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Gold maintains its shine despite price swings

By Ben Kilbey and Nick Jonson

August 4 - Gold recently has declined from the record highs achieved in June 2010 as investors have returned to risk and sapped profits. In this in-depth report, Platts looks at how gold managed to rocket so high in the first instance only to be pulled lower. Still, the outlook is price supportive for the yellow metal going forward in to Q4 2010.

The prime factor for gold's incredible rally to $1,266.50/oz in New York June 21, during electronic trading, was primarily the outlook for European Central banks and the possibility of default on Sovereign debt. Following near financial collapse in 2008 onwards policy has seen many banks "printing" money to increase liquidity and save banks from collapse, a system known as quantitative easing.

HSBC senior analyst, James Steel wrote in a note earlier this year that: "Sovereign debt risk in the OECD world is a new phenomenon in recent times and has had an especially potent impact on gold. No western country has faced a sovereign debt crisis since the Second World War and the emergence of risk in heretofore creditworthy nations largely explains the rush into bullion this year."

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Steel added that, as private sector debts have become public sector debts, "the financial markets, including the bullion markets, are paying increased attention to how governments manage their balance sheets. The precise amount of spending that governments should deploy to safeguard economic growth is open to debate, but it is widely accepted that in the near term, debt/GDP ratios will keep rising for at least the next couple of years and fiscal balances will inevitably deteriorate."

According to the most recent annual report from the Bank for International Settlements, public debt/GDP ratios in industrial countries by the end of 2011 is projected to be, on average, 30% higher than in 2007.

This has been the main driving force for gold in recent months as investors ponder the credibility of a sustained upswing in growth.

Following downgrades to countries such as Greece, Portugal and Spain, eurozone members clinched a deal in late March that would see member nations provide a safety net of loans worth upward of Eur20 billion ($26.5 billion, at time of agreement) backed by the IMF for debt-hit nations.

Other factors that helped spur gold higher included poor employment data out of the US and a weaker dollar, thus pushing investors into gold's safehaven appeal.

But after hitting a new all-time electronic high of $1,266.50 in New York June 21, gold came under heavy profit taking. August COMEX gold initially found support at $1,220-1,222, $1,200-1,204, $1,180-1,185, and most recently $1,160-1,166..

Much of the profit taking occurred as investors shifted out of safe-haven investments like gold and the US dollar into riskier assets like equities and industrial commodities. The shift followed a long-awaited agreement between the International Monetary Fund and the European Union to support Greece and other debt-laden nations.

The dollar has fallen steadily from the mid $1.19 level in early June to the lower $1.30 level against the euro, while the Dow Jones Industrial Average of major US equity shares has risen from just above 9,800 to nearly 10,500.

Though dips below $1,180-1,185 generated some physical buying, speculative investors slashed their long positions in gold. Citing data from recent Commitments of Traders report from the US Commodity Futures Trading Commission, analysts with UK investment bank Barclays in a July 26 report noted that speculators has scaled back their long exposure in gold futures.

For the week ending July 20, investors cut their longs across the entire precious metals complex, with gold suffering the heaviest long liquidation. Net fund length in COMEX gold fell by 26,600 lots (83 mt), taking speculative interest to its lowest level since March this year, Barclays analysts noted in the report.

"Indeed, the weekly drop in exposure was the second-largest weekly drop since February, while non-commercial positions as a percentage of open interest has dropped to 32%, its lowest level since December 2008," analysts added. In contrast, physical gold ETP holdings remained unchanged at 2,087.9 mt, less than 15 mt of the peak reached in mid-July.

But analysts with French investment bank BNP Paribas noted that physical holdings by the largest gold ETF, SPDR Gold Shares, fell by a net 12 mt from July 19-22. "The last occasion when the level of ETF outflows was significant was in Q1 2010, when the gold price remained rangebound," analysts said in July 26 report.

Analysts with US investment bank Goldman Sachs said the decline in net speculative length was driven in part by a sharp uptick in real interest rates in the US. Another factor was that physical holdings by ETFs stabilized after rising steadily in spring amid developments related to European sovereign debt.

The uptick in real US interest rates came as nominal rates dropped, with the 10-year US treasury yield breaking below 3% for the first time since early last year. The uptick in real US interest rates was driven in part by a lower re-pricing of inflation, since deflation -- not inflation -- appears to be the biggest challenged facing developed nations, Goldman Sachs analysts said.

But another factor in the decline was the lack of physical buying by consumers in traditionally slower summer months. Barclays analysts in a July 16 report noted that Indian gold imports in the second quarter are down 25% year over year, and down 10% from the first quarter.

The decline is significant because India is the largest importer of gold, in part because of the fall wedding season, which runs from September to November, as well as the Diwali religious festival in November.

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