Gold has confounded market watchers by refusing to behave like a safe-haven and instead has tracked equities over the past few weeks, but the escalating European debt crisis could see bullion ditch its risk-asset mantle and return to record highs.
The debt problems of some of the smaller Eurozone states have mortally wounded the premierships of Greece's George Papandreou and of Italy's Silvio Berlusconi and hounded the euro to one-month lows against the dollar and eight-month lows against the pound as confidence evaporates over the ability of Europe's leaders to stem the spread of the crisis.
Gold has risen 4 percent this month, having touched its highest in seven weeks above $1,800 an ounce this week, still back from the $1,920.30 record reached early in September, but pointing towards $2,000 judging by current options positions.
Unlike previous phases of market turmoil, such as the aftermath of the 2008 collapse of U.S. bank Lehman Brothers, when gold lost as much as seven percent in a single day, or during this May's commodities flash crash that stripped 3 percent off the price in two days, investors and analysts say gold looks unlikely to be sucked into a vortex of mass selling.
Whenever you get total panic, even gold goes down, because people take profit on their gold positions. When people start losing money very rapidly, they close down all positions including the ones that are sitting on a profit, said Jesper Dannesboe, senior commodity strategist at Societe Generale.
That's why you had that gold sell-off in September, when everything was in panic mode. You don't have quite the same panic mode right now. It's (an environment of) moderately bad news and that tends to be bullish for gold, he said, although no-one is yet placing bets on what happens if the euro melts down.
CASH FOR GOLD
In periods of extreme risk aversion and volatility, gold can hitch itself to more growth-dependent assets and succumb to broad selloffs, especially if investor panic is such that the desire for the safety of cash is the driving force. In September, the gold price shed more than 20 percent in two weeks as investors scrambled to cover losses in other markets.
Mark O'Byrne, director of bullion dealer and wealth manager Goldcore, said in an interview last week given the degree of macroeconomic risk, his company was considering increasing its allocation to gold within its passive funds to 10 percent from 5 percent currently. He added he would not be surprised to see gold trading above $1,900 because of this heightened risk.
Pau Morilla-Giner, who runs the London & Capital commodities fund, which currently allocates about 37 percent of the 200 million pounds it has under management to gold, said the 14-percent rise in the gold price since September's lows had been fuelled by a much slower, steadier rise in investment than back in the summer, when so-called hot money came flowing into the market.
I don't necessarily subscribe to the theory that on specific days of doom, gold is going to go up. It will only go up if the expectation that the reaction to that doom is monetary expansion, he said.
The worse things are for Europe, the more pressure the European Central Bank will have to provide the ultimate stimulus and that inevitably will mean yet again debasement of the currency of choice in this case the euro.
Gold has risen by nearly a third in value over the last year, driven by a rising tide of liquidity from the developed world's central banks including the U.S. Federal Reserve, the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank, which have sought to anchor interest rates by lowering them, via purchases of government debt or by intervening in the currency markets.
So the likelihood of any of the major central banks raising interest rates has dwindled considerably and price pressures remain high, meaning real interest rates, which factor in inflation, are negative throughout the G7, thereby offering hefty support to gold, which is not subject to interest.
On our analysis, since 1970 whenever U.S. real interest rates have fallen below -3 percent, gold prices have typically been able to rise by an average of 40 percent year-on-year, said analysts at Deutsche Bank in a recent report.
On this basis, if real rates remain at current depressed levels it would imply a move above $2,000/oz is only a matter of time.
The options market shows the heaviest bets among investors is for gold to end the year at or above $2,000 an ounce. For gold derivative contracts expiring at the end of December, most open interest on call options - which give the holder the right, but not the obligation, to buy an asset at a predetermined price by a set date -centres on $2,000.
Andrew Cole, a portfolio manager at Barings Asset Management, which runs a four billion pound dynamic asset-allocation fund that keeps 10 percent of that total in gold, said currency debasement underpinned the rationale behind the demand to own bullion as a safe store of value, even more so than during the subprime debt crisis of 2008 .
We're in a much darker place. Governments can't rush to the rescue in the way that they did in 2008. In 2008, there was a certain amount of optimism that we can pass what was ostensibly a private-sector debt problem onto governments, that they had big enough shoulders to carry the burden that would allow for an economic recovery, he said.
Three years on, we recognise that the economic recovery was so lacklustre that actually they now have the debt problem and there is nobody else. More debt and somebody riding to the rescue probably doesn't help. So an extended period of sub-trend growth and deleveraging looks inevitable.