Good Morning,

Gold prices fell substantially overnight, more than giving back Friday's gains, which had propelled them to six-month highs. Thus far, the $930 zone is proving difficult to overcome, although support is expected to hold close to the $900 level. The decline was attributed to dollar strength against the euro, slumping physical demand in another key market (Abu Dhabi), and to profit-taking among participants returning from the Chinese New Year celebration period.

Bullion skidded to a low of $901.20 per ounce, and was seen nervously darting prior to the NY session's opening this morning. Groundhog Day saw an icy blanket of snow covering London as if underscoring the frozen state of credit markets, and keeping City workers at home in their fast-depreciating real estate. According to projections in today Independent there is a good possibility of a 40% decline taking place in UK real estate values.

Davos participants Gordon Brown and Angela Merkel called for unity and coordination among nations as they tackle the regulatory environment in the financial industry and restructure the damaged global economy. The idea of a UN Economic Council was floated at the meeting, and some strong apprehensions were voiced about the apparent rise in protectionism in various nations and some of their economic sectors (banking, autos) in the wake of taxpayer money infusions.

Other types of problems are having Chinese officials reaching for headache medicine these days. Some 20 million Chinese rural migrant workers have lost their jobs in the economic crunch, raising the spectre of social unrest. Officials are trying to divert all kind of funds towards rural areas, in an attempt to preempt such problems. We are talking here about unemployment figures (in just one niche) larger than Australia's population...

New York spot bullion opened the first February session with a $17 loss per ounce, quoted at $910.10 as players watched the surging dollar (at 86.33 on the index) and a larger than $1 decline in crude oil (to $40.65) while also fretting about the Dow looking grim in pre-opening futures indications. No need to wonder about Phil the groundhog as far as carmakers are concerned - car sales are heavily snowed-in, and the Formerly Big Three will be lucky to move one million pieces of iron per month in 2009. Toymaker Mattel was hit with a 46% decline in Q4 profits, underscoring the disaster that the holiday season buying turned into.

Sales figures for gold jewellery (another luxury purchase for most) indicate a 70% cratering for this month, in one of the more important venues being tracked: Abu Dhabi. Fairly logical, given the high prices seen recently, and the fact that the region also serves as a gateway for bullion flows into India. gold demand there, as we learned recently, fell by 90% or more in the month of December.

Silver was off by 18 cents on the open, quoted at $12.32 per ounce, while platinum declined $18 to $969.00 and palladium showed no change, at $192.00 an ounce. On the statistical breakfast plate this morning, ISM figures for US manufacturing. Numbers are expected to show a US economy that is contracting at the fastest rate in nearly three decades. Meanwhile, real US consumer spending declined for the sixth time in seven months. Belt sales must be going through the roof. Any tighter, and Joe Six-pack is down to a single can.

My former colleague Rhona O'Connell (one of the industry's best brains) has compiled an interesting study on gold as a hedge. We bring you the results, courtesy of Mineweb. The question, of course, is: Does gold hedge you against the dollar, bonds, or equities? The answer to that depends on where you are. The latest quantitative analysis for the World Gold Council produces some interesting results. Nothing, it appears, is what it seems.

Part of the World Gold Council's investment service is a detailed quantitative analysis of gold's correlation with a wide range of asset classes and commodities. This is calculated using a series of rigorous analytical tests, carried out on a country-by-country basis. It is accepted wisdom that gold is a hedge against the dollar, equities, bonds and so forth, but nothing is ever that simple, and gold's effectiveness against other asset classes varies according to the country in which portfolio components are based. In fact, as our table below demonstrates, some asset classes are most closely correlated with gold while in others they are the least closely correlated. 

Here, then, is a distillation of the latest work from the Council, which in this most-recent analysis looked at nine countries, and also at commodities as an asset class. The methodology applies local investment research best practice to each area and includes domestic equities, regional equities in the case of Europe, international equities (non-Europe) and international bonds (both of these two latter are in domestic currency terms). The Bond index used is the Lehman Brothers' Global Aggregate Bond Index series, which is weighted by market capitalisation. The gold price (and that of other commodities) is determined in local currency units, so that each matrix generated is specific to a country or a market. Calculations are based on weekly data using underlying daily data and the results are published at the end of each calendar quarter. The work looks at three-year and five-year periods, as well as generating volatility comparison. 

The following table gives an encapsulation of some of the results of the three-year analysis. For each country, gold is listed against the asset class with which it has the highest positive correlation and the lowest (generally negative) correlation. What may not come as much of a surprise for those versed in investment strategies is that there is a very high number of assets with which the correlation coefficient is not significantly different from zero. 

In the US the exercise was carried out against commodities, equities, bonds and real estate investment trusts (REITS), while in the majority of other countries the assets considered tend to be equities, bonds and interest rates. 

Some results are as expected, but some are more surprising (two results are given for the lowest US correlation as the asset with the lowest correlation is a yield, rather than a price, so the next lowest tangible asset has also been included - which turns out to be the S+P 500). The MSCI inflation index shows up three times as the asset with the highest positive correlation - which should come as no surprise - but it has the lowest correlation in Switzerland, while Switzerland houses the highest correlation with the Lehman Brothers Treasuries index; and this Index has the lowest correlation with gold in Japan. The high correlation with bonds in Switzerland probably reflects cautious portfolio allocation (gold and bonds) while the low correlation in Japan may reflect the search for yield in the face of very low domestic rates. Yields in Australia have been high, however, and here the LB Treasuries index also has the lowest correlation with gold; this may reflect the use of both gold and global Treasuries as a hedge against local possible currency weakness. The high correlation with AIM Stocks in the UK would reflect the heavy mining component in that index. 

The Council's analysis is more detailed than the encapsulation shown here and, as noted above, one of the most important results is that gold has low correlations with a wide enough range of asset classes to make it a worthy weapon in the battle to expand your portfolio efficiency frontier. The devil is in the detail, however, and if this exercise shows us one thing it is that, while markets may be increasingly globally integrated, they are not homogeneous.

Happy GH Day!