Gold's strong rally off the mid August lows continued unabated through the month of October as a conjunction of factors spurred investor buying and pushed prices just shy of the $ 800 mark . The month saw a growing flight to safety buying as investors sought refuge from a second wave of credit turbulence.

Sustained weakness in the dollar, which sunk to a new all time low against the euro, after successive interest rates cuts by the Fed and soaring crude oil prices added to the underlying bullishness in the market.

Prices in the domestic market were largely influenced by global factors, however the appreciation of the rupee had a moderating effect on the extent of bullion price increase over the month in the domestic market vis-a-vis the international market.

The price of gold and silver rose by 3.90 per cent and 2.35 per cent respectively in Indian markets compared to rise of 6.33 per cent and 3.96 per cent in the international market.

Dollar and oil - growing influence on gold
Gold has been found to be increasingly influenced by the dollar after a reversal of this trend observed since the middle of this year. The association between gold and the dollar rate (dollar - euro exchange rate) had grown weaker since the second half of the year, reflecting the precious metal's demand as stand-alone investment, independent of dollar developments. This was evident in the decline in the daily correlation between the returns on gold and dollar rate from 0.69 in June to 0.32 in September 2007

However, the correlation with the dollar rate was rising rapidly again for gold reflected by a strong positive correlation of 0.77 in the month of October. Following the equity market turbulence and the crunch on the money markets, gold has been increasingly being bought as a hedge against dollar weakness.

Oil has been another factor that has become more important in influencing gold price. Gold's association with oil this year has been the strongest during the month of October as worries of an inflation spike have set in after crude oil crossed the $ 90 barrel mark.

Major global economic developments

US Fed cuts rates again
The US Fed cut short term rates a quarter of a percentage point while appearing to signal that it was in no rush to cut rates again in the near future. The central bank reduced the federal fund rate charged on overnight loans between banks, to 4.5 per cent from 4.75 per cent, following a half a point cut in September.

The two moves according to the Fed would help forestall some of the adverse effects on the broader economy that might arise from the summer credit crunch that drove up interest rates paid by many homeowners, corporations and banks. The Fed said it now saw the risks of weaker growth and higher inflation as roughly balanced.

IMF cuts global growth forecast for 2008
The IMF cut its forecast for global growth next year in its semi annual World Economic Outlook as a result of the global credit squeeze to 4.8 per cent down from the 5.2 per cent it expected at the time of its July updates.

Projections on growth were reined in for most advanced countries. Growth forecast for the US was cut by 0.9 per cent to 1.9 per cent, as the continued problems in the US housing market spread to other parts of the economy.

The forecast for the eurozone countries and the UK was pared by 0.4 percentage points, by 0.3 per cent in Japan
and by only 0.2 per cent in emerging and developing countries.

Physical market developments

Gold ETFs at record highs
According to analysts, the sharp uptrend in gold prices has also heightened interest in gold exchange-traded funds around the world, with physical holdings to back the shares soaring to record highs.

The CPM group notes that at the end of October, holdings in the world's main gold ETFs totaled a record 27.17 million ounces compared to the previous year level of 17.88 million ounces. This includes all but a couple of small ETFs in India. Gold holdings have touched a record every month since July. StreetTRACKS Gold Shares, the world's largest gold ETF has moved in line with the current gold price trend and surged to an all-time high.

India's gold consumption scaled down
The World Gold Council has lowered its projections for India's demand for gold this coming season on account of record high prices, from an increase of 40 per cent to 20-25 per cent. It now expects India to import 800-900 tonnes of gold this year compared to an initial forecast of about 1,000 tonnes.

Analysts however believe that the deceleration in demand would be partly offset by the onset of the India's wedding and festive season.

Outlook
In a recent release, UBS said it was "bowing to the inevitable" and upgrading its one-month forecast for gold to $850 per oz, from $700 per oz, but stressed that its three month forecast, of $750 per oz, was unchanged.

Credit Suisse is warning that falling gold production could cause a "quantum upward change" in the price. A perfect storm of bullish factors for gold as it approaches the all-time high of $850.

BMO Capital Markets has significantly increased its gold price forecasts for coming years, on the back of strong gold prices over recent weeks. The gold forecasts for 2008 and 2009 were raised to $800 per ounce.

Morgan Stanley was another prominent financial institution to change its gold forecasts in light of soaring spot gold prices. It revised the 2008 forecast up to the $800 per ounce mark.

Sarah Koshie is an Economist with National Commodity & Derivatives Exchange Limited