Gold prices witnessed a sharp increase in 2005. With prices ballooning to 17-year highs, patient investors will be rewarded by buying in the next big dip. This article analyses the causes of the year end gold rally.

Peter Bernstein begins his book Power of Gold by giving an interesting anecdote of a person who sold all his belongings, converted them into gold coins and proceeded to take a journey via the seas. Misfortune had it that the man had to encounter a mid-sea storm. Because of impending shipwreck he had no choice but to jump into the sea with all his belongings. Obviously he drowned. The question Bernstein asks is, "He had the gold or the gold had him?" Taking a leaf out of this wisdom, the central banks of the major gold holding countries (30% of world's mined gold is with the Central banks) agreed to sell gold in a phased manner so that they won't drown in case everyone went on a selling spree and as a result the prices went into a tailspin. To their utter disappointment, this decreased the value of their gold assets and exposed them further to market vulnerabilities. The fact was that they desperately wanted to sell gold, which was an unyielding asset in their books.

Come 2006-because of the uncertainly regarding economic performance and inherent risks in all the major currency areas (the US, Eurozone and Japan) these central banks suddenly did a volte face and started to buy gold instead of selling it, so that they are diversified satisfactorily in case of any currency crisis (the Economist had forecast that there was a big chance of a major currency collapse in 2006). Also, buying of gold by the central banks was amply supported by the `no vote' in France, the hurricanes that humiliated the US and aggressive buying by Middle East countries from their petrodollar accounts. Gold prices moved from the $420 levels to $540 levels in one year.

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