Physical Demand Will Determine Support for Gold

Wholesale market gold bullion prices rose to $1,607 an ounce Monday lunchtime in London—0.5% up from last Friday's close—while European stocks and commodities were broadly flat and government bond prices eased.

Silver bullion meantime rose to $29.36 per ounce just ahead of New York's open—1.2% down on last week's close.

Earlier on Monday Asian stock markets sold off following news of North Korean leader Kim Jong Il's death. South Korea's Kospi index fell 3.4%, while on the currency markets the South Korean Won sold off while the dollar strengthened.

Gold bullion will fall below $1,500 per ounce during the next three months, according to a poll of 20 hedge fund managers, economists and traders conducted by news agency Reuters.

"You're looking at Euro weakness, rather than anything else, as the driving force behind the sell-off [in gold bullion last week]," reckons David Jollie, analyst at Mitsui Precious Metals, adding that many traders will be reluctant to buy gold so close to the end of the calendar year.

"Whatever your [longer-term] view, you have to ask what the chances are of making money by the end of the year. . .that says to a lot of people that this is not a market to get longer in."

Over in New York, the difference between the number of bullish and bearish contracts held by noncommercial gold futures and options traders on the Comex exchange—the so-called speculative net long—fell 10.6% in the week ended last Tuesday, the latest data from the Commodity Futures Trading Commission show.

"The key factors that will determine how supported the gold market is on the downside will be whether the 'sticky' ETP [exchange-traded product] holdings remain relatively stable and whether physical demand responds to much lower prices," says a research note from Barclays Capital.

The volume of gold bullion held to back shares in the world's largest gold ETF—the SPDR Gold Trust—has fallen 1.4% since the end of last month to just under 1280 tonnes. Over the same period, gold bullion prices have dropped around 8%.

European finance ministers are meeting Monday in an effort to meet a self-imposed deadline for arranging €200 billion of loans promised to the International Monetary Fund at the European Union summit earlier this month. Ministers also hope to make progress on drawing up new budget rules for national governments.

"They'll try to get as much done as they can before Christmas," says Carsten Brzeski, Brussels-based senior economist at ING Group.

"But it's doubtful they'll put markets in a Christmas mood. . .there is still so much uncertainty."

Ratings agency Fitch warned on Friday that it may downgrade Belgium, Cyprus, France, Ireland, Italy, Slovenia and Spain. Fellow ratings agency Moody's meantime announced that it has cut Belgium's rating by two notches to Aa3.

"A 'comprehensive solution' to the Eurozone crisis is technically and politically beyond reach," said a statement from Fitch.

"Of particular concern is the absence of a credible financial backstop. In Fitch's opinion this requires more active and explicit commitment from the [European Central Bank] to mitigate the risk of self-fulfilling liquidity crises for potentially illiquid but solvent Euro Area Member States."

ECB president Mario Draghi however says his organization will not step up its program of buying government bonds on the open market—said to be capped at €20 billion per week.

"People have to accept that we have to, and always will, act in accordance with our mandate and within our legal foundations," Draghi says in an interview in today's Financial Times.

"The important thing is to restore the trust of the people—citizens as well as investors—in our continent. We won't achieve that by destroying the credibility of the ECB."

Fitch's warning follows a similar move by Standard & Poor's earlier this month, which saw S&P put every Eurozone member on CreditWatch negative.

Back in August, S&P cut its rating on US sovereign debt. Newswire Bloomberg today suggests that downgrade has proved to be "absurd," since U.S. Treasury bond prices have since gained more than 4%.

"It is the ability to print one's own currency to pay government bond investors back under any circumstances that makes a government bond a government bond, i.e. a (credit) risk- free asset for hold-to-maturity investors," points out Elga Bartsch, London-based chief European economist at Morgan Stanley in London, in a recent client note.

Here in the UK, chancellor George Osborne is expected to give his full backing to the Independent Commission on Banking and promise to pass legislation by 2015 that will separate investment and retail banking.

UK house prices meantime have fallen 2.7% over the last 12 months, according to figures published today by Rightmove.

"It looks like no nation, no market, no investor is free from this negative outlook. And gold is no exception," says a note from Swiss gold bullion refiner MKS.

"Gold appears to be playing a difficult role at the moment," adds the latest note from German precious metals group Heraeus.

"On one side it is the stability anchor in times of economic and financial crisis, on the other hand there are increasing signs. . .that gold is in wake of the equity and interest markets."

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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