Gold Starts Week Unchanged as Crude Oil Falls , Further Fed US Interest Rate Cuts Expected

By: Adrian_Ash

SPOT GOLD PRICES dipped before rebounding early Monday, recording an AM Fix in London of $658.50 per ounce, virtually unchanged from Friday's US close.

"Some people are still afraid there might be more bad news ahead, and liquidity in the gold market is poor because most of the traders are not back from their summer holiday," said Ng Cheng Thye, head of Standard Bank's precious metals desk in Singapore , to Bloomberg earlier.

"Investors might still liquidate assets for margin calls and those involved in the subprime woes still don't know how bad the damage is," he said, but added that physical buying from Asian jewelers should cap any decline in Dollar gold prices to $650.

Open interest in Comex gold futures and options shrank nearly 14% in the three weeks to last Tuesday, even as the bullish ratio amongst commercial speculators improved. Liquidation also hit the largest exchange-traded gold funds, with StreetTracks GLD selling three tonnes of the gold it holds in trust for its shareholders on Thursday. The LyxOr GBS fund traded in London , Paris , Milan and Frankfurt dropped more than six tonnes that day, equivalent to 6.5% of its bullion holdings.

But while the world's largest financial institutions may be forced to sell gold as they scramble to cover losses elsewhere, demand from private investors and jewelry buyers continues to look strong ahead of the traditionally busy gold-buying season in India that's due to begin next month.

The World Gold Council announced on Sunday that gold demand in Saudi Arabia rose faster than first reported between April and June, growing by more than 30% from a year earlier. "The Saudi market saw a very strong recovery in the second quarter," said Moaz Barakat, managing director of the WGC's Middle Eastern office. "Gold prices were less volatile and the euphoria of the stock market and selling gold to invest in stocks cooled off."

In Tokyo today, the benchmark June '08 gold futures contract leapt 2.5% against the Japanese Yen, closing Monday's session equivalent to $664.91 per ounce. The Nikkei stock market index rose 3% – its greatest one-day surge in 13 months – as Japanese equity investors caught up with Friday's US rally, led by a cut in the interest rate charged to big investment banks by the Federal Reserve.

The Fed's action took the cost of borrowing short-term emergency funds from its "discount window" down from 6.25% to 5.75%. The first cut since June 2003, and the largest move in the primary discount rate since November 2002, this rate-cut is only available to the largest commercial banks, but a cut in the broader Fed funds rate is now widely expected.

Investec this morning says the market is pricing in a 60% chance of lower Dollar lending rates in September. Bloomberg data show a 49% chance that the Fed Funds rate – currently at 5.25% – will drop to 4.50% by Christmas. Two-year US Treasury bond yields dropped 26 basis points last week to 4.19%.

Lower market interest rates encouraged European stocks to open around 1% higher on average today. Wall Street futures pointed to a 53-point opening gain for the Dow, as crude oil prices fell $1 per barrel on news that Hurricane Dean is set to miss the Gulf of Mexico 's major oil-producing sites.

"I imagine people are still absorbing the implications of the Fed action," says David Moore of Commonwealth Bank in Sydney , Australia . "It would have provided some support for the gold prices, certainly for investor confidence. For the week ahead, I suspect that we'll see the gold price hold mostly above $645. On the topside, I'd say, probably $667."

In the currency markets, the Dollar declines begun by the Federal Reserve's lower rates on Friday continued early Monday, with the British Pound rising to $1.9862 even as the Bank of England said that Britain's broad money supply grew by 13% year-on-year in July. Domestic credit growth hit 13.8% annualized.

The European single currency failed to rise as strongly as the Pound, however, starting the week at $1.3500 and keeping the Euro Price of Gold just shy of €488 per ounce. For British investors the metal opened the week at £331.40 per ounce, little changed from last Monday's start.

"There is still uncertainty in the markets," says today's technical gold note from Standard Bank in Johannesburg , "which should see US government bonds well bid. On Friday the yield of the 10-year US government bond was again lower at 4.68%."

With no major data releases due today, investors will be forced to consider the true cost of the Fed's lower interest rates. For while that 0.5% cut in the discount rate stemmed financial losses on Friday, growth in the cost of living has not retreated since the Fed said last month that its "predominant policy concern remained the risk that inflation would fail to moderate as expected."

Lower interest rates plus rising inflation drove investors to buy gold between 2003-2005, nearly doubling the Dollar price of bullion. A sharply higher gold price may provide comfort once again if investors begin to suffer sharp inflation-adjusted losses in both their stock and bond portfolios.

By Adrian Ash
BullionVault.com

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City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2007

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