According to a new piece of research from US fund manager GMO emerging market purchases is one of the main drivers of gold’s current rally. “Nearly 80% of the total demand for physical gold has come from retail purchases in developing markets. China and India’s combined demand alone amounts to more than that of the entire developed world.” As governments of emerging markets continue to tighten policies it will become even harder for citizens to invest abroad and as such the short-term prospects for gold are good, as few other investment options remain.

Whilst gold prices have recovered and held firm, risk assets and the Euro have weakened which suggests gold prices may now be breaking from positive correlation with the above. This is potentially a very bullish development for gold.

Gold has been trading significantly higher since last week’s announcement that the Fed plan on keeping interest rates low. If the US Dollar continues to remain weak, gold should benefit and further rallying could occur. However if this is viewed by others as an attempt to intentionally devalue the dollar, a fresh round of currency wars could also ensue.

Although gold prices have risen steadily for 11 years in a row, the increases have been incremental and measured. Governments have used paper futures markets and their central banks to limit the rally of precious metals as much as possible in order to keep attention away from their own failing currencies and unsustainable debt.

With inflation and unemployment growing and Europe in a serious mess, countries want to cheapen their currencies. They won’t admit that they are trying to make their goods competitive in markets, because the political parties have their own agendas; but by keeping interest rates low and issuing quantitative easing countries are able to pay debts and deliver on their obligations with devalued Dollars, Pounds, Euros and Yen. It is a form of taxation and confiscation from the normal citizen, they may be inflating away sovereign debt but they are also inflating away our savings. Investing in gold protects you against such inflation.

Higher gold prices also have the effect of devaluing paper currencies in relative terms and therefore right now governments are more than happy for the prices to climb. Countries that already have large gold reserves will have advantageous positions, which may be one of the reasons emerging economies are stockpiling gold while it is still affordable.

Eventually we may be faced with deep destruction of the world’s financial systems, with issues of economic importance still unaddressed it is hard to say what will happen in 2012 but it is not unreasonable to ponder whether gold will ultimately be the financial asset that repairs currencies.

Although they would never admit it, governments are also preparing for this possibility; central banks are buying gold at the expense of currencies, even the US Dollar. US Dollar exchange foreign holdings are already at record levels in many countries and as such these countries are now accumulating even more gold in an attempt to diversify their reserves.

Many economists are predicting changes that will occur in our financial markets, especially the emergence of a new Global Reserve Currency. Trading is no longer dominated by the US dollar as markets become more international, could its special status be beginning to slip away?

If the US dollar is replaced by a variety of currencies, gold will need to be a featured element in order to provide credibility, after all it is the only real money left in a world of worthless paper currencies that keep hitting the printing presses.

If gold’s role in the monetary system continues to grow, central banks will be very aware of the need to hold as much gold as possible and would consider confiscating citizens gold. Whether held in banks or not, as in 1933 the penalties for not handing over personally owned gold would be severe.

Accommodative monetary policy is bullish for gold and as the US Dollar fell, equities and the Euro have rallied with gold. Of course at the moment a weak Dollar is helpful for the US as its manufacturing sector recovery and currency wars continue.

Gold prices hit six-month lows in December 2011 when they came under pressure from investors and banks seeking cash and weak physical demand from China. Since then they have steadily recovered but hovered below the 200-day moving average of $1,634. However yesterday (10/01/2012) gold finally broke this barrier which suggests gold may now gather some momentum and begin rising more steadily.

Murenbeeld, Chief Economist at Dundee Wealth Economics, sees monetary relation (or Quantitative Easing) as the key bullish factor for gold prices. If Europe is to avoid a recession it may well be required to launch a version of quantitative easing, if this happens, there is no telling where the gold price will end up.

In the short-term, the strength of the US Dollar is the most limiting factor for gold prices. , However, it is fundamentally overvalued and as such Congress could force a ‘devaluation’ which would in turn be good for gold.

Despite the recent slowdown in China, demand for gold remains strong thanks to rising wealth, inflation fears, easing monetary policy and of course the approaching Chinese New Year. However, if the Chinese economy does sink into a recession, gold prices could be dragged down.

Most banks have lowered their gold price predictions for 2012.HSBC’s chief commodity analyst, James Steel, changed his forecast to $1,850 based on a weak Euro, liquidation and disappointing physical demand from emerging markets. Barclays forecast an average of $1,875 and Deutcsche Bank cut its average forecast to $1,825. However, all of these adjusted forecasts can still be viewed as bullish considering the current price of gold around $1,630.

