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Gold Divorces Dollar?

Monday, September 26, 2011

Prithviraj Kothari
Managing Director, RSBL and current president Bombay Bullion Association, (BBA)

Gold rebounded from Thursday's drop of 2.6 per cent but is headed for a third straight week of decline as investors worried over slower growth prospects sold the precious metal after losses in the equities and commodities markets.          

Gold fell to a six-week low in European trading on Thursday morning, hammered in a cross-commodity washout, with the dollar strengthening against the euro after the Federal Reserve issued a warning on US economic growth. But market participants seemed optimistic that the drop will prove temporary, arguing that the macroeconomic environment remains supportive against a backdrop of low long-term interest rates in the US and lasting European debt problems.

Spot gold fell as much as $30 or 1.7 per cent to its cheapest since August 8 at $1,754.90 per ounce at one stage and was last at $1,764.90/ 1,765.70 per ounce, still down $20.

Gold, which had mostly detached from its historical inverse relationship with the US dollar this year, had significantly weakened on Thursday as panicked investors sought security. This also dragged down other commodities prices.

Gold came under pressure on Thursday amid strength in the US dollar. Also weighing on gold prices is general weakness in the equity and commodity markets.

The US dollar rose sharply after the Fed’s announcement of Operation Twist. The move is expected to increase short term interest rates and spur economic growth. The currency also gained as Fed did not move to infuse more liquidity in the economy. While gold prices fell on back of strength in the US dollar, supportive factors persist for gold.

Weakening outlook for US economy is supportive for gold and bearish for US dollar. Meanwhile concerns about the economy will keep expectations high that the central bank may consider further quantitative easing to support the economy. In addition to it, Fed’s continued accommodative policy move is also supportive for gold prices.

Gold yields no interest and lower interest rates increases demand for the metal. Meanwhile higher liquidity will result in dollar devaluation which is supportive for gold. Overall, gold came under pressure on back of strength in US dollar and general selling pressure across financial markets. However we believe that downside in gold will be limited by safe haven demand. Focus will continue to be on situation in the US and Euro-zone.

For US, focus will be on economic data and talks about cuts in government spending. For Euro-zone, focus will be on Greek loan talks, regional bond yields and economic data.

There is likely no magic bullet to the debt problems facing developed nations. There are several areas of weakness that need to be addressed before any kind of real recovery will materialize. Depressing housing numbers and persistent unemployment are just the tip of the iceberg. The reduction in tax revenue at local, state and federal levels is probably keeping things it a tight spiral that will be tough to break out of. Both at home and abroad, there will still be tough times ahead.

That is what keeps central banks and private investors looking for alternatives to major currencies. This is what will continue to drive support with every dip in gold and silver prices. There is not a quick fix for the global economy, but for those who are looking to diversify their reserves or try to engage in some level of potential asset preservation, there are precious metals.

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