Gold Rallies, ECB Borrowing Positive for European Liquidity

Spot-market gold prices jumped to $1,737 an ounce Wednesday afternoon in London, as rumors continued to build of more aggressive monetary stimulus ahead of tomorrow's European Central Bank meeting.

German opposition to proposed changes to the Eurozone's rescue framework also threw doubt on whether this Friday's summit will deliver a significant deal.

Earlier in the day, gold prices fell to $1721 per ounce—1.4% down on the week—with stocks and commodities giving up their morning's gains.

"No one wants to hold stockpiles ahead of the year end and the market is extremely quiet," adds Dick Poon, Hong Kong-based manager of precious metals at German refiner Heraeus.

"Physical demand may pick up at the end of the month or early January, as jewelers prepare for the [Chinese] Lunar New Year."

However, "the market is reluctant to sell gold aggressively ahead of the European Summit on Friday," says Walter de Wet, commodities strategist at Standard Bank.

Silver prices drifted down to $32.23 per ounce—1.2% down on the start of the week.

A day earlier, gold prices jumped as high as $1732 per ounce following news that Europe may get a second rescue fund to run alongside the existing one. U.S. stocks also rallied on Tuesday, as did Asian stocks early on Wednesday.

European markets opened strongly—with banks among the strongest performers—but by lunchtime Germany's DAX was flat on the day and the FTSE had entered negative territory.

Eurozone banks meantime borrowed $50.7 billion from the European Central Bank Wednesday morning—five times the amount forecast in a poll of money market traders by newswire Reuters.

Thirty-four banks received three-month loans in the ECB's first Dollar liquidity operation since six of the world's central banks cut the cost of dollar funding last week in a coordinated move.

"Thirty-four banks is quite an impressive number," says Alan James, head of inflation-linked research at Barclays Capital in New York.

"It suggests by making the terms easier, the ECB increased expectations of use and reduced the stigma associated with using the facility. . .that's a positive for European liquidity."

Italy's banks meantime accessed €153.2 billion in emergency ECB funding last month—up from €111.3 billion in October and €41.3 billion in June—data published Wednesday by the Bank of Italy show.

Press reports suggest the ECB, which is widely expected to cut its main interest rate to record low of 1.0% tomorrow, is privately considering more aggressive solutions—possibly involving some members leaving the Eurozone—but does not wish to discuss these publicly.

"What I think is important at the moment is not showing politicians that there might be an alternative, because in their mind that might be less costly than the options they have," Reuters quotes one Eurozone central banker.

Bank of England governor Mervyn King said last week that the authorities in Britain "are making contingency plans against a wide range of contingencies," acknowledging the possibility of Eurozone breakup and adding "there will still be questions of default" either way.

King also warned banks to prepare for a "systemic banking crisis" while the BoE's Financial Stability Report said banks should "give serious consideration to raising external capital."

Elsewhere in Europe, the European Stability Mechanism—the permanent bailout mechanism originally intended to replace the ad hoc European Financial Stability Facility—may now be set up to run alongside the EFSF in order to boost the single currency's rescue system, the Financial Times reported late on Tuesday.

The ESM is intended to have a lending capacity of €500 billion—in addition to the €440 billion the EFSF has at its disposal. It is hoped the ESM will be up and running next year, though it remains unclear precisely how it will be funded.

By Wednesday afternoon, however, reports were circulating that German officials will oppose any changes to Europe's bailout mechanisms.

Germany's DAX dropped sharply early Wednesday afternoon, while stock markets elsewhere in Europe and in the US also fell.

There was also confusion yesterday over so-called private sector involvement (PSI) in any future Eurozone bailout.

"Germany has agreed to let go of the participation of the private sector, of private investors in case of the restructuring of sovereign debt," French prime minister Francois Fillon said Tuesday.

"We only made it clear," countered Steffen Seibert, chief spokesman for German chancellor Angela Merkel, "that the kind of PSI you had with Greece is an extreme case that won't be repeated."

European leaders agreed in July that private sector Greek bondholders should take losses of 21% - then agreed in October the losses should be 50%, with July's bond swap program left incomplete.

Here in the UK, Britain's prime minister David Cameron has said Britain "will not agree to a treaty change that fails to protect [Britain's] interests", ahead of Friday's European Union summit.

Germany and France agreed earlier this week to a revision of the entire EU governing treaty.

UK Industrial production fell by 1.7% in the year to October—a faster fall than the previous month, where a 1.5% year-on-year fall was recorded—data published Wednesday show.

Over the same period German industrial production grew 4.7%—slowing from 5.4% y-o-y growth in September.

In China meantime—the world's second-largest source of gold bullion demand—exports to the U.S. fell 5% in the year to October, while exports to the EU saw a drop of 9%, data published today show.

"Next year, I think that we will face severe challenges in our exports and imports," China's foreign trade director Wang Shouwen said.

"Two key tail risks to the global economy and to commodities in particular remain," says Koen Straetmans, senior strategist, real estate and commodities at ING Investment Management.

"A hard landing in China. . .[and] policy inaction leading to a meltdown of the Eurozone. . .we have an overweight position in precious metals to hedge for this tail risk."

In Japan meantime, some investors who buy reconstruction bonds—which go on sale next year to raise funds for rebuilding areas devastated by the tsunami—will be eligible to receive commemorative gold coins worth over $900 at current gold prices, Japan's finance minister announced Tuesday.

Ben Traynor
BullionVault

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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