Gold Climbs; ECB Is "Last Line" of Eurozone Defense

U.S. dollar gold prices soared to a record $1714 an ounce in Monday's Asian trade—up 3% from last week's close—following Friday's U.S. sovereign debt downgrade and Sunday's announcement by the European Central Bank that suggested a new phase in the Eurozone crisis.

Stocks and commodities sold off heavily Monday morning, while U.S. Treasury bonds rose after the ECB said it will buy Eurozone government bonds.

Silver prices peaked at $40.31 per ounce in Asian trade—5.2% up on last week's close - before easing back.

Euro gold prices hit another new record mid-morning in London—coming within 5 cents of €1200 per ounce—while on the currency markets the euro lost 1% against the dollar.

"With the dollar weakening too [against other currencies], gold has burst through the $1,700 level and looks almost certain to be heading higher," says one gold dealer here in London.

"What people are realizing is that dollar and euro currencies have real problems and I think that's manifesting in the gold prices," adds UBS Wealth Management analyst Dominic Schnider.

The ECB "will actively implement its Securities Markets Program" to buy government bonds on the open market, according to a statement released Sunday.

"The ECB is once again intervening as the last line of defense," says Jacques Cailloux, chief European economist at Royal Bank of Scotland in London.

Traders report that the ECB was active in the bond markets as soon as they opened on Monday.

The yield on Italian and Spanish government bonds fell sharply as their prices rose—a sign that the ECB's buying program is actively targeting those countries' bonds.

Italian 10-Year government bonds saw their yield fall to 5.3%—compared to a high of nearly 6.4% last week.

The yield on 10-Year Spanish bonds also dropped to around 5.3%—having hit nearly 6.5% last week.

The ECB's move "does encourage any maneuverable short positions to get out" says Mark Schofield, head of interest rate strategy at Citi.

"But the market has been about a reduction in long positions not new short positions" he added, implying the problem is longer-term investors selling out, rather than shorter-term speculation.

The ECB intervened in the bond markets—to the tune of €16.5 billion—in May last year in the weeks following the first Greek bailout. At the same time it sought to offset the potential inflationary effect of its bond purchases by raising the interest rate offered to banks to encourage deposits—a process known as sterilization.

"Given the far larger size of the Italian and Spanish debt markets. . . the ECB might need [to buy] €200 billion or more of [Italy's] debt stock, and at least €50 billion of Spanish debt," reckons Chris Scicluna, deputy head of economic research at Daiwa Capital Markets.

"I don't think that. . .€50 billion a week can be sterilized," warns ING Belgium economist Carsten Brzeski.

Sunday's ECB statement also called for "the prompt implementation of all the decisions taken at the euro area summit".

The European Financial Stability Facility—the Eurozone's €440 billion bailout mechanism—was granted bond-buying powers following last month's summit. However, it will not formally receive these powers until the relevant legislation is passed by national governments—not expected until mid-September at the earliest.

Over in Washington, ratings agency Standard & Poor's carried out its threat to downgrade U.S. sovereign debt on Friday—from AAA to AA+.

"The fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics," S&P said in a statement.

Moody's and Fitch, the other two major ratings agencies, have maintained their triple-A rating for U.S. debt—although Moody's maintains a negative outlook.

On New York's Comex exchange, the net long position of bullish minus bearish contracts held by noncommercial– so-called speculative—gold futures and options traders jumped 7.3% in the week ended 2 August, according to figures from the Commodities Futures Trading Commission.

The rise was almost entirely attributable to a rise in speculative long positions, with speculative short positions barely changed.

Gold prices "are overbought at the moment" reckons Natalie Robertson, commodities strategist at ANZ Bank.

"If you look at technicals, [gold] could be vulnerable to some profit taking."

"We foresee physical buying if gold drops to sub-$1,650 levels," adds Standard Bank commodities strategist Walter de Wet, adding that supplies of scrap gold have "moderated substantially" in the last fortnight.

"Seasonally, Q4 is the strongest quarter for gold jewelry demand, and we would expect buying interest to ramp up in August."

"We had very good business on Saturday and Sunday," confirms T.K Chandran, managing director of DKTM Jewellery in southern India.

"Everybody who comes in wants to know whether gold prices will go up more."

Ben Traynor
BullionVault

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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.

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