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Foreign Exchange

Euromoney FX survey 2011: Gold evolves as a currency

Seen as hedge to currency debasement; Integrated FX and metals pricing adds advantage

The gold price stormed through $1,500 a troy ounce last month after Standard & Poor’s warned that it might cut the US’s triple-A rating, and investors priced in the potential for a downgrade of the monetary base, in US dollar terms. In this year’s Euromoney FX survey, respondents were asked: Is gold just another currency? Thirty-four percent said ‘yes’, 42% said ‘no’, and 24% said they did not know. So it is fair to say that opinion was mixed. However, banks with integrated FX and metals trading businesses have never been surer that gold is becoming more and more like a currency. "Gold and silver trade very much like currencies," says Chris Vogelgesang, co-head of global foreign exchange at UBS.

Negative carry

He claims that the bank’s integrated trading platform has given it a head start in the rising popularity of dual currency and metals structured products, such as warrants, which it distributes through its wealth management and retail networks. Moreover, gold has become a much easier tool to trade because of the prolonged period of low interest rates. In the past, one of the impediments to trading gold had been the negative carry associated with owning the metal.

That is no longer the case, and as such the metal is a more effective currency substitute, says Geoff Kendrick, European head of foreign exchange strategy at Nomura. "It makes a lot of sense to trade gold these days because its main value is as an option, or as another version of a currency base, as opposed to the dollar or euro," he says.

"It makes a lot of sense to trade gold these days because its main value is as an option, or as another version of a currency base, as opposed to the dollar or euro"

Geoff Kendrick, Nomura

Central banks appear to be among the biggest players in the gold markets as they seek to diversify holdings out of dollars and into other currencies. Kendrick says commodity currencies, such as Australian and Canadian dollars, have been popular, and they’ve increased their allocations to gold. "Whereas western central banks have been selling gold in the past 15 years, eastern central banks such as China’s have been buying," says Kendrick. "It’s another reason why gold is so high because the market is small and the increase in central bank reserves is huge."

Although gold has the potential to be volatile it is no more volatile than commodity currencies such as the South African rand, and volatility levels are very similar. That means that if investors wanted to get exposure to gold producers in South Africa, they could just go long gold, analysts say. Interest from investors continues to grow too.

Hedge funds

According to Kendrick, the traditional buyers of physical gold have come from Germany and Israel but now hedge funds have in recent years built up positions. Hedge funds will either have a portion of their portfolio in gold in case there’s a huge currency debasement blow-up trade, such as potential quantitative easing, which also gives them a hedge against other currency positions they might have in their portfolio. Of the main price makers in gold, UBS and Deutsche Bank are considered to be the most important providers, according to hedge fund players who spoke to Euromoney this month.

Nevertheless, if gold is to be a true currency, it will need to trade on more execution venues, a London hedge fund manager tells Euromoney. "I would love to see more gold traded on ECNs," he says.

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