Analysing gold used to be easy – assuming you knew which way the dollar was going to move. The breakdown in the strong inverse relationship between the dollar’s weakness against the euro and gold has made life more difficult, but there is no shortage of justifications for gold’s strength.

Gold is seen as both a hedge against inflation and as a haven from financial armageddon. Signs of inflationary pressure, however, are hard to detect in current low levels of long-term bond yields. Global growth, meanwhile, is expected to moderate, not collapse. Gold as protection against geopolitical risk has some validity, but this demand can only be viewed as speculative.

Bulls can point to stagnant or declining gold output in traditional producing areas and the relative robustness of jewellery demand in the face of higher bullion prices. But a large overhang of above ground stocks – estimated by Barclays Capital as equivalent to more than 300 weeks of demand – means that the balance of physical supply and demand is not the dominant issue.

Some hope that gold may benefit from potential diversification of reserve assets away from the US dollar by Asian central banks. The poor yield from holding the metal – lease rates are very low – and its relative illiquidity argue against it taking a big share of any diversification. Moreover, it would make sense for any large transactions to be conducted off-market with western central banks, which continue to be net sellers.

This leaves investment demand – and here there is some good news for the bulls. The growing popularity of gold-backed tracker funds suggests that long-term institutional and retail investment demand for gold is increasing. Its importance, however, should not be overstated. As recent sharp price falls show, gold remains vulnerable to the whims of short-term speculative investors.

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