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Tom Holland

The gold market is on fire. Yesterday, the price set another record high, hitting US$1,182.95 early in New York trading. 
At that level, gold has risen an astonishing 73 per cent from its 2008 low set just over a year ago.
Yet, although the gold bulls continue to prophesy that the metal's price will soon breach US$2,000, or even US$5,000, the underpinnings of the current rally look increasingly doubtful.
Now, as a clutch of loyal readers are bound to point out, this column has questioned the sustainability of gold's rise before - and been wrong.
Most recently, early last month, with the price at US$1,048, it warned, 'At these prices, speculating on gold is a high-risk trade'.
The argument then was that the run-up in gold reflected the weakness of the US dollar. Although the price had risen strongly in dollar terms, when measured in a basket of other currencies, it had actually been range-bound over the previous four months.
Since then, the gold price has continued to rise in US dollar terms, climbing another 13 per cent. But as the first chart below shows, it has also risen sharply in terms of a basket of non-dollar currencies. The run-up in gold can no longer be attributed principally to dollar weakness. Something else is going on. 
In addition to buying gold as a currency hedge, people typically invest either as a safe haven against financial instability, as a hedge against inflation, or as a play on rising demand for jewellery.
None of those reasons holds much water at the moment. No one is very interested in safe havens since markets rediscovered their risk appetite several months ago. Nor does inflation appear much of a danger in the mid-term. Central banks may be printing money, but with plenty of excess capacity in the global economy and with both banks and consumers in the developed world shrinking their balance sheets, there are few signs of inflationary price pressures.
As a result, demand for paper gold is slowing. As the second chart below shows, the growth in gold held by the Hong Kong-listed SPDR Gold Trust, by far the world's largest exchange-traded gold fund, peaked in the first quarter of this year. Since then it has tailed off.
Meanwhile, it's not just demand for gold funds that has abated. Demand for physical gold has also been subdued. As the last chart shows, in the third quarter, demand for jewellery and for bars and coins was down steeply from a year earlier, a natural consequence of the downturn. Over the 12 months to the end of September, physical demand from India - still the world's largest gold market - was down  33 per cent compared with the previous 12-month period, easily enough to outweigh China's 13 per cent demand increase.
So, if it's neither rising investment nor heightened physical demand propelling the current run-up, we have to look elsewhere for the driver of gold's recent upward momentum.
Gold bugs point to central bank buying, noting that India recently bought 200 tonnes of gold from the International Monetary Fund, while China has also been accumulating bullion. But those purchases took place off-market and had no direct effect on the price.
A more likely explanation is the winding down of gold miners' loss-making hedges. In the past, mining companies have sold gold forward to lock in income and hedge against market declines. In a rising market, however, forward sales carry an enormous opportunity cost, and recently miners have been closing their hedge books.
In September, Barrick Gold, the world's largest gold company, said it was unwinding all its hedges. That has involved heavy buying in the forward market, which has helped to push the price higher.
But the buying won't last forever. By the end of  last month, Barrick had bought back about 64 per cent of its hedges.
When the unwinding stops, the elevated price of gold will be left looking vulnerable to an outflow of money from gold funds, possibly triggered by a rebound in the dollar as carry trades unwind.
That's not to say the price of gold can't go on rising for a while yet. It can. But it means last month's warning is still valid: At these prices, speculating on gold is a high-risk trade.



Searching for the source of the latest run-up in gold