Gold likely to perform well, but will remain volatile

One of the biggest stories of 2011 was the extraordinary run-up in the gold price and its subsequent slump. It began the year around $1,400 and went on to hit $1,900 (a fresh all-time high in nominal terms) at the end of August.

It subsequently dropped 10 per cent over the next three trading sessions after Standard & Poor's downgraded the US's triple-A credit rating and investors liquidated assets to raise cash.

Yet gold recovered quickly and made a fresh intra-day record high in early September. It then lost 20 per cent over the next three weeks as uncertainties over the European debt crisis saw investors once again headed for the relative safety of the US dollar.

Gold recovered its poise over the fourth quarter until mid-December when it suffered another steep decline which was exacerbated by thin pre-holiday trading. This took it below its 200-day moving average for the first time since early 2009. Although it closed out the year at $1,565 for a gain of 10%, there is little doubt that investors' belief in gold as a safe haven has been sorely tested.

Many investors are asking themselves if gold's bull-run is now over. Looking ahead to 2012 the drivers are likely to be the same as for last year. If central banks (especially those of countries running trade surpluses) continue to be net buyers, then gold should find strong support, at least as far as the physical market is concerned.

Physical buyers tend to be long-term holders who have made the decision to own gold because it offers a method of wealth preservation. It cannot be created by the press of a button as currency and debt instruments can. However, fund managers and other investors primarily speculate using the futures markets and ETFs.

These "paper" markets dwarf the physical in terms of the outright number of ounces traded each day. In addition, these instruments are typically traded on margin which means that a small piece of negative news can result in heavy selling and losses for leveraged longs.

Most analysts expect gold to perform well over the coming year, as investors continue to diversify their foreign exchange exposure out of fiat currencies. Yet it will remain vulnerable to sell-offs if there are additional scrambles to dump equities and bonds to raise cash. One thing is for certain: precious metals will remain volatile for as long as uncertainty over the global economic outlook continues to fester.

The writer is Market Strategist at GFT. Opinion expressed is his own and do not reflect that of Gulf News