Factbox: How to invest in gold and key price drivers?

LONDON Wed Jul 13, 2011 10:05am EDT

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LONDON (Reuters) - Gold prices surged to a record $1,578.50 an ounce on Wednesday as fears grew over the euro zone debt crisis and after minutes to the Federal Reserve's June meeting suggested some members were pondering the need for additional monetary easing.

Following are key facts about the market and different ways to invest in the precious metal.

HOW DO I INVEST?

SPOT MARKET

Large buyers and institutional investors generally buy the metal from big banks.

London is the hub of the global spot gold market, with more than $33 billion in trades passing through the city's clearing system each day. To avoid cost and security risks, bullion is not usually physically moved and deals are cleared through paper transfers.

Other significant markets for physical gold are India, China, the Middle East, Singapore, Turkey, Italy and the United States.

FUTURES MARKETS

Investors can also enter the market via futures exchanges, where people trade in contracts to buy or sell a particular commodity at a fixed price on a certain future date.

The COMEX division of the New York Mercantile Exchange is the world's largest gold futures market in terms of trading volume. The Tokyo Commodity exchange, popularly known as TOCOM, is the most important futures market in Asia.

China launched its first gold futures contract on January 9, 2008. Several other countries, including India, Dubai and Turkey, have also launched futures exchanges.

EXCHANGE-TRADED FUNDS

Media coverage of high gold prices has also attracted investments into exchange-traded funds (ETFs), which issue securities backed by physical metal and allow people to gain exposure to the underlying gold prices without taking delivery of the metal itself.

Gold held in New York's SPDR Gold Trust, the world's largest gold-backed ETF, rose to a record high of 1,320.436 tonnes in June 2010. The ETF's holdings are equivalent to nearly half of global annual mine supply and are worth some $62 billion at today's prices.

Other gold ETFs include iShares COMEX Gold Trust, ETF Securities' Gold Bullion Securities and ETFS Physical Gold, and Zurich Cantonal Bank's Physical Gold.

BARS AND COINS

Retail investors can buy gold from metals traders selling bars and coins in specialist shops or on the Internet. They pay a premium for investment products of 5-20 percent above spot prices, depending on the size of the product and the weight of demand.

KEY PRICE DRIVERS:

INVESTORS

Rising interest in commodities, including gold, from investment funds in recent years has been a major factor behind bullion's rally to historic highs. Gold's strong performance in recent years has attracted more players and increased inflows of money into the overall market.

FOREIGN EXCHANGE RATES

Gold is a popular hedge against currency market volatility. It has traditionally moved in the opposite direction to the U.S. dollar as weakness in the U.S. unit makes dollar-priced gold cheaper for holders of other currencies and vice versa.

This link sometimes breaks down in times of widespread market stress, however, as both gold and the dollar benefit from risk aversion. Their ratio turned positive in late 2008 and early 2009 after the crisis following the Lehman Brothers failure.

Despite another drop in the usual strong correlation between gold and the euro-dollar exchange rate, the currency market still plays a major long-term role in setting gold's direction.

Analysts say gold's strong performance last year was largely driven by concerns over the stability of all currencies, though primarily the dollar, as major economies have moved to dampen strength in their currencies to safeguard exports.

OIL PRICES

Gold has historically had a correlation with crude oil prices, because the metal can be used as a hedge against oil-led inflation. Strength in crude prices can also boost interest in commodities as an asset class. More recently this correlation has weakened, with gold prices hitting a series of highs in the past two years while oil prices retreated from record peaks, though both have been boosted this year by Middle East unrest.

FISCAL AND POLITICAL TENSIONS

The precious metal is widely considered a "safe haven," bought during uncertain times in a flight to quality.

Financial market uncertainty, as currently seen in the case of burgeoning debt problems for Greece and other euro zone countries, tends to boost inflows to gold.

Major geopolitical events, such as the recent outbreak of unrest across the Middle East and North Africa, can also induce price rises.

CENTRAL BANK GOLD RESERVES

Central banks hold gold as part of their reserves. Buying or selling of the metal by the banks can influence prices.

On August 7, 2009, a group of 19 European central banks agreed to renew a pact to limit gold sales, originally signed in 1999 and renewed for a further five years in 2004.

Annual sales under the pact are limited to 400 tonnes, down from 500 tonnes in the second agreement, which expired in late September 2009. Sales under the new pact have been low, however.

More recently, central banks, chiefly in Asia, have shown a tendency to add to their gold reserves, with Mexico and Russia some of the most recent countries to purchase bullion. This has also provided a major support to prices.

HEDGING

At the beginning of the 21st century, when gold prices were languishing around $300 an ounce, gold producers sold a part of their expected output with a promise to deliver the metal at a future date.

But when prices started rising, they suffered losses and there was a move to buy back their hedging positions to fully gain from higher market prices, a practice known as de-hedging.

Significant producer de-hedging can boost market sentiment and support gold prices. However, the rate of de-hedging has slowed markedly in recent years as the outstanding global hedge book has shrunk.

The world's biggest gold miner, Barrick Gold, cut its gold hedges by about 3 million ounces to eliminate its entire hedge-book in the fourth quarter of 2009, while AngloGold Ashanti, also a major producer, closed its hedgebook last year.

SUPPLY/DEMAND

Supply and demand fundamentals generally do not play as big a role in determining gold prices as those of other commodities because of huge above-ground stocks, now estimated at around 167,000 tonnes -- more than 60 times annual mine production.

Gold is not consumed in the same way as copper or oil.

Peak buying seasons in major consuming countries such as India and China exert some influence on the market, but other factors such as the dollar and financial risk carry more weight.

(Compiled by Jan Harvey and Atul Prakash; editing by Keiron Henderson)

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