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Gold Bounces as Volcker Challenges Inflation-Targeting and Bail-Out Policies

Commodities / Gold & Silver 2009 Apr 20, 2009 - 08:13 AM GMT

By: Adrian_Ash


THE PRICE OF PHYSICAL GOLD rose as the US opening drew near on Monday, jumping 1% from an AM Gold Fix here in London of $870 per ounce after losing value for the last four weeks running.

European bourses meanwhile fell, unwinding more than half of last week's 2.7% gains.

Crude oil slipped below $50 per barrel. Treasury bonds rose. The Dollar was little changed on the currency market, but it knocked 2¢ off the British Pound ahead of Wednesday's UK government budget.

Expected to show record borrowing of £160 billion ($232bn) for 2009-10, the UK government's forecast will include £60bn to fund the rescue of Britain's largest banks.

"Govts think by bailing out banks, they're fighting deflation," writes renowned market analyst Harry Schultz in the typical staccato of his eponymous letter, published monthly since 1964.

"But so far, the boat-bailing buckets have leaks."

Many US banks, notes Schultz, are using their bail-out funds to simply buy government bonds, "ineffectually" giving it straight back to government. Meanwhile, growth in the money-supply "is actually falling & has been for months.

"Everyone wants inflation, at least mild inflation," says Schultz. But "it's not happening yet.

"This is good for govt bonds, bad for most mkts & biz & jobs & public mood. It is neither good nor bad for Gold Investment; is neutral. But if deflation gets much worse, it helps gold – as a rare zone that has intrinsic value."

Analysis from the Wall Street Journal today shows the largest recipients of tax-funded aid cutting their new loans and refinancing by almost one-quarter in February compared with October – back when the Treasury Department's 'Troubled Asset Relief Program' (TARP) began.

Asked by US president Barack Obama to find ways to "simplify [America's] monstrous tax code" last week, former Fed chairman Paul Volcker openly challenged the central bank's bail-out policies in a heated debate this weekend, warning that "I don’t think the political system will tolerate the degree of activity that the Federal Reserve, in conjunction with the Treasury, has taken."

Now head of President Obama's Economic Recovery Advisory Board, Volcker also challenged Fed vice-chairman Donald Kohn to defend his "low inflation" target of 2% per annum.

"[That means] telling people in a generation they're going to be losing half their purchasing power," Volcker said during questions-and-answers at Vanderbilt University on Saturday.

Kohn replied that "Your problem is that 2% would then become three becomes four," before claiming that other central banks already running a 2% target haven't had that problem.

Here in London, however, the inflation-targeting Bank of England has over-shot its 2% target in 31 of the last 36 months.

"We are very vulnerable to an inflation explosion," warned former St.Louis Fed president William Poole at a conference in Nashville, Tennessee this weekend.

Current Fed officials "are dramatically underplaying the risks and liability side of the [central bank's $2.1 trillion] balance sheet," he added, clearly challenging New York Fed president William Dudley's assertion at the same event that he's "not worried at all" about the volume of toxic assets now held as collateral against bail-out loans to commercial banks.

"The roll call of Quantitative Easing central banks could increase by two this week," notes Steven Barrow in his latest update for Standard Bank clients, pointing to Canada and Sweden.

Overnight, Barrow adds, "ECB President Trichet gave another clear indication that [Eurozone] rates will be cut 0.25% at the next meeting."

For French, German and Italian investors now Ready to Buy  Gold, the price moved 1.8% higher Monday morning to €678 an ounce.

UK investors saw the price jump 3.2% from Friday's 13-week low to break back above £600 an ounce, a level first reached in Dec. 2008.

Latest data released Friday showed the "net long" position in US Gold Futures held by speculative funds bouncing from an two-month low in the week-ending last Tuesday.

As a proportion of all betting on gold by hedge funds and other large speculators, the "bull ratio" rose to 85% from its worst level so far in 2009 at 84.2%.

The volume of gold held to back the value of Gold ETF shares in New York's SPDR trust meantime showed a 2.0% drop last week, slipping back to a one-month low of 1,106 tonnes.

That's still 39% greater than at the start of 2009, however.

Over in the traditionally gold-hungry market of India, the import drought of Jan. to March has been broken by a 10-tonne inflow so far this month, reports the Business Standard today, with a further 25 tonnes expected in the next fortnight.

By Adrian Ash

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2009

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.

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