According to the annual survey of industry predictions by the London Bullion Market Association (LBMA), 23 of the largest bullion banks have predicted that gold prices will surpass the high of $1,920 touched in 2011 and may well exceed $2,000 in 2012.

Negative real interest rates and gold purchasing from central banks will continue to support the appeal of buying gold. The amount of physical gold available is shrinking, thanks to demand from emerging economies and accumulation by central banks. As a result increased demand from investors will likely lead to a long-term trend of higher gold prices, causing a rising average over the next few years.

This year gold prices are likely to be as volatile as they were in 2011 with big gains, often followed by declines that may lead investors to doubt gold’s asset class. Gold bears may have been everywhere towards the end of 2011 predicting lows of $1,000 or less, but they were wrong just like they have been in the past and now gold has shaken off year end loses and is preparing for another bull run, so if you haven’t already this may be the perfect time to invest in gold.

Gold also lost out to European safe-haven assets when German interest rates turned negative and as a result, a record €463.6bn was deposited in cash with the ECB.

Gold prices remain above the psychological barrier of $1,600 but have still failed to break the 200-day moving average of around $1634. Should the Euro manage to rally then gold prices would be supported and are likely trigger more buying.

Many analysts are claiming we are now in a bear market and predict gold prices will fall as far as $1,000 an ounce. After breaking its 200 day moving average for the first time in three years, there is no telling how far gold may now fall; especially as it no longer appears to be a safe-haven asset. However all the economic difficulties that have pushed gold prices up have not disappeared and as such it is likely that gold prices will once again rally in 2012.

Despite the increase in gold prices, Chinese demand continues to be just as high. Although the Chinese government keeps very quiet about its gold reserves it is believed that China holds in excess of 33.89 million fine troy ounces as its reserves and that this is increasing rapidly. In 2007, China overtook South Africa as the world’s largest gold producer and China has been making the most of this cost advantage.

The Chinese however, are also in need of monetary support after The People’s Bank of China made it easier for banks to lend more money, by cutting the level of reserves the banks have to hold. Over the past week, China’s central bank has had to intervene in the currency markets, but for once, it’s not been acting to keep the Renminbi weak against the dollar. The blame lies with China’s property bubble which seems about to burst. The good news is that China’s attempts to prop up the market appear to be working; but the bad news is that investors are beginning to realise that the Reminbi can fall as well as rise.

Also underpinning the gold price was the continued buying by central banks. South Korea is the latest bank to buy gold in an attempt to diversify its foreign reserves and protect against financial instability. A number of banks have disclosed information about their continuing gold purchases; these include Thailand, Russia and Bolivia. Although gold seems to have currently lost its status as a safe-haven asset, increased demand from central banks is supporting gold prices.

EU leaders will be meeting in Brussels this morning (08/12/11) in order to try and agree on a deal to tackle the Euro Zone debt crisis. Most investors and analysts have labelled this the ‘do or die’ moment for Europe. It is now apparent that any solution must be credible and enduring; the markets will no longer be fed drips and drabs of false hope. One way or another, EU leaders must announce a viable plan.

Chancellor Merkel and President Sarkozy are calling for renewed contracts between countries that enforce budgetary discipline with automatic penalties for those who overspend. However, similar sanctions were previously included in the contracts and those clearly weren’t enforced, so how much difference will this really make?

After Standard and Poor’s put all Euro zone countries on credit watch it seems that the main focus is on restoring market confidence and as such EU leaders appear to be hardening their positions. However, if the EU is to survive in the long run there needs to be improved solidarity and collective fiscal union.

The ECB (European Central Bank) has cut its main interest rate back to 1% ahead of the EU Summit. Unfortunately, this is much of the same from the ECB and it doesn’t have the authority to do what is necessary to stop the debt crisis worsening. Italy and its debts are too big to be rescued by other governments so instead the attention continues to circle back to whether or not the ECB will have to surrender and print money. Of course gold would benefit from this, as people would seek to invest in gold again, in search of safe-haven assets and protection from inflation.

The auction saw the Spanish government pay 6.97% for £3.56 billion (a fraction of what it needed to raise) of 10 year Spanish bonds, up from 5.43% when they last auctioned 10 year bonds in October.
Gold has failed to act as a traditional safe haven asset amidst the deepening Euro Zone crisis and instead dropped with equities and other risk assets. This was somewhat due to investors being forced to sell gold in order to obtain Dollars or invest in US Treasuries. The Euro weakness also continues to undermine gold, as the Dollar strengthens and gold becomes more expensive.

