Gold's cross-currency strength signals its evolution

LONDON (Reuters) - Gold's rally to record highs in euro and sterling terms and the resilience of spot prices in the face of a rising dollar is sign-posting the metal's broadening insurance appeal, as sovereign debt fears shift to the fore.

Worries over Greece's fiscal outlook created a perfect storm for euro-priced gold this month, as some investors selling the single currency chose bullion as an alternative.

News that the next UK general election could result in a hung parliament, making it harder for an incoming government to tackle Britain's debt, sparked a similar rally in sterling gold , taking it to a record 759.86 pounds an ounce.

Investors' growing sensitivity toward sovereign risk is starting to suggest dollar-denominated gold can maintain strength even as the dollar rises -- usually a prime factor pushing the precious metal down.

"Gold is holding up very well given the foreign exchange market movements, and you have to ask why that is," said GFMS Chairman Philip Klapwijk. "Sovereign debt is very high up the agenda at the moment."

Spot gold held above $1,115 an ounce on Wednesday, off the record high of $1,226.10 it hit in December but still above the $1,096.25 at which it started the year.

The dollar has gained nearly 4 percent versus the euro in that time, largely on fears over fiscal issues in Portugal, Italy, Ireland, Greece and Spain.

GLOBAL RISK

But sovereign debt issues don't stop there. In January the World Economic Forum said the risk that deteriorating government finances could push economies into full debt crises was the main threat facing the world in 2010.

The U.S. fiscal deficit is projected to reach $1.56 trillion this year, Japanese debt is nearing 200 percent of GDP, while Fitch Ratings said earlier this week that Britain's sovereign credit profile has deteriorated.

"Until we start to see governments bringing down debt, the (sovereign) risk will stay with us," said Saxo Bank senior manager Ole Hansen.

A Reuters monthly poll of 65 forex strategists showed the Greek debt crisis could force euro volatility against the dollar higher still in March.

Usually the euro's decline versus the dollar would drag gold lower, but that relationship has weakened.

Using 1 as a perfect correlation and -1 as an inverse correlation, the traditionally strong link between gold and the euro-dollar exchange rate fell from 0.9 in early February to as low as -0.2 a month later, according to Reuters data.

UGLY CONTEST

With the world's leading currencies currently involved in what analysts refer to as an 'ugly competition', gold is gaining traction.

"People have real fears about what is going to happen in Greece and Spain and the effect it is going to have on the euro, and they are saying the only thing that is safe and secure is gold," said ANZ Bank's head of metals sales Peter Hillyard.

"Whether that is foolish or not, it is current thinking."

Major economies' adoption of low interest rates to stimulate economic growth have cut the earning power of cash on deposit -- also cutting the opportunity cost of holding non-interest bearing gold.

Governments are unlikely to address falling currency values at present, analysts say, as a weak currency can protect exports and boost recovery. Moves to raise cash via bond issuance to steer economies away from crisis are also unsettling investors.

"Long-term investors are beginning to realize that gold is the only thing that is going to protect you from governments who decide that the way out of this problem is to borrow more," said Bullman Investment Management Managing Director Nick Bullman.

From a chart perspective, gold has been building a solid base. It has risen steadily in euro and sterling terms since its late December correction, while dollar-priced gold has been on an upward trend since a dip to 2010 lows in February.

"Clearly gold has been based as something of an insurance policy," said Sean Corrigan, chief investment strategist at Switzerland's Diapason Commodities Management.

And buyers of physical gold, who typically lend strong support to the market, are more comfortable with prices above $1,000 an ounce, dealers say, putting a solid floor in prices.

Now gold has proved it can hold its own in a rising dollar environment, any change in that trend may prove explosive.

"If dollar gold prices manage to hold up under the prior circumstances, how are they going to perform when the U.S. dollar is back under pressure again?" said Klapwijk of GFMS.

(Additional reporting by Veronica Brown; Editing by Sue Thomas)