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Investors Reallocate from Oil to Gold as Inflation Defense

Commodities / Gold & Silver Jun 20, 2008 - 08:32 AM GMT

By: Adrian_Ash

Commodities SPOT GOLD PRICES ticked higher from an overnight lull early Friday, recording the highest Morning Fix in London since June 9th at precisely $900.00 per ounce.

Crude oil futures bounced more than 1% from Thursday's sudden $4 sell-off to $131 per barrel, while European stock markets dropped towards a three-month low, led by banking shares.


Barclays – the UK 's fourth largest lender – was rumored to be finalizing a $1 billion sale of equity to Sumitomo, the Japanese banking giant.

The price of insuring European bank debt against default today rose to a two-month high.

"With the Euro back up to $1.557 today," notes Mitsui here in London , "we may see yesterday's high in Gold [at $907.90] tested once more.

"The Dow Jones stock index is sitting on long-term support, and with it being a Friday – and expiry day for options contracts – it could be one to keep a close eye on."

Thursday's jump at the US open – the third such jump in four days – took the Gold Price back above $900 per ounce, a level it's reached, breached but failed to hold five times since mid-January.

Coming just as the price of oil fell sharply, the word here in London has it that several large investment funds – keen to maintain an inflation hedge but concerned by political and regulatory meddling in the energy markets – are switching out of traded commodities and moving into Gold .

On Monday, Republican Senator Kay Bailey Hutchison (Texas) told Fox News that leaders of both US political parties "would absolutely agree on" trying to curb speculative trading in the oil market.

On Tuesday, Democrat Bill Nelson ( Florida ) claimed that "Clearly, unregulated speculators have bid up oil prices to unbelievable and unacceptable highs.

"Congress needs to step in."

And on Thursday in Brussels , a meeting of European finance ministers heard the Austrian chancellor, Alfred Gusenbauer, repeated his call for a tax on non-commercial commodity traders, adding that "we will not accept consumers paying for speculators."

Meantime in London , the ICE commodity exchange – which sees 30% of the world's daily trading volume in crude oil futures – will be policed by US commodities regulator, the CFTC, following a deal agreed by the British and American authorities on Wednesday.

Working to close what US senator Carl Levin calls "the London loophole", oil traders dealing through London will be monitored by the US watchdog, with position limits set by Washington .

"American imperialism," spat the City of London 's head of policy, Stuart Fraser, earlier this week. "If a bunch of senators want to get rude about [ UK financial watchdog] the FSA, that's fine, but don't interfere in our market."

The ICE has until October to impose the new position limits on non-commercial traders. But just like the self-defeating export bans imposed on key food-stuffs by several Asian governments this spring, the restrictions look unlikely to stem the underlying surge in inflation.

"Any expectation that WTI crude oil prices will fall as a result...are likely to go unmet," said Charles Vice, ICE president, to a special Senate committee recently.

Moreover, "I'm not convinced myself that these changes are going to have a significant detrimental impact on volume levels going through ICE," believes Hugo Jenkins, head of the Futures & Options Association.

"There's [still] a lot of worry about inflation," as Mario Innecco, a broker in Gold futures at MF Global in London to Bloomberg today. So with politicians and media accusing commodity traders of "hoarding" necessities, the switch into non-essential hard assets – such as Gold Bullion – becomes ever-more attractive.

"The Gold Market has to be prepared for a reaction to a possible puncturing of the oil price bubble," writes Lawrence Williams for MineWeb. Ajay Kedia, head of Kedia Commodities in Mumbai agrees, telling Myiris.com today that demand for gold "as a hedge against inflation" may be affected by a drop in the price of oil.

But Thursday's sharp drop in oil prices came as global inflation in fact pushed higher as the Chinese government pushed domestic gasoline prices more than 16% higher overnight by cutting its fuel subsidies.

"The Chinese increasing fuel prices could have triggered more Gold Buying from the Chinese," says Innecco at MF Global.

"It's crazy," shouted one Shanghai driver to a reporter from Thomson-Reuters today. "Inflation is becoming serious and harming my ordinary life – I won't be able to stand it for long if prices continue to rise."

Word of the price hike "spread fast by phone and SMS" the newswire reports, with police mobilized in the major cities after fighting broke out at several filling stations.

Today the government of India said consumer-price inflation reached 11% in the year to last Friday, a new 13-year high that knocked 3.4% off the BSE stock market.

In Tokyo the Nikkei index closed down for the week as the US Dollar slipped back vs. the Yen.

The Gold Price for Japanese investors jumped 1.6% higher to end Friday in Tokyo at a three-month closing high.

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 2008

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.

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