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30 March 2011

Gold Breaks Out of "Limbo" as US Fed's Tightening-Talk Is Outweighed by Euro Downgrades and Global Liquidity

THE PRICE OF wholeasale gold bullion jumped out of what one dealer called "limbo" lunchtime Wednesday in London, hitting $1429 per ounce as world stock markets rose but major-economy government bonds slipped in price, alongside oil and base metals.

Silver bullion rose 1.7% to $37.67 – just shy of last week's new 31-year highs.

The British Pound rose following news of a sharp "bounce back" from the mid-winter slump in UK retail sales, leading analysts to forecast a rise in Bank of England interest rates.

With real UK interest rates – adjusted for inflation – currently more negative than at any time since the late 1970s, the gold price in Sterling today pushed up to £891 per ounce, some 2.8% higher from the start of March.

Looking ahead to Friday's official US employment report, "Our real interest lies with what the labour market signals for Fed policy in terms of liquidity," says Walter de Wet at Standard Bank in London.

"When the Fed drains liquidity, it will be bearish for commodities in general, for gold specifically," explains de Wet, noting that gold "has by far the greatest causality with [money-supply] liquidity, followed by crude, and then the base metals."

Tuesday saw non-voting Federal Reserve president James Bullard say in a speech that "If the economy is 2011, I think it will be time for us to start to reverse our ultra-aggressive and ultra-easy monetary policy."

A new auction of 5-year US Treasury bonds drew the highest interest rates paid by Washington in 11 months.

ADP Payroll's private-sector data today showed weaker-than-expected growth in US hiring for Feb.

On Standard Bank's metrics, the Federal Reserve's balance-sheet only accounts for one third of global liquidity. The remainder – calculated by Standard Bank from other central-bank currency reserves – has already swelled by 3.5% since the start of Jan.

As for the widely-touted rise in Euro interest rates due on April 7, "the greatest initial impact for commodities...may come via the exchange rate," says de Wet, because it may support the Euro vis-à-vis the Dollar and provide support for commodities on the downside."

The Euro was little changed below $1.41 to the Dollar on Wednesday, helping the price of gold bullion for French, German and Italian buyers unwind the week's 1.3% loss so far to trade back at almost €32,600 per kilo.

"Financial markets throughout the Euro area have been under pressure [from] credit-rating actions," says a new report from the International Monetary Fund, even though those credit-rating downgrades "were concentrated in few countries such as Greece, Iceland, Ireland, Portugal and Spain."

Following yesterday's fresh downgrade of Lisbon's credit rating by the S&P agency, Portuguese 10-year bond yields today rose further above 8.0%.

"There seems to be no relief," says one analyst quoted by Bloomberg, "and it's only a matter of time before Portugal asks for help."

"Investment demand will remain the key determinant of where the gold price goes over the next year or two and sovereign debt fears will be the engine room behind that," said Paul Burton – managing director of London's GFMS World Gold Limited – at the first day of this week's Paydirt 2011 Gold Conference in Perth, Australia on Tuesday.

Looking at global gold mining supply, "It has been a lean time in terms of major finds," Burton said, quoted by MineWeb.

"We can expect, because of current prices, that there will be a short-term rise in gold production but it will decline thereafter, and this will only add to merger and acquisition activity."

The gold mining industry is making less profit than many people assume, he went on, because "total cash costs" – including the infrastructure which local governments now demand in exchange for granting licenses – have risen sharply.

"Basically, the sector needs the gold price to stay above US$800 an ounce for a producer to stay in business."

Adrian Ash

Formerly City correspondent for The Daily Reckoning in London and head of editorial at the UK's leading financial advisory for private investors, Adrian Ash is the editor of Gold News and head of research at BullionVault – winner of the Queen's Award for Enterprise Innovation, 2009 and now backed by the World Gold Council market-development and research body – where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2011

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