At the moment the gold market is tricky to predict because the factors pressuring gold prices would normally be driving investors to buy gold, not liquidate. However, if the ECB is forced to launch quantitative easing we could see gold rally. Gold has also become increasingly sensitive to environments where the US Dollar is strengthening.

In the long-term the outlook for gold is bullish; the solution to the world’s debt problems will probably be inflationary and that’s good for gold investment. Demand for bullion is likely to remain high as long as real interest rates remain negative and the risk premium on US equities remains high.

After the US government’s announcement on Monday that its “Super” committee had failed to meet its target of $1.2 trillion in deficit cuts, confidence in the US and stocks fell. Gold could well benefit from the US deficit problems if attention is now drawn away from the Euro Zone to the US. If combined with a decline in the Euro, gold could well rally.

On Wednesday, European Commission president Jose Manuel Barroso launched a consultation on whether the 17 euro zone countries could issue joint stability bonds. The creation of joint bonds would lead to the stronger nations in the EU supporting the weaker ones but it would supposedly reduce the borrowing costs for all. However, EU nations would need to pledge part of their foreign exchange holdings or gold reserves as security and this has been written off as an absolute no by the Chancellor of Germany, Angela Merkel. The US, the UK and Asia are all calling for more solidarity and consensus within the Euro Zone, which raises the question how much longer can they put off the inevitable?

It has been accepted that it is up to Germany to save the Euro, either by letting the ECB print money or issuing join bonds. However on Wednesday, Germany sold just 3.6bn Euros ($4.8bn; £3bn) worth of 10-year bonds, from 6bn Euros on offer. Markets were certainly rattled by this but bond auctions fail all the time. The problem is far more money was retained than normal and it’s a big indicator that people aren’t so willing to lend money to Germany anymore, whereas the UK and US are still attracting investors. The problem is that even with its yield of 1.98% (far lower than Italy or Spain) Germany is still part of the Euro and investors are becoming increasingly concerned about investing in a currency that could fall apart. The Euro Zone story is going to run and run and it’s not going to end until the weaker countries leave the Euro Zone or Germany lets the ECB print money.

Right now investors are liquidating to buy US treasuries and invest in US Dollars; however this isn’t expected to last long, once liquidity is satisfied we will see investors once again investing in gold.

Everybody is aware that there is still no answer as of yet to the Euro Zone’s problems. Every time another half hearted idea appears to be agreed, there is another spanner thrown in works and we are right back at square one again; still faced with the ultimate question, will Greece default or not?

With Italy’s ten-year bond yield rising to over 7%, the highest since 1999, the focus has shifted from the political problems in Greece to the problems emerging in Italy. The market rallied on Monday after incorrect information was released claiming that Mr Berlusconi, the Italian Prime Minister, would step down. Berlusconi denied he planned to resign. However, following the results of a crucial budget vote yesterday where Berlusconi failed to win the majority, he has now agreed to resign after the budget reforms have been passed. Mr Berlusconi has survived more than 50 confidence votes in the past, however after losing the budget vote President Giorgio Napolitano called for his resignation.

It is still unclear whether the Italian President will subject the Italian people to elections or call on political parties to form a unity government. If elections were to be held, the subsequent increased uncertainty for world markets would be bullish for gold.

Italy’s’ rate of 7% is considered by most investors as unsustainable. The higher the yield (the implied cost of borrowing) the more likely it is that the country’s huge economy will need to be bailed out which is something that the Euro Zone has been desperately trying to avoid. Italy now appears to be stuck in a downward spiral. If nobody will lend to Italy, then Italy cannot repay its debts: and if Italy cannot repay its debts, then nobody will lend to it.

The longer the instability continues in the Euro zone, the greater the impact will likely be on the gold price and we will surely see it continue to move upwards. We are already seeing investors pull out of European bonds and invest in gold instead. Based on previous performance, a prediction of $2,300 for next year doesn’t seem like an unreasonable forecast, however with so many factors and the Euro Zone constantly struggling for survival, precious metal prices are far from predictable.

Currently two Euro Zone nations will shortly have new Prime Ministers and these Euro Zone issues are currently the main driving force for gold prices. However the US still faces deficit problems and according to a New York Times/CBS News poll, Congress’ approval rating recently fell to a record low of 9%. A loss in confidence in elected officials globally is traditionally positive for gold and this appears to be happening everywhere.

At the moment gold is reacting to the general market feeling that the European crisis will get worse before it gets better, we do not have a lasting solution and therefore high uncertainty remains. This seems to have provoked gold to returning to its favoured role as a safe-haven asset instead of moving in line with currencies; as such, investors are once again buying gold to position themselves against any further bad news that comes out of the Euro Zone.