Gold Trades at 16-Month High Ahead of US Interest Rates Decision, Investment Banking Results, Inflation Data and Northern Rock Bail-Out

GOLD… … PRICES ROSE throughout the Asian session on Monday, putting the Spot Gold Price above $712 per ounce at the start of London trade – its highest weekly start since May 2006.

Tomorrow will bring a widely-expected cut in US interest rates by the Federal Reserve, followed by the latest price-inflation data for consumers in Canada and the United States on Weds.

“With a sustained period of high oil prices threatening to stoke inflation and the possibility of a cut in the benchmark interest rate in the US, gold may be poised to climb still further in coming months,” says the latest monthly research from Virtual Metals, the highly respected London consultancy.

Gold's last two sustained bull-market rallies – between 1977-80 and 2001-06 – both came when real interest rates slipped below zero. Negative returns to cash after inflation mean that money-in-the-bank loses purchasing power, making gold yet more attractive as a store of value.

“It makes less sense to own bonds, to own a bank account paying interest because you're getting squeezed,” says Thomas Winmill, president of the US Midas Fund. “The way to play a negative interest rate environment is to own hard assets.”

Both Bloomberg and Reuters today report bullish surveys of professional gold traders and analysts. US stock futures pointed lower at 07:30 EST after Microsoft lost its appeal against a $613 million anti-trust fine in Europe. Tomorrow will see Lehman Bros. lead a rash of quarterly results from the major investment banks.

Analysts expect that the credit crunch starting in August will have hit profits hard. How the banks classify their various assets – especially the proportion classed as illiquid, unpriceable “level 3” investments – will also be studied closely.

“I would think that probably the large majority of people think Gold Prices will go through $730, which is a pretty good reason to think they will,” says Stephen Briggs, an economist at SocGen's corporate and investment banking division.

“The big players…they buy gold because they think everyone else is going to buy it, because they think it's something that will go up. [So] it snowballs on itself.”

Japanese gold futures for delivery in Aug. '08 ended the day unchanged in Tokyo, while the Nikkei stock-market index added nearly 2%. Asia's other major stock markets slipped, however.

In London, the FTSE100 gapped down at the open to lose 1.7% by lunchtime, and Europe's 300 largest shares dropped the same proportion on average. Northern Rock, the struggling UK mortgage bank, dropped another one-third of its value as long lines of depositors continued to withdraw money from its 76 branches nationwide.

Estimates say Northern Rock lost more than £2 billion ($4 billion) in panicked withdrawals on Friday and Saturday. If the UK authorities fail to find a buyer for the struggling bank – which financed three-quarters of its lending by borrowing short-term funds from the money markets – the company will have to be wound down, valuing the shares around 180 pence according to today's Financial Times.

The shares peaked at 1,258p in Feb. By midday in London today they were trading at 270p.

“The Bank of England's reputation is damaged,” write Willem Buiter and Anne Sibert, two London-based academic economists in the Financial Times today. “It had to provide credit [to prevent Northern Rock collapsing] after the governor took a strong public stand against bail-outs.”

As the collapse of Northern Rock wore on, the British Pound fell hard on the currency markets, dropping another cent versus the Dollar after Friday's three-cent fall to slip below $2.00 for the first time in three weeks.

The Japanese Yen was little changed around ¥115 per Dollar, and the Euro held steady at $1.3860. Those moves put the Sterling Price of Gold at a new 16-month high above £357, while French and German investors wanting to Buy Gold Today saw the price gain 0.6% from last week's start to €514 per ounce.

“In contrast to the rally seen in spring last year, which was mostly fuelled by speculative buying,” says Wolfgang Wrzesniok at Heraeus, the German refining group, “gold demand this time is concentrated in physical buying, either in form of jewelry, bars, coins and in exchange-traded funds.

“The long-absent argument that physical gold provides a good safe haven in times of crisis seems to be reaching a bigger audience again. In contrast, the speculative positions on the COMEX [derivatives exchange] have recently risen as well but are still well below last year’s high.

“From a qualitative point of view the current price move has therefore all the ingredients to be more sustainable than the one last year, which ended after less than a month in a 200-dollar-drop in gold value.”

Adrian Ash
BullionVault

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 BullionVault – where you can buy gold today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2007

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