Gold rallied above 1620 for the first time on record amid fears of US debt default. At current price level, some investors have begun asking whether a bubble is forming. The European sovereign crisis is stabilized in the near-term and the US should eventually reach a deal before the deadline to avoid default. These should lead to risk-taking taking activities. We do not think a bubble is forming and believe that gold's rally should continue as long as factors such as negative real interest rates, weakness in USD and official sector buying remain.
Although the measures announced after last week's EU meeting managed to soothe the markets and lifted sentiment, the sovereign debt crisis in peripheral countries has yet to be resolved. It's true that peripheral yield spreads narrowed. However, the levels remained elevated and signaled the market continued to expect default in some countries. Moody's cut Greece's credit rating by 3 notches to Ca although EU member states agreed on a new bailout plan last week. The rating agency said that 'the combination of the announced EU program and the debt exchange proposals by major financial institutions imply that private creditors will experience substantial losses on their holding of Greek government bonds and this is something we need to reflect in the rating'.
The new bailout package was solely for Greece and many details are not applied equally in other countries (Portugal, Ireland) that tapped funds from the EU/IMF. For instance, the document stressed that the 'private sector involvement' arrangement is an 'exceptional and unique solution' for Greece only. All other euro countries 'solemnly reaffirm their inflexible determination to honor fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms'. Therefore, EU members will need to discuss all over again should problems arise in these countries.
A lack of progress in discussion between the White House and Republicans on raising the debt ceiling has hurt market sentiment. While the Democrats said they would not accept short-term extensions, it may turn out that the 2 parties will agree on a temporary plan to avoid default or a government shutdown. Yet, the long-term risk remains there with US rating will remain in negative watches. In the long-term, the country will have to adopt stringent measures to reduce deficits. We expect the spending cut would be huge enough to hurt US' economy and trigger a new round of monetary easing. This would weaken USD and drive gold higher.