Last Updated : 04 August 2011 at 13:35 IST
By Renisha Chainani
Gold keeps finding new catalysts to rise and hit record highs every time. On 2nd August, despite news reports showing Republicans and Democrats are on the verge of resolving the debt-ceiling issue, it rose to view records of $1660.
Many of us anticipated a temporary correction lower in Gold when the deficit-ceiling impasse ended, because Gold had ran up roughly 10% from 1st July to entire month, a period when the debt-ceiling gridlock and potential for a default increasingly dominated headlines.
There was an expectation that some short-term speculators would sell after an agreement in order to liquidate positions or capture profits. Gold pulled back by around $20 when electronic screen trading opened Sunday night on reports that Republicans and Democrats were close to a compromise. But the market soon regained its footing and went on to new highs even as the two parties worked toward an agreement.
The following catalysts underpin the ongoing gold rally:
1) US debt crisis
President Barack Obama said congressional leaders agreed on a plan to prevent a default, curbing demand for the metal as a protection of wealth. Obama announced that leaders of both parties in the U.S. House and Senate had approved an agreement to raise the nation’s debt ceiling by $2.1 trillion and cut the federal deficit by as much as $2.5 trillion over a decade.
Despite the temporary pullback in Gold and Silver, the debt deal is actually bullish for precious metals. The debt deal allows the government to continue its massive spending and debt cycle, which will cause investors to seek out protection from the U.S. Dollar. Furthermore, someone has to purchase government bonds, and the Federal Reserve is the most likely candidate. The past two quantitative easing programs from the Fed paved the way for all time record gold prices, just imagine where QE 3 will put gold at in the near future.
2) European debt Issues
Meanwhile, investors remain wary of debt levels in periphery European nations, with 10-year yields on Spanish and Italian bonds rising again. Political leaders in both countries cancelled holidays and called emergency talks to address the crisis that reignited fears of new and bigger euro area bailouts for the first time since European leaders reached agreement to contain the crisis on July 21.
3) Continuation of Central Bank Buying
News that the Bank of Korea bought 25 metric tons over the past two months, its first purchases since the 1997-98 Asian financial crisis. South Korea is the world’s seventh-biggest foreign-exchange reserve holder.
Sixty-four percent of its reserves are in dollars. So in essence, they are diversifying their reserves.
Further, this only adds to expectations that China will keep adding gold to its massive foreign reserves. It has the second-biggest economy on the planet, and China is only the sixth-largest holder of reserves with 1,054.1 tons. That’s only 1.6% of their currency reserves. If they start loading the barrels…and start to diversify like South Korea has done, you could see Gold continue to spring forward.
3) Recent Weak US Economic Data
The latest weak data from the United States, following a batch of dour manufacturing surveys on Monday, added to fears over a deteriorating global economy. U.S. consumer spending dropped in June for the first time in nearly two years and incomes barely rose. Weak economic data means low interest rates are likely for a longer period of time. This supports gold several ways. It pressures the dollar, adds to worries about longer-term inflation and means a lower so-called “opportunity cost” of holding gold, or income that would be lost by holding gold if investors instead could get higher yields in fixed-income assets.
4) Possible Downgrades in US
A bill that has now passed both chambers of Congress has added to worries about a downgrade of U.S. debt, which is supportive for gold. Though the Senate has passed the bill to raise the US debt ceiling by $2.4 trillion, it might allow the Treasury to keep paying bills till 2012; it is projected to trim the budget deficits by only $2.1 trillion over the next decade. This is far below the roughly $4 trillion that Standard & Poor’s has said was necessary to avoid a downgrade.
Last month S&P warned that the US faced a 50-50 chance of having their credit rating cut within the next three months. Shortly after the agency put the US on a negative watch, the value of the dollar fell. Despite the debt deal made overnight which will include large spending cuts over the next ten years, the rating is still under review.
5) Investment and Speculative Demand
Assets in exchange traded funds that follow gold prices are at an all-time high as more investors tap the liquid vehicles to get exposure to the precious metal. Holdings in exchange traded products backed by gold climbed a record $113 billion on July 29, according to data from Bloomberg. The roughly $66 billion SPDR Gold Shares is the largest ETF in the category. Holdings in the SPDR Gold Trust, the world's largest gold-backed exchange-traded fund, jumped six percent to 1280 tonnes in July highest since end of last year. Holdings are only 40 tonnes less than previous high of 1320 tonnes in June 2010.
Moreover, most recent data from the Commodity Futures Trading Commission shows that as of July 26, the large non-commercial accounts—essentially the funds— were net long by 269,489 lots for futures and options combined, the most since last October.
Technicals
There is a strong upward channel trend from last three years in gold. Even though critics of gold will quickly call an end to gold’s run on a decline, investors should keep the big picture in mind. Gold continues to receive buying support as it nears the bottom of this channel. Even if gold declines to $1550, the longer-term technical trend looks strong.
(The author is Manager - Research Edelweiss Comtrade Ltd.)
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