LONDON (Commodity Online): Investors are going mad after gold. The yellow metal price that has been rising steadily over the last one month is nearing the magical figure of $1200 per ounce as Asian markets opened on Thursday. Why are investors pouring their money into gold these days?

In this following analysis, global investment bank Merrill Lynch pin-points the reasons that is driving people to put money into gold:

Why are investors piling into gold? First and foremost, money is flowing into gold as investors seek to protect themselves from USD currency risk. Looking at daily gold spot returns and decomposing them into factors, we find that USD depreciation and currency risk have been important contributors to higher gold prices. Secondly, our analysis also suggests that changes in gold prices have been leading indicators of changes in 5Y breakeven inflation rates and in the USD yield curve slope (10Y-2Y) since April, suggesting that gold is really moving ahead of inflation expectations.

Decomposing the FX driven gold rally of 2009

In the most recent rally, some currencies have shown high correlation and high beta relative to gold prices since April. More specifically, EUR and CAD have shown the highest beta and correlation to gold, while KRW and JPY show some of the lowest in the last 8 months. But even those currencies that have not been correlated with gold have tended to be more correlated in the more recent period when using forward looking measures like implied volatility in the options markets.

When EURUSD drops, gold tends to hold its value

So what is driving the correlation between gold and the various currencies? Our analysis suggests that the correlation of gold returns to EURUSD is a lot higher on the upside that it is on the downside. This is a rather interesting development that it is also present in other currency crosses. The simple explanation, in our opinion, is that the supply of money in all currency areas is increasing a lot faster than the supply gold. So the weaker dollar is contributing to push gold prices higher in USD, but the increase in money supply in all countries is driving gold prices in every currency.

Compared to the expansion in the money supply …

In our view, the massive expansion in money supply observed in 2008 represents a competitive debasement of fiat currencies relative to gold. With the exception of the JPY, broad money in local currency expanded at rates between 8.5% for the EUR and nearly 25% for the TRY, compared to an expansion in the global stock of gold of 1.18%. For the time being, however, the rapid increase in real money has not been accompanied by a broad-based increase in consumer prices as the credit multiplier has remained rather muted in most countries.

Extracted from the Metals Report, Merrill Lynch