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Gold Lower Ahead of US Fed Interest Rate Indecision on Dollar and Inflation

Commodities / Gold & Silver Jun 25, 2008 - 09:49 AM GMT

By: Adrian_Ash

Commodities THE SPOT PRICE OF GOLD ticked lower in London on Wednesday, dropping $4 per ounce from last night's close as currency, bond and stock market traders awaited today's decision and statement on US interest rates from the Federal Reserve.

"The Dollar managed to stabilize [overnight] in after-market trading," notes Manqoba Madinane at Standard Bank in Johannesburg , "possibly indicating that investors anticipate hawkish comments from the Fed on inflation today."


An anti-inflation tone "would support the Dollar and pressure Gold ," says his colleague Walter de Wet.

But whatever " Strong Dollar " stance the Fed may attempt, all 102 economists surveyed by Bloomberg News expect no actual change in the cost of borrowing Dollars on Wednesday.

Interest rate futures now put the odds of "no change" at more than 90% after Tuesday's news of a 17-year low in US consumer confidence plus the fastest drop in house prices on record.

That would leave US interest rates at 2.0% per annum, less than half the rate of Consumer Price inflation – and negative real rates of interest traditionally drive savers and investors to Buy Gold as a defense against falling spending power. ( Learn more in this Free Gold Report here... )

Upstaging the Fed's decision today, former Fed chairman Alan Greenspan said "[the United States is] on the brink of recession," to a conference in South Africa this morning.

"A rebound at this stage is not something I think is in the immediate outlook. There are still very considerable structural problems remaining in the financial system. They will remain for a while. It's going to be very difficult."

Commenting on the Reserve Bank of South Africa 's recent decision to raise its interest rates to 12.0% in the face of 10.4% price inflation, "significant pressures are coming from oil and food," Greenspan went on.

"The price increases are real and unless the central bank leans against them ... you will get a highly unstable inflation environment."

Leaning against US inflation, however, was rarely a policy employed by Greenspan himself. And now, "given the uncertainty about both upside and downside risks, the Fed is likely to stay on hold indefinitely," says a note from Deutsche Bank.

"Low, even negative real short-term interest rates are here to stay for a considerable period," agrees Paul McCulley at Pimco. Because in his view – and in the Fed's eyes as well – "deflating asset prices in a highly levered economy are a much more nefarious outcome than temporary increases in inflation in goods and services."

But with some $70bn in President Bush's economic stimulus tax rebates now reaching US households, and with surging oil and food prices forcing the Fed to at least address inflation in today's statement, many professional analysts foresee a stronger Dollar – and thus weaker Gold – ahead.

"Gold should trade within a $750-950 range over the next six months," says BNP Paribas, "before it weakens significantly in 2009."

"We expect the Gold Price to trend lower over the latter part of 2008 as the US Dollar gets more solid footings," agrees Australia 's Commonwealth Bank in a new report, "and to continue to trend lower over the first half of 2009 as investor support for gold wanes."

By lunchtime in London today, the Gold Market held right at the mid-point of its last four weeks' trading range. The Dollar meantime stayed flat vs. the Japanese Yen, but dropped slightly against the major European currencies.

The Gold Price in Euros slipped to a seven-session low beneath €568 per ounce. British investors wanting to Buy Gold today saw it offered just north of £450 per ounce in BullionVault's Zurich vault.

Crude oil held near $137 a barrel in New York ahead of today's US stockpile inventory report. European stock markets ticked higher in thin trade, as London UK 's fourth-largest bank – Barclays – announced a £4.5 billion ($8.9bn) sale of equity to Middle Eastern and Japanese investment funds.

"One of the huge problems we encounter is that people are always overweight their experience relative to historical data," says James Montier, behavioral strategist at Societe Generale, the second-largest bank in France .

"No one [now working in finance] has really experienced the bursting of a credit bubble. That makes it difficult for people to work out what it is going to be like."

"I'd be surprised if the average age [of financial analysts] was over 40," says Professor Andrew Clare of Cass Business School here in London . "They are a) too young to have any inflation experience, or b) they have put faith in monetary policy regimes that have proliferated since the early 90s."

Looking at the future cost of living implied by inflation-protected US Treasury bonds (TIPS), Jeremy Gaunt at Reuters notes inflation expectation of less than 2.5%.

"Eurozone equivalents are roughly the same. This would seem pretty low given a record oil price that has nearly doubled in the past 12 months, Gold up more than 35% and food commodities such as corn soaring 78%."

"When it comes to war, commodity prices go ballistic. If you want to hedge against war, you should hold physical commodities."

"Now I know it's difficult to hold a lot of cocoa and coffee and uranium in your kitchen," joked Asian fund-manager Dr. Marc Faber at an investment conference in Tokyo today.

"But you can hold precious metals in a safety deposit box for diversification. That is what I would recommend.

"Demand for commodities and oil will not vanish. The shift in demand that drove up commodity prices is not going to go away. Commodity cycles are long in nature."

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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