Gold Hits Fresh Records, Stocks Enter Bear Market, Fed Needs to "Do What It Takes to Cause Inflation"

By: Ben_Traynor

U.S. DOLLAR gold prices raced to $1778 an ounce Tuesday morning London time – a record high, and 9.6% up since Aug. 2, the day President Obama signed the US debt ceiling bill.

In contrast, silver prices dropped to a low of $38.06 per ounce – 0.7% down on last Friday's close.

Gold prices at Tuesday morning's London Fix set new records in all three currencies – the Dollar, Pound and Euro.

Commodities were mixed, while stocks continued to plummet as policymakers on both sides of the Atlantic consider their next moves.

"Being so close to the market, it feels very crazy," says a Hong Kong bullion dealer.

"A few months later [however] this is just going to be a blip on the chart."

"The market is now worried about another global recession," adds Natalie Robertson, a ANZ Bank commodity analyst.

Stock markets continued their downward slide on Tuesday, with the UK's FTSE 100 index officially entering bear market territory. The FTSE dipped to 4796, more than 20% down on February's 2011 peak.

The MSCI All World index also entered a bear market after falling for the tenth day running.

Falling stock markets "have highlighted that world growth is weakening" says Jason Teh, portfolio manager at Investors Mutual in Sydney, which oversees around $3 billion in assets.

"The question is, when do you expect the government to provide some sort of intervention measure or stimulus?"

The US Federal Reserve should make it "very clear" that it is trying to create "moderate inflation", says Harvard economist Kenneth Rogoff.

"Out-of-the-box policies are called for, especially much more aggressive monetary policy," the former Fed economist said Monday.

"In the classic classroom QE, it's open-ended...you say, 'I'm trying to create inflation...and I’m going to do whatever it takes.'"

Ratings agency Standard & Poor's continued its downgrading of US debt instruments on Monday, following last Friday's decision to strip US sovereign debt of its AAA rating.

Mortgage finance companies Fannie Mae and Freddie Mac – both dependent on the US government – had their ratings cut, as did several insurance providers, including Warren Buffett's Berkshire Hathaway.

"The market's near-term focus will be on further ratings downgrades to come," says Tom Pawlicki, precious metals and energy analyst at MF Global.

"Any potential [Fed] action to implement further easing will also offer support [to gold]. In the background, support will come from central bank buying, investment inflows, and weakness in economic data."

The Federal Open Market Committee will announce the Fed's latest monetary policy decisions later today.

"We expect gold prices to continue to climb in 2011 and 2012 given the current low level of US real [inflation-adjusted] interest rates," said a note from Goldman Sachs Monday, in which the investment bank upped its 12-month gold price forecast to $1860 per ounce.

"Real interest rates...remain supportive of gold," agrees Walter de Wet, commodities strategist at Standard Bank.

"The futures market now firmly believes the Fed will hold rates constant for much longer, assigning a probability of more than 82% to a flat funds rate for at least another 12 months. This would put short term real interest rates in negative territory well into 2012."

Over in Europe, Spanish and Italian bond prices continued to rise Tuesday morning – pushing their yields closer to 5% – as the European Central Bank continued to buy the government debt of the third- and fourth-largest economies in the Eurozone.

The ECB will want to "make a strong statement with their purchases reckons Elwin de Groot, senior market economist at Rabobank Nederland in Utrecht.

"They're likely to continue with this [bond purchase program] for some time."

Here in the UK – where leaders have cut short holidays to respond to rioting in suburbs of north, south, east and west London as well as elsewhere in the country – there were further signs of economic slowdown in Tuesday morning's data.

Manufacturing production fell 0.4% in June – with year-on-year growth slowing to 2.1%, down from 2.8% the previous month. The trade gap for goods meantime widened to £-8.87 billion – a 4.8% change from May.

"The worry," says James Knightley, London-based economist at ING Group, "is that plunging equity markets will hurt business confidence and lead to firms cutting orders thus prompting further falls in output...as a result, the prospect of further action from the Bank of England continues to grow."

The State Bank of Vietnam announced Tuesday that it will allow dealers to import five tonnes of gold bullion – and may also allow a further five tonnes to be imported in the coming weeks – after domestic gold prices diverged sharply from those quoted on the international spot market.

The SBV – which controls them import and export of bullion via licenses – said the decision will "stabilize" Vietnam's gold market, though it advised people against buying gold right now because of the inflated domestic price.

By Ben Traynor
BullionVault.com

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Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK's longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

(c) BullionVault 2011

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