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Commodity Markets Analysis - Central Banks to Curtail Plans to Sell Gold

Commodities / Gold & Silver Sep 06, 2007 - 09:31 AM GMT

By: Gold_Investments

Commodities Gold
Spot gold was trading at $683.50/684.00 an ounce as of 1215 GMT.

Gold has continued to show strength in Asian and European trading. Gold is being supported by a weaker dollar and near record oil prices again. The continuing uncertainty in the financial markets is likely to be leading to an increase in safe haven buying as well.

China and US Treasuries
Ambrose Evans-Pritchard, the International Business Editor of The Telegraph (UK) reports that "a sharp drop in foreign holdings of US Treasury bonds over the last five weeks has raised concerns that China is quietly withdrawing its funds from the United States, leaving the dollar increasingly vulnerable.

Data released by the New York Federal Reserve shows that foreign central banks have cut their stash of U.S. Treasuries by $48 billion since late July, with falls of $32 billion in the last two weeks alone.
"This comes as a big surprise and it is definitely worrying," said Hans Redeker, currency chief at BNP Paribas.

"We won't know if China is behind this until the Treasury releases its TIC data in November, but what it does show is that world central banks are in a hurry to get out of the US. They don't seem to be switching into other currencies, so it is possible they are moving into gold instead. Gold is now gaining momentum across all currencies and has broken through resistance at 500 euros," he said.

While there is no clear evidence that China is diversifying into gold, it seems likely that this is the case as they have clearly stated their intentions in this regard.

China and Gold
Much commented was the recent Chinese government investment of $3 billion in New York-based buyout firm Blackstone Group LP through the soon-to-be-formed State Investment Co.. But as important, if not more so, is the People's Bank of China statements that they will diversify into what they have termed 'strategic' resources and metals including gold. In April, The Wall Street Journal reported that People's Bank of China Vice Governor Xiang Junbo reiterated this intention. Some Chinese economists are urging Beijing to quadruple its gold reserves to 2,500 tonnes from the current 600 tonnes. Tan Yaling, an economist at the Bank of China, backed the call for higher gold reserves to "help the government prevent risks and handle emergencies in case of future possible turbulence in the international political and economic situation".

Interestingly, a mere 5% Chinese allocation to gold would be very small in the light of the fact that Greece has 80% of its reserves by value in gold, Portugal 79%, Italy 66%, Germany 63%, Netherlands 56% and France 56%. Some of this gold may have already been leased onto the market. Thirty years ago China held 95% of its foreign reserves in gold. Today, China's gold reserve only accounts for 1.3% of total reserves. A figure well below the average minimum 3%-5% adopted in many other countries. China with an estimated gold reserve of 600 tonnes has a fraction of that believed held in the U.S. with some 8,500 tonnes, the world's largest holder.

This Chinese demand is not solely governmental and there is a significant increase in private demand for jewellery and investment. It is often forgotten that the Chinese gold market was only opened in 2002 and that was the first time in over 50 years (since 1949) that Chinese individuals could buy gold in jewellery or bullion format. With the huge increase in volatility in the Chinese stock market and fears of a crash, many of their huge and growing middle classes and nearly some 500,000 plus millionaires (in 2004 Merrill Lynch & Co estimated that there were more than 300,000 mainland Chinese with a net worth over $1 million, excluding property) will diversify partly into gold.

Bloomberg reported overnight that the German Bundesbank does not have any plans to sell any gold. German Finance Minister Peer Steinbrueck said his discussions with members of the Bundesbank's board show that Germany's central bank has no intention to sell some of its gold reserves. Steinbrueck spoke on German ARD television, answering questions sent in from viewers via podcast.

The global credit crisis will likely lead to many western central banks curtailing gold sales. Meanwhile there is increasing demand from the Chinese central bank and also what are termed "tier 2" central banks: Russia, Argentina, South Africa.

Gold Lease Rates
Gold lease rates has increased significantly in recent months. Bullion banks are thus seeking higher rates of return on the bullion they lease out and this is a further sign of robust physical demand.
This is important to keep an eye on.

Spot silver is trading at $12.22/12.24 an ounce (1215 GMT).

Platinum was trading at $1274/1280 (1215 GMT).
Spot palladium was trading at $330/3346 an ounce (1215 GMT).

Forex and Gold
The USD remained under pressure overnight, following yesterday's fall against major currencies and gold after the ADP employment report for August came in much weaker than expected, leaving markets nervous about Friday's non-farm payrolls report. Dollar selling intensified after pending home sales also disappointed with sales falling by a dramatic 12.2% over the month of July, painting an even bleaker picture of the outlook for the U.S. housing sector and economy in general. Markets had expected a fall of 2.2%. This further convinced markets that the Fed will cut interest rates at its meeting on 18 September.

The euro climbed almost a cent on the back of the data, holding its gains overnight with the poor housing data contributing to a sharp fall in equity markets. The mood on Wall Street was not helped by a relatively upbeat Beige Book, which stated that there was little evidence so far in the real economy (ex housing) of the recent distress in financial markets. With risk aversion picking up again the yen also benefited as carry traders were exited yet again. This risk aversion will ultimately benefit the Chinese yuan, the Norwegian krone, the Singapore dollar, the Japanese yen, the Swiss franc and gold.

Oil prices continue their quite and steady rise towards the all time record high of 78.77 USD reached on Aug 1. U.S. crude climbed to $76.29 a barrel by 1000 GMT. London Brent crude was up 51 cents at $74.85 a barrel. While U.S. supply worries and hurricane threats were cite, high oil prices continue to be fundamentally a result of a very tight global supply/demand equation in oil. Many analysts have ignored oil's recent and continuing strength and this is another important and fundamental factor supporting gold.

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