Gold Suffers Worst Drop in 7 Weeks as Euro Sinks; Expect Physical Demand to Rise; Global Credit Crunch Yet to End

By: Adrian_Ash

SPOT GOLD PRICES sank in Asian and early London trade on Tuesday, dropping 2.1% from the overnight close in New York – when the Dow Jones index of US equities recorded a new all-time high – to bounce off $732 per ounce and deliver gold's sharpest losses since Aug.16th.

"Buckle up, it should be an interesting ride," advise the technical team at Mitsui in London . "The precious metals markets have stalled, sparking liquidation."

Pointing to a sharp reversal of the European single currency's surge against the US Dollar, they add that "if the Gold Market were to approach $720 expect the physical demand to accelerate, supporting Gold Prices ."

The Euro's sudden 0.7% pullback from Monday's fresh all-time highs helped cap gold's losses to 1.2% by lunchtime in Frankfurt , with the Gold Price in Euros trading at €519 per ounce. Gold Priced in British Pounds slipped 1.6% to dip below £360 per ounce for the first time in a week.

Crude oil prices fell for the third day running, and government bonds also slipped lower as global equities hit a fresh record high on the MSCI index, up more than 0.8% for the session so far.

"A correction in precious metals, specifically gold, could occur due to over-large US futures market positions," as John Reade at UBS warned in a note yesterday. "The metal [had] not seen wide-scale profit taking and we remain cautious about the near-term outlook."

The long position held by speculative traders in Comex gold futures grew by four-fifths in the four weeks ending Sept. 25th. Their bullish position surged from 77% to 84% – a clear sign of over-heating.

The gold market has been twice as volatile as US stocks over the last 12 months. Until Tuesday's drop, it had risen for six weeks running.

On the other side of the trade, meantime, "the reality is the fundamentals [in the global debt markets] haven't gotten any better, and, if anything, they've gotten worse," says Mark Kiesel, an $85-billion manager at Pimco, the world's largest bond fund group.

Around three-quarters of the 30 fund managers interviewed by Ried, Thunberg & Co., a New Jersey consultancy, now expect a hedge fund or credit firm to collapse "in the near future".

Here in London, a report in today's Telegraph confirms what Gold News proposed last Thursday – that Britain's biggest banks are shunning Bank of England support in favor of European Central Bank cash, lent fully 1.75% cheaper.

"It is fair to say they have been borrowing from the ECB on a very large scale," one European official tells the paper. "It's cheap, so why not?"

The ECB lent €190 billion ($268bn) last week at a "penalty" rate of 5.0%. The Bank of England's equivalent loans – which nobody took up – were offered at 6.75%.

"There's been a huge amount of borrowing," says Hans Redeker at BNP Paribas. "It is causing movements in the Euro-Sterling exchange rate that do not make any sense otherwise.

"The money markets may look as if they are functioning again in Britain , but in reality they are not."

Back in the Gold Market , meantime, and while gold-mining analysts and executives are bullish on Gold Prices , the stocks they promote may struggle to rise alongside the metal itself, says John Hathaway, portfolio manager of the $1.1 billion Tocqueville Fund in New York .

"The Fed would like to think there is no inflation," Hathaway tells Barron's magazine in an interview this week, "but the cost of building a mine is up by roughly 50% in the last five years.

"You would think if your product price went up by 100% in a five-year period – which gold basically has – that the companies would be rolling in cash," he goes on. "But returns on equity are low. Newmont Mining's return on equity is less than 2% in the latest 12 months. Gold Fields' is 8%. Randgold Resources' is about 11%."

Meantime, investors in AngloGold Ashanti lost nearly 7% yesterday on a triple-whammy of bad news. First, a ZAR 2.6-million lawsuit (US$376,000) from a former employee suffering from silicosis has been postponed until early '08. It was originally scheduled for June.

The company also halted blast works on Monday at its Mponeng mine near Carletonville, Johannesburg , after a rockfall killed four workers last Friday. Almost 30 employees have been killed at AngloGold mines in South Africa so far in 2007.

Finally, AngloGold's biggest corporate investor – Anglo American, the world's second largest diversified mining group – announced it will sell half of its remaining 41% position in the gold miner.

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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