The City Herald

If you are one of the many dental patients in the UK that have had braces furnished with gold, you have two reasons to smile when your treatment ends. The first is a perfect smile. The second is that your braces – which would normally be left in the clinic for recycling – may now be worth £100 on the scrap market.

Since the beginning of the credit crisis, the price per troy ounce gold skyrocketed from $800 one year back to a record high of $1,227 (£757) earlier this month. This upsurge, pushed mainly by a weaker dollar and the increasing appetite of investors for safer assets, encouraged many to sell their castoffs of the precious metal. “I think about 65 per cent of my customers are selling me things rather than the other way around,” one Leicester-based jeweller told The Economic Times.

However hurrying may have not been the best option. Investment bank Morgan Stanley forecasts a peak above $1,300 for the price of gold in 2010, topping the performance of commercial and residential property and bonds. The enthusiasm of some fund managers in the UK goes even further. According to a survey by the Association of Investment Companies (AIC), 28 percent predict gold to be the best performer next year.

Gold price performance in the past five years

With these glowing prospects, you might also be thinking about allocating part of your portfolio to gold. Unlike the last sustained bull market of this commodity in the 1970s, it is nowadays very simple to get exposure to gold. Among other options you can buy stocks of mining companies or simple invest in Exchange Traded Funds (ETFs) that aims to tracks the price of the precious metal. Digital gold or ‘e-gold’ is also an increasingly popular option, however the providers are not regulated and therefore the risks are higher.

But before reaching for the yellow metal, you should be aware of the key factors that influence its price.

In times of uncertainty (like the current financial crisis) gold is often chosen as the ultimate safe refuge by investors. To hedge themselves against market uncertainties, central banks and other financial institutions almost always resort to gold. Unlike other currencies, its supply is limited and cannot be increased by governments ‘out of thin air’. Moreover, its value does not depend on the credit rating of any particular institution.

Since the beginning of the global meltdown, many countries have exchanged dollars for gold as a strategy to keep their reserves protected from volatility. The central bank of India, for example, bought 200t last month in an effort to move away from the waning American currency. Because the value of gold is determined by the fundamental rule of supply and demand (as any other commodity), when central banks or investors rush to purchase it, the price goes up.

Put simply, as the value of the dollar falls, the price of gold increases and vice-versa. If interest rates in the United States stay low for an ‘extended period’, as announced by the Federal Reserve, so will the eagerness of investors to buy dollars. But as soon as interest rates rise and the dollar regains its strength, the price of gold is deemed to decline.

Hence betting on the price of gold is also betting on the prospects of the US and its monetary system. “Until the dollar puts in a convincing rebound, then the onus is to the upside in gold,” HSBC metals analyst Jim Steel told goldinvestingnews.com.

So is that it? Not quite. Another (and surely the trickiest) aspect that influences the price of gold is speculation. As its price keeps rising, more investors will expect it to keep going up. From 1995 to 2005, gold has been trading between $250 and $420 with the sharp rise beginning only thereafter. Many analysts say that hedge funds are on the back of this boost.

Along with trying to predict the price of gold it is also crucial to be clear on the purposes of having it in your portfolio. If you want to hedge yourself against volatility and inflation in the long term, gold is almost always a good option. Its natural scarcity and constant demand (for industrial use and jewellery) will guarantee that prices go up.

But if your decision to invest in gold is motivated by short-term gains, you may be setting yourself up against market conditions very hard to foresee. If the US raises interest rates and the dollar reclaims its vigor prior to your predictions – or if the price of gold suddenly tanks after an unwarranted market rally – your prospects for lustrous profits can quickly vanish.