Gold Fever: The Yellow Metal Has Gone from Strength to Strength as Investors Cower in Fear from Market Uncertainty, the Falling Dollar and the Possibility of Economic Stimulus Induced Inflation to Come. M J Morgan Reports

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Gold is up some 25% this year, breaching $1,100/oz in November, whilst the dollar is down nearly 8%. With US interest rates seen as unlikely to rise anytime soon, most market participants remain quietly bullish that gold will at least maintain its recent highs, above the psychologically significant $1,000/oz level, or even continue to rise.

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Market confidence was buoyed in early November by the purchase by the Indian central bank of 200t of bullion from the IMF for $6.7bn, taking its total holdings to 5577t or around 6% of its total reserves by value. This bodes well for the next sale by the IMF of a further 200t. Since this combined 400t sale represents in excess of 10% of the world's annual gold supply, the ease with which it has proceeded has reduced marked concerns about oversupply.

Is this a growing trend amongst central banks? All eyes are now on China to see if it will be the principal purchaser of the second IMF sale, as a clearer indication of whether they are looking to hold a greater proportion of their central bank reserves in gold. As of April, China held 1,054t of gold or, according to official figures, around 1% of total reserves. By way of comparison, the US, Germany, Italy and France (the four largest holders of gold) hold around 70% of their wealth in gold. Whilst still very small, the share of China's reserves held in gold has grown 75% in the last six years.

Since China overtook South Africa to become the world's largest gold producer, it is possible that rising prices will make it less likely that China will buy the IMF gold and instead look to its own production to swell its reserves. Russia and Sri Lanka have also recently been increasing their gold reserves.

Somewhat at the bullish end of the spectrum, but worthy of note, is a Bank of America Merrill Lynch report, cited by Bloomberg, suggesting that gold prices will proceed to $1,500/oz within the next 18 months. More circumspect, BNP Paribas Fortis/VM Metals forecast gold to peak at $1,200/oz in the next couple of months and be at $950/02 by October 2010. Despite the rally taking place in the context of lower volumes, which would suggest greater potential volatility, the demand that does exist is coming less from jewellery and derivatives and increasingly from those demanding physical delivery and possession of their bullion. …