Gold price does not make it a safe haven

With the calamitous downfall of some of the world's most prominent financial institutions, and the knock-on effect it has had on equities, bonds and currencies, investors are feeling exposed. As a physical asset, gold is no one's liability. There is no risk that a coupon or a redemption payment will not be made, as for a bond, or that a company will go out of business, as for an equity, or that savings will be lost through a bank that is going out of business. And unlike a currency, the value of gold is not undermined by a country's inflation. But even when prospects are generally more optimistic, smart investors know it is wise to retain an allocation to gold as insurance; like an insurance policy, gold's value as an asset becomes most obvious when it is most needed.

Of course, a number of investors have made strong returns from gold's stellar price performance over recent years and some are wondering why gold is not hitting more record prices in today's current turmoil. However, it is too simplistic to look at just gold's safe haven appeal for answers as to the gold price's performance.

In relative terms, the gold price has outperformed most other commodities. But at the moment everything is being driven by the need for cash. There has been evidence of profit-taking by investors and selling by leveraged institutions that have needed cash to meet margin calls on other assets - these institutions have owned gold as a safety net and have been forced to draw on that safety net. The fall in other commodities has also affected gold, reflecting its inclusion in major commodity indices.

There are a range of different influences that can affect the gold price and push it in different directions. Two key influences over the last year are gold's relationship with the US dollar and its safe haven appeal.

The dollar effect

Often these two factors have pushed the gold price in the same direction for instance, markets have responded to bad news from the financial sector by pushing down the US dollar. In such cases, the gold price has benefited from both its safe haven appeal and the lower dollar. However, this isn't always the case. If the bad news has emanated from Europe, the dollar has sometimes risen in response. Sometimes the safe haven effect will dominate, and at other times the dollar effect will dominate. Over the last few weeks, it has been the dollar effect that has dominated.

It is important not to draw conclusions from short term price movements. It is too early to say that the worst is over for the global economy and financial sector, and too soon to say that the dollar's decline is over.

Aside from the demand drivers, one must also remember the importance of the supply side when looking at the outlook for gold. There has been a gradual reduction of mine output in recent years, with only a small number of major gold finds by the mining industry, which is constraining supply.

The real value of gold is not that it provides a quick, speculative fix, but its capacity to provide a sure and steady means of protecting wealth. Those who allocated a proportion of their portfolio prior to the current financial crisis will be the ones truly benefiting in today's market.

- The writer is President, World Gold Council