What's Behind the Gold Price Surge

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Nor is the dollar especially under pressure lately. The U.S. Dollar Index, a futures contract offered by the New York Board of Trade that reflects the dollar's standing in relation to other major currencies, rose 0.16%, to 78.56, in response to the nonfarm payrolls report on Sept. 4 but is far below the 88-90 range it reached back in February. Still, the index is above the 71 level it sank to during the first half of 2008 when gold first broke above $1,000. Frank Holmes, commodities fund manager at U.S. Global Investors (GROW), believes that if the dollar were to drop back to its 2008 lows, the price of gold would probably shoot to $1,200,

That's unlikely to happen any time soon, however. While the choppiness in the overall economy has worked against the greenback for much of the third quarter, there are signs of a reversal, at least in relation to the euro. The yield differential between 2-year U.S. Treasury notes and the 2-year German sovereign bond had narrowed from 56 basis points three months ago to just 17 basis points on Sept. 4. "We're seeing a very choppy quarter for all the [major] currencies," which may be one reason that investor demand for gold has strengthened lately, says Meg Browne, senior currency strategist at Brown Brothers Harriman.

Stronger Dollar Anticipated

While currency fluctuations reflect shifting signals in the economic data, a more positive tone to recent economic reports "has tended to ease the sense of risk in the economy" and made investors gravitate toward higher yielding currencies than the dollar, she says.

But with the U.S. economy expected to recover ahead of Europe's economy, she sees U.S. interest rates moving up and supporting a stronger dollar over time.

Apart from the monetary considerations, there's the impact of physical supply and demand shifts. Standard & Poor's analyst Sam Stovall said on Sept. 4 that S&P expects gold prices to continue to climb due to declining mine production around the world. With global mine output decreasing at a 0.8% compound annual rate from 1999 through 2008, according to GFMS, Stovall predicts "production will remain stagnant for the next several years, as old mines are becoming depleted and are not being replaced to the extent needed to lift output. This, combined with rising demand, should cause the chronic gap between production and consumption of gold to widen further, in our view, helping to lift the gold price." (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).)

Royal Gold's Royalties Appealing

September typically marks the start of an extended period of higher seasonal demand for gold, which spurs restocking of inventories to satisfy increased demand for gold jewelry, says Holmes at U.S. Global Investors. That began earlier than usual this year with the Muslim Ramadan celebration and will build with India's post-monsoon rural wedding season, followed by the Diwali holidays across Southeast Asia and then Christmas. The fact that September historically has been a time of weakness in the dollar also works in gold's favor, he adds.

For those who are optimistic about gold prices continuing to move higher, Ernest Hathaway, registered principal at Financial Strategies Institute in Midvale, Utah, recommends using the SPDR Gold Shares ETF (GLD). He has also begun to buy single mining stocks such as NovaGold Resources (NG), which covers its expenses through profits on its copper production. He doesn't suggest that conservative retirees invest in mining stocks, however.

Holmes says his fund's portfolio now has a bigger exposure to gold stocks than to physical bullion. Among his picks are Royal Gold (RGLD), which has a strong royalty business with high profit margins and whose management owns a big portion of the outstanding shares. Another favorite is Freeport-McMoRan Copper & Gold (FCX), which recently eliminated its convertible preferred stock and bought back shares when they were cheaper. He likes that Freeport gives investors exposure to China—now the world's largest producer—and that most of Freeport's gold is produced as a byproduct of its copper production at no extra cost.

Bogoslaw is a reporter for BusinessWeek's Investing channel.

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