Monday, May 10, 2010

Euro Bailout Multiplies; Gold Suffers Letdown

It's no longer 110 billion Euros. After a marathon meeting, the EU and IMF have agreed to commit a full 750 billion Euros to a defense fund that will be used to prop up all vulnerable European governments. The announcement of 110 billion euros having failed to impress markets on Friday, the package was multiplied due to selloffs in Portugese bonds. The European central bank has also committed to buying bonds of (vulnerable) governments, which are planned to be sterilized so that the overall monetary base won't increase. The package is intended to be a once-and-for-all measure; 250 billion is to come from the IMF. As some may have guessed, the Federal Reserve is involved too: it's setting up a currency swap line with the European Central Bank. The German government's portion of the Grecian bailout has yet to be approved by the upper house, which saw enough defeats of Angela Merkel's coalition to make her lose control of it.

Given this item, the news that the British central bank has held interest rates steady at 0.5%, and is keeping its quantitative-easing program, faded into the backdrop. So did the announcement by the People's Bank of China saying that it will manage the yuan with reference to a basket of currencies, which may be preparation for an upvaluation with respect to the greenback.

Regardless of the longer-term effect on gold these measures will have, the announcement of the expanded bailout package sent the metal tumbling. When the week's trading began, gold dropped about ten dollars an ounce. Last night's trading was volatile, but $1,200 was largely surmounted again; that changed as night turned into morning. Starting at 2:00 AM ET, from almost exactly $1,200, the metal dipped down several dollars an ounce at first. Partially recovering a little more than an hour later, it plunged down to $1,183.20 just after 4 AM. Since then, the metal has lumbered back up to almost $1,195 before tailing off again. As of 8:12, the spot price was $1,191.10 for a drop of $16.90 since last Friday's close. The Kitco Gold Index attributed +$14.60 to a weakening greenback and -$31.50 to predominant selling, a sign that a lot of postcrisis profit-taking kicked in.

As indicated above, the U.S. Dollar Index also tumbled on the news. Initally opening below 84, the Index slid before stabilizing last night. An attempted run above 84 around 9:00 PM failed to hold. Instead, it continued sliding; at bottom, made as of 4:30, it was below 83. The Index since recovered to pull up to a little below 83.5, but the bailout expansion's effect on the Euro clearly took its toll on the greenback. As of 8:20 AM, the Index was at 83.49.

The morning Wall Street Journal report ascribed gold's drop to relief selling.
However, the nervousness that defined the market last week hasn't entirely disappeared, said Afshin Nabavi, head of trading and physical sales at MKS Finance. He expects some buying of gold once the market digests the initial news of the EU aid package.

Goldman Sachs Monday said in a report that it raised its 12-month gold forecast to $1,335/oz from its previous estimate on April 12 of $1,320/oz. The Wall Street firm said the low interest-rate environment will favor gold investment, but the risk is that the U.S. Federal Reserve tightens monetary policy earlier than expected.
A Reuters report mentioned the same cause, although it said that the size of the package introduced moral hazard and stoked fears of inflation.
"Safe-haven buying has tended to lift gold in recent weeks, and as that comes out of the market we will see gold pull back," said Standard Chartered analyst Daniel Smith. "But we expect the pull-back to be relatively mild. Gold will move higher again."

"The recent rise has clearly been linked to safe-haven buying but we have also seen gold rally on the back of other (assets) and commodities," he said, adding that the metal is likely to benefit from a more inflationary environment.
Also mentioned is the drop triggering buying in the Indian physical markets, and the fact that other commodities have surged after the news - particularly, crude oil.

Gold pulled back up somewhat as regular trading began. After sinking to $1,191 by 8:10, the metal jumped up to almost $1,198 before pulling back to $1,193. Subsequently, it pulled back up again. As of 8:51 AM, the spot price was $1,194.00 for a loss of $14.00 since Friday's close. The Kitco Gold Index attributed -$24.70 to predominant selling and +$10.70 to weakness in the U.S. dollar. That weakness has lessened, as the U.S. Dollar Index jumped up above 83.5 to reach 83.78 by 8:40. Tailing off, it sunk back to above the 83.5 level before pulling back up again. As of 8:57, it was at 83.54.

The pullback in gold really isn't that surprising, given its rocket-up as a crisis haven. The metal may recover today, as the implications of the expanded bailout sink in, but the prime driver for its run above $1,200 is gone for now. The metal might have a tough slog today.

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