Gold Likely to Hit New Highs This Year

The ongoing sovereign debt crisis in the Euro area and S&P’s downgrade of the U.S. credit rating have increased the safe haven demand for gold and the prices have reached new highs. But investors remain skeptical whether there could be further rally in the price.

Analysts at HSBC Global Research said they believed gold could rally as high as $1,850 per ounce this year, averaging more than $1,700 for the remainder of 2011.

“During periods when public confidence in paper money and Fed policy is low, gold prices tend to appreciate strongly. The current climate is just such a period. Gold has good historical track record for appreciation in times of crisis,” said the research note.

S&P lowered the long-term U.S. credit rating to AA+ from AAA, saying that in its opinion, a recently passed deficit cutting plan fell short of the goal of stabilizing the government's medium-term debt dynamics.The outlook on the long-term rating was also listed as negative, and the rating could fall further.

The Federal Reserve’s decision last week to keep interest rates unchanged until at least mid-2013 has further fueled safe haven demand for gold.

In previous periods of elevated stress, including the late 1970s, gold prices appreciated strongly. Based on this, the current gold rally is likely to continue until confidence in paper money and central bank policies is restored, HSBC said.

The metal has been one of the few beneficiaries of the global financial crisis, with its prices witnessing an increase of 175 percent since August 2007.

“Gold has rallied since the beginning of the financial crisis, in large part because as a hard asset it has no counterparty or credit risk. Unlike other hard assets, however, it is highly liquid with an active global market. Gold is also viewed as a surrogate currency,” the note said.

Further, gold has no intervention risks compared to safe haven currencies such as Japanese yen (JPY) and Swiss franc (CHF).

Recently, the Japanese authorities intervened in the FX markets to sell the yen, in a bid to prevent any negative effect of strong yen on the economy, which was hit by a devastating tsunami, earthquake and nuclear accident in March.

Similarly, the Swiss central bank announced measures to contain the strength of Swiss franc, as the safe haven demand for its currency has been increasing since the beginning of this year, due to continued risk aversion dominating the market sentiment amid concerns about financial stability and the global economic outlook.

“Gold, however, does not face the threat of intervention and may move higher unimpeded by any government. As a rule, central bankers and policymakers do not refer to gold prices nor does gold price appreciation appear to be a threat to any country’s interests. The most important difference between gold and safe haven currencies is that the supply of gold is not dictated by government monetary policy,” said HSBC.

Also, central banks may prime the printing presses at will, but the supply of gold is fixed in the near term and increases only as a function of mine output. The recent Fed decision to leave interest rates unchanged for two years leaves the door open for a considerable increase in liquidity, as the supply of gold stays relatively fixed.

“Gold seems poised to hit $1,850/oz. If history is any judge, the decade-long gold rally will not end until sovereign risks – inside and outside of the U.S. – recede. Given present conditions, this may be unlikely until the U.S. fiscal situation is put on a sustainable path. This may require that the U.S. budget is reduced and progress made on reducing the growth in the debt-to-GDP ratio,” said the note.