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Gold Rallies on Negative Real Interest Rates

Commodities / Gold & Silver Jun 24, 2008 - 09:53 AM GMT

By: Adrian_Ash

Commodities
SPOT GOLD PRICES
ticked higher in Asian and early London trade on Tuesday, recovering one-third of Monday's 2.7% drop as crude oil pushed higher and European stock markets sank.

The Dollar held flat ahead of tomorrow's Federal Reserve vote on interest rates. It's widely expected to leave the real returns paid to cash 2% below zero.


"The short-term bullish signals are still in place despite the dip," writes Phil Smith in today's technical analysis for Reuters India.

"There are some good support levels Gold will meet on any test of the downside."

"The Gold Market is reluctant to go lower," agrees Narayan Gopalakrishnan, a trader at MKS Finance in Geneva , speaking to Bloomberg by phone.

"We are still seeing physical buying."

Over in the financial markets, London 's FTSE100 stock index fell 1.3% early Tuesday as money moved into government bonds following the worst UK mortgage data on record.

Traders cut their bets on the Bank of England hiking its interest rates after the British Bankers Association said the number of new UK mortgages approved in May fell below 28,000 – down by one-fifth from April and 56% lower than May '07.

Already squeezed by lower home equity, however, UK consumers should expect to see energy prices rise 40% by Christmas said the head of Centrica – the UK 's leading gas provider – to a parliamentary committee today.

"As long as stagflation is such a key theme, Gold has a lot of support at these levels," believes Susanne Toren at Zuercher Kantonalbank in Switzerland .

The threat of an inflationary recession is growing across Western Europe , in fact, with consumer sentiment in Germany falling in June for the second month running on the latest GfK survey, driven down by the rising cost of living.

The manufacturing outlook in the 16-nation Eurozone just showed its first contraction since July 2003 says the RBS purchasing managers index.

"The ECB hiking interest rates in July would be consistent with a stagflationary feel," believes Michael Hume, an analyst at Lehman Brothers. Last week George Irvin, research professor at SOAS in London , warned that "excessive anti-inflationary zeal [at the European Central Bank] will lead to Japanese-style deflation lasting a decade or more."

Now at 4.0%, Eurozone interest rates stand only just ahead of May's official Consumer Price inflation figure.

"Low, even negative real short-term interest rates are here to stay for a considerable period," writes Paul McCulley – managing director of Pimco, the world's biggest bond fund. Also warning of a "modern-day depression", he believes that the Federal Reserve will not raise US interest rates because "deflating asset prices in a highly levered economy are a much more nefarious outcome than temporary increases in inflation in goods and services."

"This is particularly the case from a starting point of low inflation in goods and services."

Inflation in US goods and services last month hit 4.2% year-on-year. Current Fed interest rates are less than half that level. ( How come The Price of Gold Rises When Stagflation Hits ? For detailed research on gold and real interest rates , download this Free Gold Report now... )

Fighting to reverse the deflation in US housing assets, meantime, a raft of homebuilders are now using government-backed loans to create 100% mortgages, reports the Wall Street Journal today.

This means "$500 gets you into a new home" according to one advert – equivalent to the recent tax rebates sent out as economic stimulus checks, as another ad notes.

Down-payments made by mortgage and construction companies now account for one-third of the 200,000 loans backed so far this year by the Federal Housing Association (FHA) – "up from 18% in all of 2003 and less than 2% in 2000," writes Nick Timiraos for the WSJ .

"The Federal Housing Association is essentially filling the void left by the collapse of the subprime market...[and] above-average default rates for seller-assisted down-payment programs will force the agency to request a government subsidy for the first time in its 74-year history.

"The agency says it will need $1.4 billion next year."

By Adrian Ash
BullionVault.com

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 www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2008

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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