Gold Bounces off $1800 as Italy gets Shut Out of Bond Markets

By: Ben_Traynor

THE DOLLAR gold price dropped to $1800 an ounce early on Tuesday morning – a 6.2% fall from last Tuesday's record high – before recovering to around $1825 by lunchtime, as news that China could increase purchases of Italian debt failed to convince markets.

The silver price dropped to $40.12 – a 3.1% loss for the week so far – before it too rallied along with European stock markets, which recovered early losses.

Broad commodities rose, with WTI crude oil up 1.3% to $89 per barrel.

"Since present economic conditions provide plenty of reasons to bullish and very few to be bearish...round figures such as $1,800 can be useful indicators of where investors are prepared to buy back in to [gold] following a dip," said one London gold dealer this morning.

"We see [gold price weakness] as an opportunity for investors to buy," Vasu Menon, vice-president of wealth management at Oversea-Chinese Banking Corp. told Bloomberg Television on Tuesday.
"We recommend buying gold on dips," agrees a report from Societe Generale.

"The ongoing debt/deficit crisis is likely to result in an extended period of super lax monetary conditions in the U. and Europe... gold is likely to make fresh all-time record highs before year-end."

However, the gold price's "inability to reclaim the $1900 level has shifted the focus lower in the short term," warn technical analysts at bullion bank Scotia Mocatta.

China could be about to make "significant" purchases of Italian government bonds, the Financial Times reported on Monday, citing recent meetings between Chinese and Italian officials in Beijing and Rome.

Europe's problems, however, are "bigger than China alone can help with," counters Ju Wang, fixed income strategist at Barclays Capital in Singapore.

"China probably will continue to help to shore up the Euro, but its involvement in direct purchases of troubled Europe debt is unlikely to be too aggressive."

China has an estimated $3.2 trillion in foreign exchange reserves. At current exchange rates Italy's gross government debt for will amount to four-fifths of that by the end of 2011, according to International Monetary Fund forecasts.

The benchmark yield on 10-Year Italian government bonds hit 5.7% on Tuesday morning – the highest level since the European Central Bank began buying Italian debt last month.

Italy auctioned €3.9 billion of 5-Year bonds on Tuesday morning – at an average yield of 5.6%. This compares to 4.93% at an auction of 5-Year bonds in July. Italy's Treasury cancelled its August auction of medium-to-long term bonds, announcing that it would instead offer 12-month Treasury bills.

Italy is being "increasingly shut out of markets," says Rabobank rate strategist Richard McGuire, noting that Italy's yield curve has is flattening as shorter-date bond yields rise faster than longer-dated ones.

Elsewhere in Europe, it is Germany's "top priority to avoid an uncontrolled default [by Greece] because it would not only hit Greece," German chancellor Angela Merkel said Tuesday
"We would very quickly see a domino effect."

The yield on Greek 10-Year bonds hit 25% this morning, while shorter-dated 2-Year bond yields rose to 76%.

The perceived probability of a Greek default meantime rose to 98% on Tuesday, as implied by the costs of credit default swaps – which act as a form of bond insurance.

In the UK, meantime, "sustained high inflation is not a threat" in the current environment, Bank of England monetary policy committee member Adam Posen said Tuesday.

"The inflation that we have suffered due to temporary factors in the UK is about to peak...the right thing to do right now is for the Bank of England and the other G7 central banks to engage in further monetary stimulus."

Posen has voted to increase the Bank's quantitative easing program by £50 billion at every meeting since last October.

UK consumer price inflation rose to 4.5% last month – up from 4.4% in July – compared to the MPC's official target of 2.0%.

The gold price could challenge its previous inflation-adjusted high, as a result of an "extended period of negative real interest rates", according to a report published Tuesday by analysts at Morgan Stanley.

Gold hit $850 per ounce in January 1980. Adjusted for inflation, the analysts estimate that an equivalent high today would be around $2330.

By Ben Traynor
BullionVault.com

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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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