How to invest in gold and key price drivers

Reuters - Gold surges to a record above $1,313 an ounce on Wednesday after a spate of lacklustre U.S. data fuelled expectations the Fed may move towards further quantitative easing to help the economy, undermining the dollar.

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 $20 billion in trades passing through London'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 Jan. 9, 2008. Several other countries, including India, Dubai and Turkey, have also launched futures exchanges.

EXCHANGE-TRADED FUNDS

The wider 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. The ETF's holdings are equivalent to more than half global annual mine supply, and are worth some $54.9 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 small premium for investment products, of between 5-20 percent above spot price 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.

U.S. DOLLAR

Despite the recent 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 the direction of gold.

Gold is a usually popular hedge against currency weakness. A weak U.S. currency also makes dollar-priced gold cheaper for holders of other currencies and vice versa.

This link sometimes breaks down in times of widespread financial 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 Lehman Brothers crisis.

OIL PRICES

Gold has historically had a correlation with crude oil prices, as 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 continuing to rise in the last two years as oil prices retreated from record peaks.

FISCAL AND POLITICAL TENSIONS

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

Financial market shocks, as seen in the aftermath of the collapse of Lehman Brothers and more recently in the case of burgeoning euro zone debt problems, tend to boost inflows to gold.

Major geopolitical events including bomb blasts, terror attacks and assassinations 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 Aug. 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 . Sales under the new pact have been low, however.

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 shrank.

The world's biggest gold miner, Barrick Gold, cut its gold hedges by about 3 million ounces to eliminate its entire hedgebook in the fourth quarter of 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 160,000 tonnes -- more than 60 times annual mine production.

Gold is not "consumed" like copper or oil.

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