Gold hits 16-year high

Gold hits 16-year high

Gold hit $440 an ounce, its highest in 16-and-a quarter years, in Europe on Monday. Dealers were eyeing $450 last seen in June 1988 as dollar weakness on worries about the US current account gap strengthened the attraction of yellow metal for non-US investors.

Although we might see some small profit-taking, we are in a bull trend and should remain there for now, Frederic Panizzutti, analyst at MKS Finance, said, adding that a move to $450 depended on another drop in the US currency.

By afternoon, spot gold stood at $440.00/440.75 an ounce, up on New Yorks late quote on Friday at $437.70/438.20, as the dollar hit a 9-year low against a basket of major currencies.

The dollar, down more than 5% against major currencies since October, shrugged off upbeat US economic data last week, as currency markets focused on speculation that Washington was happy to see a weaker currency, which would help narrow the deficit.
Analysts said the expected imminent launch of an exchange-traded gold fund in New York was adding to positive sentiment.

The gold-backed security, known as street tracks, is designed as an alternative to investing in physical gold an expensive buy for small retail players.

Platinum also strengthened after a run up on Friday when Asian dealers speculated about the contents of a key outlook report from precious metals refiner Johnson Matthey. Traders expect the report, due on Tuesday, to show stronger supply/demand fundamentals for the metal. Spot stood at $877.50/882.50, compared with $871.50/876.50 late in New York on Friday.

Silver followed gold, moving up to $7.60/7.63 from $7.57/7.60 in New York on Friday.

After hitting a 16-year peak last week, gold is threatening to break new ground. In India, it has already hit an all-time high. The rally has continued even while high prices have dampened demand.

That further lends support to the argument that demand-supply situation is not the reason for this rally in gold prices. Although demand has been marginally higher than supply in the first six months of 2004, the yellow metal was in a significant surplus of over 600 tonne in 2003. Clearly, currency movements are having a large say in gold prices.

Most commodities and gold are quoted internationally in dollar terms. In other words, the price of gold is always relative to dollars. So, even when other fundamental drivers remain unchanged, a variation in the value of dollar impacts prices.

And that is what seems to be happening. Last week, the dollar fell to a record low against the euro, Europes common currency. In fact, the greenback has dropped nearly 8% against the euro over the past three months. Not surprisingly, in dollar terms, gold has appreciated about 9% during that time.

That currency effects are at play is also evident in the price of gold in other currencies. While there have been fluctuations, the price of gold has remained in a tight band all through the recent rally.

For Europeans, the yellow metal is as expensive or cheap as it was a year ago. Things are even more dramatic in the case of the South African rand.

The yellow metal has been on a long-term declining trend in the South African market. The metal has fallen from over rand 3,700 to an ounce in late 2001 to about rand 2,600 to an ounce now.

Even in the latest rally, gold has shown a downward trend in South Africa. And that is because the rand has been having a good run against the dollar.

However, as far as dollar-denominated price is concerned, things are unlikely to cool down soon. Much of the weakness in the dollar is being attributed to the unusually high trade deficit that the US is running.

Against a trade deficit of nearly $500 billion last year, through September, the US was running a trade deficit at the rate of nearly $600 billion.

This, according to some estimates, calls for a further 10% adjustment in the dollar. If this scenario comes through then gold could appreciate by that much.

However, if the outlook for the dollar worsens or the confidence in the currency drops then there could be an across-currency appreciation in gold prices.

Traditionally, gold is seen as a hedge against inflation and a safe haven in situations of emergency. Therefore, in the event of any further deterioration in the outlook for dollar, there could be some genuine surge in demand, which could push up prices further, and for every one.

But as of now, it is only the dollar-denominated gold that has become expensive. Euro zone buyers, for instance, should have little reason to complain.

Lose bonds
The Bombay Stock Exchanges banking index BANKEX has underperformed the benchmark sensex over the past three months.

Even the talk of consolidation and a stronger SARFAESI Act has not been able to get the sector to move as much as some of the others. Much of this is on account of the rising yields of government securities.

The yield on the 10-year benchmark paper has increased by about 200-basis points since March this year to near 7.3%. This is giving jitters to banks that are sitting on huge government paper.

The yields are reaching the point where the deprecation in the value of the bond-holding of Indian banks could eat a part of the core profits.

Although the Reserve Bank of India did allow some leverage in permitting a larger share of bonds in the held-to-maturity (HTM) category (which will not be affected by the changes in the interest rates), that has not made things easier.

This transfer to the HTM category is to be done at the market prices. With the yields backing up substantially, any transfer would now entail very serious loses.

Of course, the investment fluctuation reserve (IFR) option is there for banks to cushion some of the impact, but that is of limited significance as the kitty is still very small.

In the case of most public sector banks, hugely exposed to the interest rate risk because of their huge holdings in government securities, IFR coverage is much less than 5% of marked-to-market portfolio.

This uncertainty is holding bank stocks back even when credit expansion is taking place at a mind-boggling pace. For, in the event of interest rates increasing further this expansion would come to naught, as profits bond losses would have eaten up a part of the core income.

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