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Gold Consolidates - Where Next ?

With the nightmare scenario of a US credit rating downgrade, coupled with Italian and Spanish bonds nearing the critical levels of 7% level just a week ago - the markets have staged a remarkable recovery. The skies did not fall in and nor did a financial meltdown occur that many had feared.

What is it at play and how will it affect the outlook for gold prices ?

Italian and Spanish 10 year bonds both moved significantly lower from around 6.5% to the current 5% level as the ECB buys their debt in a show of force. In short, the ECB has again bought time while it seeks to sort an effective bail-out fund. In parallel France, Italy, Spain and Belgium have all banned short selling the effect of which is less than generally expected but it does however demonstrate the political will do something in a crisis. Something that has hitherto been lacking. For those that view the financial crisis
fundamentally as one where the politicians prevaricate and the markets punish them - then the politicians have scored a good goal, but are still 2-1 down. The thing is - the politicians need to make hay and make effective policy decisions because they cannot keep buying time forever. Intervention, throwing sand in the gears of the markets (banning short-selling) and overly optimistic growth forecasts are not an affective long
term solution ... and the clock is ticking.

Gold is a fantastic barometer which is the sum of all of those economic, social and political concerns and best reflects how people broadly feel - today the slide of nearly 3% from its peak of $1813 to the current $1760 level confirms that the world has again stepped back from the brink and is a less dark and dangerous place from a week ago. That said, prices remain robust and are holding up well.

Physical demand remains robust with offtake in Asia (primarily China) and this is lending fantastic support to the market. Meanwhile there have been suggestions that China will increase its gold reserves from the current 1054 tonnes (representing only 1.6% of their reserves - or $55bn out of $3Tr of reserves) but it would buy only when prices were attractive. Again this lends great support to the current price and is very supportive.

We expect gold to track sideways for the next few weeks while the markets digest recent moves by politicians on both sides of the Atlantic - if further effective policies come forward then gold could end the year lower than the current levels - but a failure to provide any follow through will see us testing fresh highs.

In short, gold has relatively limited downside and some good upside potential as we enter the fourth quarter (traditionally a strong period for gold buying) - always assuming the chaps on the CME holding their significant speculative longs continue to do so and remain patient. As such, eyes will be on economic policy (especially concerning jobs creation) and the impact on the hot money on the CME in holding their longs.

Ross Norman
Sharps Pixley, London