2009 saw the FTSE Industrial Metals and Mining sector return more than 350% for the year. The dollar index fell by 4.2% and gold raced to a new record of US $1,226, eventually dropping to a 24% gain over the year.

In summary, 2009 has been a phenomenal year for gold. BUT will this success pass over to 2010?

This year is truly the major test. It’s the year we’ve been waiting for, the one that could spell out what will happen for the years to come.

The loose monetary policies from governments across the world have flooded the markets with capital and, it seems just about everything has soaked it up. The S&P is approximately 40% more expensive in relation to earnings than its long term average. Oil is trading at a 15 month high. And as we’ve noted above, metals have had an outstanding year: silver gained 49%, palladium gained 117% and copper gained close to 140%.

2009 was the year equities and commodities all went up. Will they come down in 2010?

The new year brings with it mixed signals. Analysts have come out with their usual price predictions for 2010. But we don’t think you should pay much attention to them. This year, even more than any other, will be filled with turn of events that will dumbfound analysts. Caution is needed in volatile times like these. Your money needs to work for you better than the banks interest rates, but you also need to assess the risk when making any investment decision. You need to keep up to date with events that are shaping the gold price.

With this in mind we turn to last week’s major event ...

Last week we saw the markets first real movement in 2010. News that China’s banks had lent out close to $88 bn in the first week of January 2010 (which is not far off last year’s monthly average) was met with typical Chinese swiftness in action. On Tuesday, 12th January, the authorities decided to clamp down on the amount Chinese banks could lend by raising the required reserve ratio for commercial banks by 0.5%. They also hiked the interest rates in the interbank market for the second time in two weeks.

China had decided to act to tighten monetary policy sooner rather than later. In reaction the gold price and equity markets across the world fell. Taking a look at the graph below we can see the price of gold reacting to the news from China. But just as before buying support for gold came through to buoy the price above US $1100.

The weekly movement highlights the volatility of gold at the moment.

The three major questions overhanging this year's gold price are:

1. When will governments raise interest rates?
2. What will happen to the US dollar?
3. How will governments handle the quantitative easing policies they’ve put into action over the last year?

China’s economy has been growing at an annual rate of about 10% over the last 30 years. That level of growth is unsustainable over the longer term. The Financial Times reported that big city Chinese flats are selling for 15-20 times average household income. This is more than Japan at the height of it’s bubble. The extra liquidity has blown up bubbles in Chinese stocks and property.

In response the authorities have moved to prevent China from overheating. Last week’s actions were an attempt to gain better control over the economy and reign in the liquidity it had pumped in to the system during 2009.

How governments deal with the monetary stimulus’s from last year will shape the gold price as well as markets. We expect wide volatility this year as investment demand will continue to push and pull gold depending on the attractiveness of other investments.

The shape of economies

Undercapitalised banks, particularly in Europe, lead us to wonder whether they can satisfy a sustained economic upturn in 2010. The Eurozone looks at an uncertain future with Greece, Ireland and Spain posing difficult questions. The ECB will have to take into account these nations as well as those moving at a faster recovery, Germany and France for example, when it sets interest rates.

The job losses in America are accelerating. 85,000 people lost their jobs in December.

In summary a sustained recovery is not clear.

Eventually, however, once a recovery looks likely interest rates will also have to rise to stave off inflation. This in effect will increase bond yields making them compete with commodities and assets for investors attention. It would also mean an end to the US dollar carry trade we’ve mentioned before [click here to see ‘Gold’s evolving supply and demand’].

Credit Suisse puts the dollar carry trade at $1.4 trn - $2 trn. Raising interest rates would mean an end to this which could result in renewed interest, and a rebound, in the US dollar. This would potentially have a devastating effect on the gold price [click here to see ‘The inverse relationship between the dollar and gold’].

At the moment nothing is clear, and as long as it stays that way it is good news for gold. Gold thrives in times of uncertainty and turmoil.