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Gold’s prospects rosy in 2011 but pitfalls abound

By Claudia Assis | Marketwatch.com

SAN FRANCISCO (MarketWatch) — Newly wealthy Chinese families and well-heeled U.S. fund managers conspired to push gold to records this year and their investment rationale - rooted in fears of currency debasement and higher inflation - is likely to keep the gold rush going in 2011. But some of the global buyers that lifted gold futures past $1,400 an ounce could head for the exits if rising rates make bond yields more attractive. That’s one of the pitfalls facing gold next year. “All the factors that have driven gold higher - the uncertainties, commodities as an asset class, gold as the ultimate currency - I don’t see that changing significantly” said Bill O’Neill, a principal at Logic Advisors in New Jersey.

The second half of the year is harder to predict, with one potential setback coming in the form of surging interest rates in Europe and the U.S., he said. Much higher interest rates would push investors away from gold, which bears no interest, pays no dividends and thus carries an opportunity cost.

The market could absorb higher interest rates over time, “but no surging interest rates,” he added. O’Neill sees gold hovering around $1,500 an ounce next year.

Gold has gained 25% this year, putting it on track for its third double-digit gain of the last four years. To chart gold’s price movements since 2000 is to draw an imaginary mountain slope offering few toeholds in its steep ascent.

Global appetite

This year, fears of a sovereign credit crunch in Europe; lack of confidence in the dollar, the euro and other major currencies; and low real interest rates pushed Western investors towards gold in droves.
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In Asia, there was fear of runaway inflation, particularly in China; more money around as emerging Asian economies grew and more joined the ranks of the middle class; and the presence of investors traditionally more predisposed to own gold - Indians and the Chinese are among the top consumers of gold in the world.

Western investors in 2010 bid more than ever for gold coins, bought futures contracts, and also poured record amounts of money into exchange-traded funds backed by gold. Gold futures soared to a settlement record of $1,416.10 an ounce on Dec. 6.

Indians, Chinese, and others in Asia kept buying physical gold, in addition to investing in it, despite the ever-increasing prices.

Jewelry demand in the four corners of the globe held despite the higher prices. In addition, the influx of scrap gold, normally a cooling factor whenever gold prices spike higher, was largely absent this year, analysts said.
Fund flurry

The demand from some of these buyers also makes gold vulnerable to a swift correction. Large hedge funds, which helped push gold to the forefront of investing this year, could sell their gold positions as easily as they bought them, swiftly taking the floor from under prices.

“It would be a big impact for sure, but for the time being, I don’t think they will,” said Dan Smith, an analyst with Standard Chartered in London. “It’s still a very bullish story.” ....

To read the rest of this story visit http://www.marketwatch.com/story/golds-prospects-rosy-in-2011-but-pitfalls-abound-2010-12-16?pagenumber=1

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