pushing the price of gold to staggering new highs.

But Rachel Benepe envisions an alternate scenario.

"Once fear starts to subside a little bit, people will move out of gold," added Benepe. "It is really there as a hedge. And it is really there to protect your money in the face of that risk."

Historically, gold prices have trended higher amid a falling U.S. dollar, and vice-versa. But recent months have seen both the dollar and gold rising at the same time, what Bank of America's Mary Ann Bartels calls a "decoupling" of the traditional inverse relationship.

"Gold has decoupled from the dollar," explained Benepe. "Really, this is a story of a weaker euro, not a stronger dollar."

Bottom line: if the euro recovers, expect gold prices to moderate. If not, the future price of gold is anyone's guess.