Gold Does Not Offer Comfort in Liquidity Crunch

U.S. dollar gold bullion prices dropped to $1,609 an ounce Wednesday lunchtime in London—1.9% down from the high for the week so far, set less than three hours earlier.

Stocks and commodities also traded lower following an announcement by the European Central Bank about its latest liquidity operation.

"We don't see much fresh [gold] buying from investors as the year end nears," says Dick Poon, Hong Kong-based manager at precious metals group Heraeus.

Silver bullion fell to $29.29/oz—having briefly passing the $30 mark—as the Euro fell against the Dollar following news that European banks borrowed a total of €489 billion at the ECB's Three-Year Longer Term Refinancing Operation, which settled Wednesday morning.

The LTRO—through which the ECB offered to lend to banks for three years against collateral that includes distressed Eurozone government debt—saw 523 bidders.

The ECB offered the loans at a rate of 1%.

"It was obviously an offer the banks could not refuse," says Laurent Fransolet, head of fixed income strategy at Barclays Capital in London.

"It shows the ECB is not out of ammunition and it gives banks security on liquidity for a few years. On the other hand it means banks will rely on the ECB for longer."

"This is basically free money," said Jens-Oliver Niklasch, Stuttgart-based strategist at Landesbank Baden-Wuerttemberg, speaking before the ECB announced the LTRO results.

"The conditions are unbeatable. Everybody who can will try to get a piece of this cake."

"It remains to be seen [however]," warns ING economist Carsten Brzeski, "whether the money will filter through to the real economy as the ECB hopes. Many banks still have to increase their capital ratios."

"The cash could be used simply to shore up [banks'] balance sheets," agrees Kit Juckes, currency strategist at Societe Generale.

"Or some of it could go into assets, including but not exclusively higher-yielding peripheral debt."

Deutsche Bank has estimated that around half of the €442 billion borrowed by banks at a one-year LTRO in 2009 was used to buy sovereign debt—the majority going into Greek and Spanish government bonds—the Financial Times reports.

The euro fell 0.9% against the dollar immediately following the ECB's announcement, breaking a rally that began early on Tuesday and continuing to fall throughout the rest of the morning.

European stock markets also fell, while dollar gold bullion prices dropped more than 1% in an hour from $1,640/oz, their high for the week so far.

In the same period, the gold price in Euros fell 0.6% to €39,847 per kilogram (€1,239 per ounce), while the Sterling Price of gold bullion also dropped 0.6%, hitting £1,033 per ounce.

Despite rallying for most of this week (until the ECB announcement), the dollar price of gold bullion remains 5.6% down on the start of last week.

"Gold is not the asset of choice on a search for liquidity," says Dominic Schnider, head of commodity research at UBS Wealth Management.

"It gives you comfort against currency risks, inflation, sovereign debt problems, but not liquidity crunch. . .[however] holdings of gold ETFs are still holding up despite the recent sell-off, which is a good sign."

The volume of gold bullion held to back shares in the SPDR Gold Trust (ticker: GLD)—the world's largest gold ETF—fell by around 15 tonnes last week, but on Tuesday remained more than 40 tonnes above its 2011 average.

Here in Britain, minutes from the Bank of England's Monetary Policy Committee meeting earlier this month show all nine MPC members were unanimous in voting to keep the bank's main interest rate at 0.5%—where it has stayed since March 2009.

The MPC was also unanimous in maintaining the size of the bank's quantitative easing program at £275 billion—to which it was increased in October.

"The Committee agreed that a decision to change policy was not warranted at this meeting," the minutes record.

"Some members [though] continued to note that the balance of risks to inflation. . .[means] that a further expansion of the asset purchase programme might well become warranted in due course."

Over in the U.S., the Federal Reserve Tuesday proposed new rules aimed at curbing U.S. banks' risk-taking activities. The plan calls for banks to assess their liquidity needs at least once a month. It stops short, however, of mandating minimum levels of liquid capital, with the Fed saying it will wait to hear the recommendations of the Basel Committee on Banking Supervision.

Analysts meantime expect US banks to post worse results for the fourth quarter of 2011 than they did in Q3, newswire Bloomberg reports.

Ben Traynor
BullionVault

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.

(c) BullionVault 2011

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.