Bullion for you: it's a new golden era

As shares lose their lustre and the dollar rusts, the metal is dazzling investors. And this time it's no flash in the pan

As global stock markets falter, and share portfolios continue to dwindle in value, many fund managers are coming to an alarming conclusion: their wedding ring may be the best-performing asset they own.

We are now more than a third of the way into 2002, and the much-vaunted recovery seems to be having trouble taking hold. World politics are messy, oil prices high, equities look dangerous and even the mighty dollar has taken a beating. Is it a coincidence that, for the past four weeks, the price of gold has stayed above $300 an ounce, and is still rising?

Not only is this the metal's most sustained run over $300 for four years, but it comes on the back of a long rally that has lifted gold by more than 16 per cent over the past 12 months. It has significantly outperformed the big stock indices in all the leading economies, and strategists take the surge in gold as a sure sign equities will stay in the doghouse for some time.

This time last year, a fall through $250/oz seemed on the cards; for some, $350/oz now seems a distinct possibility. Gold enthusiasts are delighted, as are the traditionalists who enjoy these occasional reminders that gold is a safe haven in times of trouble.

But this latest rally has raised some serious questions about the precious metal, and even the gold cynics are taking a second look. The price rise is looking far more sustainable than at any time in the last five years and there are already analysts suggesting that the days of weak, volatile gold could be over. Bullion is suddenly looking like a serious asset class again, and the emphasis now is on working out what factors are going to keep the good times rolling.

On the surface, the gold rally appears to be the result of frenzied buying by panic-stricken Japanese housewives. As one London Metals Exchange trader explains: "Mrs Watanabe's faith in her savings, stocks and government has disinte- grated. She's buying gold up by the kilobar because it's the only thing that doesn't show any signs of falling off a cliff."

Certainly, Japanese buying and hoarding has been exceptionally strong. At the end of this week, the World Gold Council (WGC) will publish the quarterly results of global trading, and the report is tipped to highlight the rampant Far-East market. The panic has largely been driven by the apparent inability of the Japanese to solve the long-running banking problems that dog the country's economy, and the buying spree has started to spread to the rest of Asia. New data shows gold imports to Japan in March up 570 per cent compared with the same period in 2001.

Gold's safe-haven status has also been boosted by the dollar's recent turmoil. Fears of a delayed recovery, or worse a double-dip recession, have destroyed much of the currency's reputation as the safest port in an economic storm. Funds around the world have shifted out of the greenback and into gold.

But, as WGC analysts explain, the focus on Japanese buying misses the other driving forces behind the gold rally. One of these is that the terms of an accord called the Washington Agreement, struck in 1999, are finally beginning to bite.

The agreement came at a time of chaos for gold. The spot market prices were down to $255/oz and central banks were talking about speeding up the selling of their bullion reserves. After Germany and Switzerland sold large chunks, the lowest point came when the Bank of England indicated that it might get rid of up to half its reserves. The Washington Agreement, signed by most of the big market players except the US and Japan, limited the signatories to a combined total of 400 tonnes of sales each year.

The accord has brought a new sense of order to the market, in effect eliminating many of the sudden price plunges that accompanied the old announcements of central bank sales. It runs out in 2004, and many are expecting a renewal of its terms, probably for at least a decade.

But the Washington Agreement has had an even more fundamental effect because of what it has done to the old practice of gold hedging. Back in 1999, all but a few of the big gold mining companies were involved in hedging themselves against the falling gold price. In effect, many became short-sellers of the very metal they were pulling out of the ground.

As SG Securities gold analyst Stephen Briggs puts it: "Hedging was becoming ridiculous, and the options themselves were becoming increasingly exotic and complicated. There were mining companies going out of business as the price rose."

The Washington Agreement, which removes a lot of the opportunity to make money from sharply falling gold, has persuaded most gold miners to reduce their hedge books dramatically. With less short-selling going on, price falls are far less exaggerated than they used to be.

"Gold has regained its safe-haven status because it now looks less likely that your gold bar is going to plunge in price," says Mr Briggs.

Bears of gold still need convincing that the good times are here to stay. As many point out, industrial demand for gold – particularly from the electronics sector – has fallen in recent years and shows few signs of imminent recovery. In the jewellery market, which accounts for 85 per cent of world gold use, big consumers like the US and Japan are showing a growing preference for platinum. But the bulls believe all this is actually good news, and that gold's status will be reinforced when things finally start to pick up. As one Toronto analyst says: "Gold has finally got some decent fundamentals beyond being the knee-jerk response to a load of bad news elsewhere."

For the first time in three years, a majority of analysts believe gold could finish the year above $300/oz.