Thursday, July 7, 2011

London Gold Market Report - July 7, 2011

London Gold Market Report
from Ben Traynor
Thursday 07 July, 08:30 EDT

Gold Falls, Debt Ceiling Plan B "Insane", ECB Hikes But Cheap UK Money "Subsidizes the Foolish"

U.S. DOLLAR gold prices dropped to $1525 an ounce Thursday morning London time – still 2.5% up from where they ended last week – as stocks and commodities gained and US Treasury bonds fell, while rumors spread that the US Treasury is holding secret debt ceiling talks.

"Despite the push in gold prices, physical selling is subdued with Indian demand still strong," says Marc Ground, commodities strategist at Standard Bank.

"Concerns over Eurozone debt, rising inflation in China, and an upcoming debate on raising the US debt ceiling" should be supportive of the gold price adds Swiss precious metals group MKS.

Reuters reported Wednesday that the US Treasury is secretly discussing how it might avoid a US default if Congress does not vote to raise the $14.3 trillion federal debt ceiling before August 2 – the date the Treasury expects to hit that borrowing limit.

One option reportedly being considered would involve the Treasury delaying $49 billion of Social Security payments due on August 3. This would enable the government to cover payments to government bondholders.

However, it is "not obvious...that the president has the legal authority to pick and choose who gets paid," notes former Treasury official Michael Barr.

Even if President Obama does have the authority, Barr says, it is not clear that such a plan would work "as a practical matter".

"The notion that we would just pay Wall Street bondholders and the Chinese government and not meet our Social Security and veterans' obligations is insanity," says David Plouffe, senior advisor to Obama.

Over in Europe meantime – and after Portuguese bonds were downgraded to junk status and Italian yields breached 5% this week – the Spanish government successfully sold €3 billion of new debt on Thursday.

The new 5-Year bond was sold at a yield of 4.871% - up from the 4.549% Spain offered on May 5, the last time the 5-Year bond was sold.

In Frankfurt the European Central Bank announced Thursday that it will raise its benchmark interest rate from 1.25% to 1.5%.

"This may in fact be Trichet's last interest rate increase," said Julian Callow, chief European economist at Barclays Capital, speaking before the much-anticipated announcement, citing signs of weak growth in many European countries.

"The sands are shifting in the global economy under the ECB's feet."

Here in London meantime the Bank of England voted for the 28th month in a row to keep its main interest rate at 0.5%.

"We see the first rate increase coming in November," says Philip Shaw, London-based chief economist at Investec Securities. 

"But we've been tempted to push that call into 2012...the governor [of the Bank] has made a clear case for keeping rates on hold and not tightening policy to get inflation down rapidly."

Earlier this week campaign group Save Our Savers wrote to each member of the Bank's Monetary Policy Committee urging them "to bring inflation back under control" by hiking rates.

Consumer price inflation rose to 4.5% in May – more than double the Bank's official target.

"The thrifty and the responsible are involuntarily subsidizing the profligate and foolish...with an effective transfer of wealth from savers to borrowers," said a statement from the group.

Save Our Savers estimates that the combined effects of inflation and low interest rates have wiped £50 billion off the value of UK savings over the last two years.

Back in the bullion markets, silver prices sank to $35.79 per ounce during Thursday morning's London trade – still 5.7% up from last Friday's close.

"There doesn't seem to be strong interest" in silver from Asia, one Hong Kong bullion dealer noted on Thursday.

"While we believe silver could continue to outperform other precious metals, we are concerned about persistent levels of volatility," adds a note from Morgan Stanley.

"Consequently, we maintain our preference for gold in the short term."

Goldman Sachs said on Thursday it considers gold to be currently "under-bought" relative to the level of US real interest rates.

"[We] expect current low real rates to motivate a rise in net speculative positions, providing support for a further rally in gold prices."

Goldman Sachs expects, however, that gold prices will peak next year "as US real interest rates rise with the ongoing economic recovery".

Ben Traynor

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