What strong gold says about the weak dollar

TODAY, commentators overwhelmingly agree that a weakening US dollar cannot possibly lose its status as the world’s dominant currency because there is “no alternative” on the visible horizon. Perhaps, but don’t tell that to the many countries racing to find an alternative, and such complacency will only accelerate their search.

The prime example right now is gold, up 20 per cent in six months. Surging demand is not led by the usual suspects – investors large and small, seeking a hedge against inflation and low real interest rates. Instead, the heavy buyers are central banks, which are sharply reducing their US dollar holdings and seeking a safe alternative. Central banks are buying more tonnes of gold now than at any time since data began in 1950, and they currently account for a record 33 per cent of monthly global demand for gold.

This buying boom has helped push the price of gold to near-record levels and more than 50 per cent higher than what models based on real interest rates would suggest. Clearly, something new is driving gold prices.