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June 25, 2009

London Gold Market Report
by Adrian Ash

"Do We Buy Gold or T-Bonds?" Asks Chinese Official as US Debt Piles Up; California Ready to Use I.O.U.s as Payment

THE WHOLESALE PRICE of physical gold rose again early Thursday in London, reaching one-week highs for UK and Euro investors as local stock markets fell and crude oil bounced back above $69 per barrel.

Base metals rose, soft commodities fell and government debt prices were mixed after yesterday's "no change" decision from the US Federal Reserve, rising at short maturities but falling on long-dated debt worldwide.

Gold in Dollars recorded its best London Gold Fix since last Friday at $934.25 an ounce.

"Gold broke the 100-day moving average at 927 with gusto," says a technical note from London market-makers Scotia Mocatta, "trading as high as 940.

"[Weds] shows as an 'up day' and thus confirms the technical reversal [and] gives added confidence that the metal may have 'hammered out its lows' to the downside.

"As a technical trade we would Buy Gold here, looking for an initial move to 944 - the mid-June congestion - with our stop below 927."

Reviewing the Fed's sixth month of zero-bound interest rates, "It watches and waits," says Brad DeLong, professor of economics at Berkeley.

"The FOMC chose not to mess with success - or at least, with some signs of stabilization," says a note from J.P.Morgan.

"Moreover, there were no changes to any of the Fed's large-scale asset purchase programs."

Foreign central banks also continue to buy US securities - particularly government debt - reports John Jansen at AcrossTheCurve.com, with 68% of Tuesday's $40bn auction of new two-year Treasury bonds going to so-called 'indirect' bids "which the Street holds is a proxy for central-bank interest."

A change in definition means 'indirect bidders' may include some non-central bank demand, but some 62% of yesterday's $38bn in 5-year notes also went to indirect bidders, Jansen adds, helping squash the average yield down to 2.70%.

Five-year yields in the open market ended last night at 2.75%.

"Central banks are adding to their Dollar reserves," writes former US Treasury and IMF economist Brad Setser in his blog for the Council on Foreign Relations.

The New York Fed's custodial holdings - securities it holds on behalf of foreign central banks - "have been growing at a smart clip," Setser goes on, noting that over the last three months, foreign agencies grew their custodial accounts by $160bn, "with Treasuries accounting for all the increase."

But "central banks could be clustered at the short-end of the curve because they fear that US inflation will rise - and they don't want to be stuck with longer-term US bonds."

"Should we Buy Gold or US Treasuries?" asked Li Lianzhong, chief economist at China's Communist Party policy research office, at a conference in Beijing today.

There is no suggestion Li was setting an official line, says the Reuters report quoting his comments. But "The US is printing dollars on a massive scale, and in view of that trend, according to the laws of economics, there is no doubt that the Dollar will fall.

"So gold should be a better choice."

California's controller said last night that unless the state resolves its $24 billion budget deficit by next week, it will have to start issuing I.O.U.s to pay its bills.

"Next Wednesday we start a fiscal year with a massively unbalanced spending plan and a cash shortfall not seen since the Great Depression," said John Chiang in a statement.

Calling the US economy "a shambles", legendary value-investor Warren Buffett told CNBC overnight that "We have had no bounce...There are a lot of excesses to be wrung out, and that process is still under way.

"It looks to me it will be under way for quite a while."

Meantime in the United Arab Emirates, the Dubai Gold and Commodities Exchange said trading volumes rose 60% in May to the second-highest since its 2005 launch as speculative interest returned.

"We have experienced a wholesale return of trading liquidity to the market," said CEO Malcolm Wall Morris, forecasting "a year of consolidation rather than aggressive growth", with Gold Futures contracts set to make up 45% of DGCX business, down from 70% last year.

"Dubai is a pay-as-you-go model, dependent on foreigners' money and talent," says a new report from Swiss bank UBS, warning that the Middle East's boom town could suffer yet further as ex-pats head home.

"If foreigners exit, there is a domino effect through the entire economy."

Writing for Resource Capital Research's Sydney office, "Re-emergence of inflation is the monster under bed which could crawl out and become the dominant driving force in gold markets," says senior gold analyst Dr Tony Parry, quoted by the Australian Journal of Mining.

"It could see the Gold Price above US$1,000 per ounce in 2010."

Adrian Ash
BullionVault.com

Head of research at BullionVault.com, the fastest growing gold bullion service online, Adrian Ash is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.

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