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Gold Underpinned By Downgrade Worries, Economy, European Debt Issues

Kitco News) – Gold keeps finding new catalysts to rise and hit record highs Tuesday despite news reports showing Republicans and Democrats are on the verge of resolving the debt-ceiling issue.

A bill that has now passed both chambers of Congress has added to worries about a downgrade of U.S. debt, which is supportive for gold. Analysts also said gold is underpinned by ongoing European debt issues, a continuation of central-bank buying after Bank of Korea purchases, plus still-soft U.S. economic data that means continued loose monetary policy and perhaps even more stimulus.

“More and more people are turning to safe-haven buying,” said Afshin Nabavi, head of trading at MKS Finance.

December gold hit $1,645.60 an ounce Tuesday, a record for a most-active contract on the Comex division of the New York Mercantile Exchange. The rise came about even though the House of Representatives Monday passed a bill to increase the debt limit and the Senate did the same early Tuesday afternoon, as expected. President Obama has indicated he will sign the measure.
Numerous analysts previously said they anticipated a temporary correction lower in gold when the deficit-ceiling impasse ended. December gold ran up roughly $150 from the July 1 low to Friday’s close, a period when the debt-ceiling gridlock and potential for a default increasingly dominated headlines. There was an expectations that some short-term speculators would sell after an agreement in order to liquidate positions or capture profits.

December gold pulled back by around $20 when electronic screen trading opened Sunday night on reports that Republicans and Democrats were close to a compromise.  But the market soon regained its footing and went on to new highs even as the two parties worked toward an agreement.

A correction could still occur, said Robin Bhar, senior metals analyst with Credit Agricole CIB. “But the fact we haven’t seen it so far suggests there is a whole host of other factors strongly in gold’s favor,” he said.

For starters, there are the details of the budget and debt-ceiling compromise. While it might allow the Treasury to keep paying bills, it is projected to trim the budget deficits by only $2.1 trillion over the next decade. This is far below the roughly $4 trillion that Standard & Poor’s has said was necessary to avoid a downgrade.

“We are pricing in a possible downgrade,” said George Gero, vice president and precious-metals strategist with RBC Capital Markets Global Futures. “And we are pricing in problems (that will continue) after the debt-ceiling talks are beyond the headlines. We are pricing in problems in the euro zone and the Middle East.”

Prospects for a downgrade of U.S. debt could leave some investors skittish about holding the dollar.

“The dollar in the past has been a safe haven,” Bhar said. “But there are some concerns as to it will continue to be in the future.”

Meanwhile, investors remain wary of debt levels in periphery European nations, with 10-year yields on Spanish and Italian bonds rising again, said Jim Comiskey, senior market strategist with MF Global. “There is a continued flight to quality (into gold),” he said.

The market also remains underpinned by worries about global economic growth, which could be complicated by the debt problems in the U.S. and Europe, analysts said. Bhar pointed out that gold climbed steadily in the aftermath of a report showing U.S. consumer spending fell 0.2% in June, the first drop in almost two years. “That fanned the flames and helped gold move to a new high,” he said.

This in turn came after an unexpected decline in the manufacturing purchasing index put out Monday by the Institute for Supply Management. The key U.S. data for the week will be July non-farm payrolls released Friday. Expectations are for a modest 75,000 increase in jobs, with the unemployment rate holding at 9.2%.

Weak economic data means low interest rates are likely for a longer period of time, Gero said. This supports gold several ways. It pressures the dollar, adds to worries about longer-term inflation and means a lower so-called “opportunity cost” of holding gold, or income that would be lost by holding gold if investors instead could get higher yields in fixed-income assets.

“Friday’s unemployment number is going to be a key for the direction of this market,” said Mike Daly, gold and silver specialist with PFGBEST. “If it’s not good, then everybody is going to say there is going to be more stimulus added and QE3 (third round of quantitative easing). If that happens, all that does is to help gold.”

A continuation of weak data likely would add to the interest in a meeting of Federal Open Market Committee policy-setters next week.

Analysts also cited continued central-bank buying of gold after news that the Bank of Korea bought 25 metric tons over the past two months, its first purchases since the 1997-98 Asian financial crisis.

“South Korea is the world’s seventh-biggest foreign-exchange reserve holder,” Comiskey said. “Sixty-four percent of its reserves are in dollars. So in essence, they are diversifying their reserves.”

Further, this only adds to expectations that China will keep adding gold to its massive foreign reserves, he said.

“It has the second-biggest economy on the planet, and China is only the sixth-largest holder of reserves with 1,054.1 tons,” Comiskey said. “That’s only 1.6% of their currency reserves. If they start loading the barrels…and start to diversify like South Korea has done, you could see gold continue to spring forward.

There is a risk for a correction lower if some development occurs and is perceived as not friendly for gold, particularly since positioning data for the futures market shows speculators already heavily bullish, which in turn means potential for long liquidation. The most recent data from the Commodity Futures Trading Commission shows that as of July 26, the large non-commercial accounts—essentially the funds— were net long by 269,489 lots for futures and options combined, the most since last October.

“Nothing goes straight up,” Daly said. “We’ll have some pullbacks.”

Some said a correction might even improve the health of the market and one can be expected at some point.

“And of course, the higher you go, the more volatile you are,” Gero said. “A 5% correction is much bigger at $1,640 than at $1,440.”

However, Daly said, Asian buyers are likely to use any pullbacks as buying opportunities, especially ahead of gift-giving autumn festivals and the “wedding season” in the key gold-consuming nation of India.

“My opinion at this point is everybody is buying gold because they don’t know what else to do,” Daly said. “It’s a safe haven. They are going off of historical facts. And historically, gold and silver seem to retain value better than most commodities in times of chaos. We’re definitely in a chaotic period.”