Gold Treads Water as "Carry Trade" Unwinds; Bank of Japan Recalls Loans

By: Adrian_Ash

SPOT GOLD PRICES for immediate delivery were little moved against the US Dollar early on Tuesday, slipping 0.3% to record an AM Fix in London of $667.35 per ounce.

But gold rose against all other major currencies besides the Japanese Yen, however, as European bourses struggled to recover after opening the day 0.5% lower.

Asian stock markets outside China also pulled back or held steady at best, with shares in Sydney ending 0.8% lighter after sharp falls in the banking and home-loans sector. South Korea 's Kospi index dropped 1.7%. Hong Kong shares ended 0.5% higher.

In the money markets, Tokyo's overnight call rate traded sharply lower today, sinking to just 0.01% – way below the official rate of 0.5% – before the Bank of Japan reversed ¥1.6 trillion ($13.6bn) of the cash injections it made Friday and Monday. The move came as the Yen continued to rise on the currency markets, adding to the losses suffered by "carry trade" speculators selling the Japanese currency to buy higher-yielding assets.

The US Dollar, now paying 4.75% above Japanese interest rates each year, has more than wiped out that entire profit by falling 5% against the Yen since the end of June. The British Pound, now paying 5.75% annual interest, has dropped almost 6% of its value against the Yen inside three weeks.

The Australian Dollar now pays 6.5% per year after the Reserve Bank hiked its interest rates last week. But the Aussie Dollar has fallen by more than 8% since the middle of July, while the New Zealand Dollar – loved by carry-trade speculators for its 8.25% cash rate – has dropped nearly 12% against the Yen inside a month.

As the Japanese Yen rose yet again on Tuesday, marking its second day as the only major currency to gain versus the Dollar, the price of gold for Japanese investors held below ¥80,000 per ounce. In the Tokyo futures market, gold contracts for June '08 delivery ticked 0.4% lower to the equivalent of $674.50.

Gold priced against Euros rose, however, touching €493.60 per ounce and nearing Friday's two-week high as the single currency continued to slip against the US Dollar. The Euro dipped below $1.35 to record a five-week low.

The British Pound also slid further on news that consumer price inflation – the official measure – slowed to 1.9% annually last month, down from 2.4% in June. Retail price inflation, the old and more trusted measure, slid to 3.8% from 4.4%. Anticipating an end to the Bank of England's interest-rate hikes, currency traders sold the Pound below the $2.00 mark for the first time since the start of July. That helped take the Sterling price of gold above £334 per ounce this morning, near to a two-month high for British investors wanting to buy gold today.

Focusing on the Dollar price of gold alone, last week's activity was "neutral" according to Christopher B. Langguth in Mitsui's latest technical analysis of the gold market. His weekly candlestick chart shows the uptrend starting in July 2005 still firmly in place.

"There should be buyers waiting to see if it can trade at $688.50," Langguth adds, "while the sellers are waiting at $652.50. The overall direction [for now] is sideways."

"Both the 200-day moving average and the trend line on the weekly chart cut in between 650 and 660," notes Phil Smith for Reuters India, "so expect to see some good support around these levels."

Short term, however, the risk of further falls in global financial markets may weigh on gold prices again as investment banks scramble to find cash ahead of tomorrow's deadline for hedge fund withdrawals. Wednesday marks the 45-day notice period for investors to withdraw their cash before the end of the third quarter on Sept. 30th. With highly-geared funds holding US home-loan derivatives likely to be showing severe losses, redemptions may rock the financial markets once more.

"More volatility across the precious metals complex appears likely as global financial markets have yet to calm," says Deutsche Bank in a report, "and we expect gold will continue to perform as it has from the start – simultaneously functioning as a source of liquidity and as a safe-haven asset.

"With many funds tied up across a variety of asset classes, gold will likely again suffer from sell-offs if funds need to cover losses elsewhere."

Should the turmoil caused by over-geared hedge funds continue, however – and the collapse of US home-loan derivatives tip the stock market into a longer-term dive – gold may well regain its famous "safe haven" status.

The metal traditionally wins out, as it did throughout the 1970s and again at the start of this decade, when grinding losses in paper securities force investors to seek a solid and reliable alternative elsewhere.

By Adrian Ash
BullionVault.com

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
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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