Gold Contines Slide; China, U.S. Dollar Throws Damper

It's no secret that PRC officials would like to diversify out of the U.S. dollar, and that desire led many in the gold world to hope that gold would be a major part of the new reserves composition. That hope was thrown a wet blanket overnight, as the Head of State Administration of Foreign Exchange, Yi Gang, said that gold isn't planned to be a major destination for redeployed funds.

The price has "had handsome gains in recent years,” Yi said. But, “if we look at the past 30 years, it had big ups and downs.” China has lifted its holding of gold by 454 tons to 1,054 since 2003, leaving it with the world's fifth-biggest holding. After India, China is the biggest consumer of gold and, according to Mr Yi, increasing its reserves of gold will "push up prices" and "hurt Chinese gold consumers."

He also noted that there is no push to abandon the U.S. dollar or U.S. Treasury securities.

China has invested [hundreds of] billions of [its reserves] in US government bonds, making it the country's largest creditor, and Mr Yi insisted today the investment is "very important" and that "China is a responsible investor, and we don’t want to politicise the issue.”

There have been calls for the PRC to divest in retaliation for U.S. military sales to Taiwan, particularly from the PRC military. This statement can be read as a fend-off of those demands.

Whatever the implications for geopolitics, though, it had an impact on gold - but that impact wasn't very harsh. The metal did slump in Hong Kong trading overnight, but not by that much. It did, however, add to the downward pressure to the metal. Later, it was pushed out of a range established overnight and into a new lower one.

The $1,120-$1,125 range established in yesterday's afternoon trading held for the rest of yesterday. The announcements above did put gold to the lower end of the range in Hong Kong trading, but didn't crack it. That crack didn't come until London trading opened; it was prompted by the U.S. dollar rallying. Another test of the $1,120 level took place at about 5 AM, reversed, and then turned into a drop that pushed the price briefly to $1,114.30 before recovering above $1,115. Since then, gold's been trading in a new $1,115-$1,120 range. As of 8:09 AM ET, spot gold was at $1,117.50 for a drop of $6.20 on the day. The Kitco Gold Index has $2.00' worth of decline attributed to predominant selling and $4.20's worth due to strengthening of the greenback.

The U.S. Dollar Index managed to break though its resistance level of 80.5, first by settling into a trading range with a higher ceiling: 80.55. Then, at about 2 AM, the Index rallied to 80.6 before pulling back to 80.46. Subsequently, a little before 4 AM, the Index rallied to well above 80.65, spent some time fluctuating with a floor of 80.6, and rallied again. Its peak, reached after 7 AM, was 80.798. Since then, it's fluctuated in a range bordered by 80.8 on the upside and 80.7 on the downside. As of 8:19 AM ET, the Index was at 80.77. So far, anyways, the 80.5 level has proven to be more porous than I had assumed earlier. Today's trading will show whether or not it was bested at the day level rather than at the interday level.

The morning's Reuters report, as webbed by the Globe and Mail, says that the U.S. dollar's rise was primarily responsible for gold's fall - but bargain-hunting has intervened to partially mitigate that decline. Gold actually set another new record in Euro terms at its highs. The influence of the PRC announcement was described as restrained:

UBS analyst Edel Tully said in a note that given the price-negative undertones of Mr. Yi's comments, the gold market's reaction to the news had been muted.

“While we would expect more near-term downside for gold once the news sinks in, it is unlikely to entirely quash market expectations that China will indeed move to increase its reserve capacity for gold,” she said.

The article also mentions that the greenback's rise was caused in large part by Grecian Prime Minister Papandreou warning of a new financial meltdown if the Grecian crisis worsened. Negotiating ploy it may have been, but it was still taken seriously by the currency market.

The same factors were described as weighing on the gold market in a Wall Street Journal Online article, with Yi Gang's annoucement being the focal point. Two analysts differed on its significance:

"It's completely unsurprising," said Stephen Briggs, an analyst at RBS Global Banking & Markets. "It is obvious that for China to have a material amount of gold in reserves, it would disrupt the gold market. It's not viable." The idea that China gradually makes gold purchases from domestic producers is "more sensible," Mr. Briggs said.

The comments will, however, weigh on sentiment, said Andy Smith at Bache Commodities.

"I would expect through the day, if the dollar continues to strengthen, gold will be under pressure," he said, noting it "downgrades expectations" that China will be a big market gold buyer.

Like the Reuters report, this one described the effect as muted.

Regular trading opened with traders taking both items in hand and pushing gold down. The newer range of $1,115-$1,120 was broken; like the last one, to the downside. Starting at 8:15 AM ET, gold was shoved down about ten dollars an ounce; the low, reached around 8:45, was $1,107.60. Since that bottom, a relief rally has pushed the metal up a little. As of 8:59 AM ET, the spot price was $1,111.30. The Kitco Gold Index divided the $12.40 loss into $7.90 for predominant selling and $4.50 for greenback strengthening.

The U.S. Dollar Index continued rallying, making it to 80.845 at 8:39 before sliding back. As of 8:57 AM, it was at 80.78.

Given the magnitude of the drop, it's an open question whether or not the recent reverse head-and-shoulders pattern that pushed gold up to $1,140 is a third busted bullish formation. The day's trading will show if gold can recover, or not.