Gold Drops Hard with Stocks, Oil & Euros After Yen Surges; Bond Holders Await "Trick AND Treat" from the Fed

By: Adrian_Ash

SPOT GOLD PRICES failed to recover a sharp overnight drop early Monday, sinking below $750 per ounce for the first time in 10 days to cap a run of eight weekly gains in nine.

Crude oil prices also fell hard – losing almost $5 per barrel from last Thursday's new record highs – while world stock markets sank alongside, dropping more than 1.9% on the MSCI's Asia-Pacific index.

The US Dollar, in contrast, suddenly spiked higher from new historic lows after the Japanese Yen had earlier gained 1.2% following the G7 summit in Washington that ended on Saturday.

The Euro dropped nearly two cents inside three hours.

"Investors are selling gold to pay margins on their equities," reckons Bernard Sin at MKS Finance in Geneva .

"The Gold Market needs a correction. It is very long at the moment."

Racing earlier to a near 6-week high vs. the Dollar in Asian trade, the Yen acted as a proxy for the Chinese Yuan after the "group of seven" developed-world leaders said it wanted Beijing "to allow an accelerated appreciation of its effective exchange rate".

The Japanese Yen is the most heavily traded Asian currency, while the Chinese Yuan remains fixed to the US Dollar and a basket of other major currencies, albeit inside a "flexible" band that lets it rise 0.5% each day.

The Yen last rose this sharply amid the "credit crunch" turmoil of early August.

Back in the gold market, spot Gold Prices dropped more than $18 per ounce between the Asian opening and midday in London , undoing all of last week's gains as the Yen shot higher in Tokyo trade.

The Nikkei stock index dropped 2.2% to reach a four-week low, while Japanese government bonds rose for the fifth session running, putting in their best performance since July.

Gold futures traded in Tokyo dropped more than 1.8% for the session. The Aug. '08 contract ended Monday's session equal to $770.43 per ounce.

"You can say everything is still positive for gold," reckons Ronald Leung, head of Lee Cheong Gold Dealers in Hong Kong , speaking to Reuters. "There's light buying on the physical side.

"I think $750 to $752 should be the support. Resistance is at $770. People are still on the bullish side and happy to buy."

Here in London , the FTSE100 index began the week 114 points lower, gapping down at the open as the 300 biggest stocks in Europe dropped 1.4% on average, adding to last week's 2.3% loss.

Earlier on the currency markets the British Pound had spiked to a new 26-year high above $2.0550, while the Euro recorded new all-time highs vs. the Dollar above $1.4340 before its sudden slide.

For European investors wanting to Buy Gold Today , the price vs. British Pounds slipped almost 0.9% by the time London opened, losing another £2.50 to trade below £367.50 by lunchtime.

Gold Priced in Euros dropped to a 10-day low below €528 per ounce.

"We are playing catch up with the US ," reckoned David Buik of Cantor Index, speaking of the sell-off in European stocks today.

"It was ludicrous to think early last week that credit conditions were getting easier. We got terrible results from Citigroup, Wachovia and Bank of America."

Almost one-third of the 500 companies in Wall Street's S&P index will report their third-quarter results this week. Out of 131 companies reporting so far, says Reuters, more than 25% have missed analyst forecasts.

On Friday, US stocks suffered their worst day in two months. The futures market now puts the chance of a cut in US interest rates at 98%, up from just 32% at the start of last week.

There is little economic data due before the Fed's next meeting, with only jobless and new-home sales figures this Thursday. But a sharp cut to Dollar interest rates when the Federal Reserve meets on Halloween (Weds 31st Oct) would prove both "trick and treat" for bond investors.

The first rate-cut in this new cycle sparked a 5.2% drop in the Dollar's trade-weighted index since mid-August, plus an 18% rally in world Gold Prices. The accompanying rally in US government bonds – which tend to rise as interest rates fall – has flatly ignored the loss of purchasing power that Dollar-denominated bonds are suffering.

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"Obviously there is a limit to the extent that [US] obligations to foreigners can reach," said Alan Greenspan, former chairman of the Fed, in a speech on Saturday.

The Dollar's current historic lows may be "an indication America is approaching this limit," he added, failing to note his own role in creating nearly $9 trillion now outstanding in US government obligations.

Foreign investors already look sick of the Dollar's ongoing plunge, dumping $163 billion of US assets in August alone. Yet the price of two-year US Treasury bonds has shot higher regardless, pushing the yield offered to new buyers down to a two-year low.

Ten-year US bonds now yield less than 4.39%, down from 5.30% at the start of June.

In short, Western investment funds and institutions are buying government debt even as America 's largest creditors in Asia are trying to quit their positions. And meantime, the loss of Dollar-purchasing power is NOT being countered by higher interest rates.

The last time Dollar-bond holders were destroyed by low interest rates, back at the end of the 1970s, investors fled into the "safe haven" of gold – and Gold Prices rose more than 8-fold inside three years.

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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