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Is the gold price bubble ready to burst?

In recent weeks the price of gold has seemed to defy the laws of gravity, making fresh trading highs every day before hitting a record above $1,900 an ounce in mid-August. The parabolic price rise of gold ended abruptly with a sharp two hundred dollar sell off shortly thereafter and has continued to experience increased volatility with $50 price swings. The increased volatility raises concern that the uptrend in gold is ending and the meteoric price rise may have created a bubble that is about to burst.


The primary driver for the price of gold is investment flow seeking a safe haven and investors hedging against risk. Global concern about sovereign debt risks in the US and Europe and uncertainty about the global economy are the major risks fuelling demand for gold.

According to the World Gold Council, demand for gold remained strong in the second quarter of 2011. China and India remain the largest buyers of gold; however the World Gold Council reports that Saudi Arabia was one of the top gold buyers in 2010, but demand has declined by 21 tons in Q2 2011 or 16% below the previous year’s levels. The weak demand for gold from the Middle East region has been attributed to the rising price of gold and continued regional unrest discouraging purchases of gold jewellery. Saudi Arabia is the largest jewellery producer in the Middle East using 140 tons of gold a year.


The fundamentals for gold remain positive with prices likely to find support from three major investment trends; portfolio diversification, hedging against inflation/ currency risk and central bank demand. Investors will continue to look to gold for portfolio diversification because it is not closely correlated with most other ***ets.

Saudi nationals hold significant US paper ***ets and the recent downgrade of the US credit rating, coupled with global equity market volatility, makes gold an important part of an investment portfolio to protect wealth and manage risk.


Quantitative easing by the Federal Reserve and weakening of the US dollar are major factors driving the price of gold. With US interest rates at a record low, and the US budget deficit expanding at a record pace, the US dollar faces an increased risk of devaluation.

Gold has emerged as an alternative to the US dollar and other currencies.


With around 86% of Saudi revenue coming from oil and oil priced in US dollars, gold is also being used as a hedge against a weaker US dollar and to diversify US dollar reserve holdings in Saudi Arabia.

In addition, the IMF recently warned of the risk of rising inflation in Saudi Arabia, which also reflects higher food prices and rising rents.


Central bank demand for gold is rising as they add gold to diversify their reserves. The World Gold Council reported in June that Saudi Arabia doubled its gold reserves to 322.9 tons from 143 tons in 2009.

The Saudi central bank is ranked 16th among world central banks in relation to their holding of gold reserves.


Although the fundamentals suggest that gold prices may be headed higher, some economists warn that the sharp price rise and increased volatility in the price of gold makes gold less of a safe haven and risk capital are the only funds that should be deployed in the gold market now.

This may discourage investment flows and pave the way for more short-term selling pressure in gold.

As long as global economic uncertainties remain unresolved it is likely that consumers, governments, central banks and investors will continue to buy gold to try to protect their wealth.



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EF Worldwide Ltd, registered in Guernsey
Nicolas Shamtanis
Dealing Room Manager
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