Good Day,

Gold bulls were granted a half-day reprieve by none other than Mr. Bernanke, who, yesterday, intimated that given US economic conditions at the present time, interest rate hikes are probably a bit further out in time than the clustering of recent bets about them would have us believe. Friday's stellar jobs figures (naturally, dismissed by the uber-bulls as smoke and mirrors fabrication) had pushed expectations about the probability of interest rates being raised by the Fed from the back shelf (Q3 2010) all the way up to late Q1 of 2010.

Analysts at GoldEssential.com characterized the shifting market climate manifest since last week as follows: Last Friday's payrolls however diminished expectations beliefs that central bankers were caught between two extremes - inflation and a weak economy, which has dented the case for gold slightly. Much of the intensity of Friday's $50+ drop was due to several layers of stop losses that were triggered and that had been building up as a technical overbought reading for the yellow metal had been developing following the nearly endless hunt for record highs.

Bullion prices opened Tuesday's session under renewed selling pressure, held back by a 0.14 gain in the US dollar on the trade-weighted index and by a larger than $1 decline in crude oil values (last seen at $72.88 per barrel). Gold spot started the day with a $7.60 loss, quoted at $1150.00 precisely, on the bid-side. Silver fell 30 cents and was seen decisively breaking the $18 level with a quote at $17.87 per ounce.

Platinum and palladium on the other hand, each added $2 to rise to $1441 and $374 respectively. Rhodium marked time at $2.200 per ounce, showing no change. Shortly after the open, the selling in gold intensified and brought back the possibility that supports -though to lie near $1130/35- could once again be tested before this phase in the market comes to a close. The other precious metals followed suit.

We have, for some time, been watching the 1.50 pivot point on the euro-dollar rate (as well as the 74 level on the dollar index) as potential indicators of a shift in the bullion markets as well. A significant majority of the recent gains in gold were mirror images of the gains the euro had achieved against an ever-weakening dollar. The greenback was trading at 1.479 against the European common currency this morning, and according to sources queried by Bloomberg, it:

May have a long-term, multi-month drop toward its 2008 low, falling below support at $1.4625, BNP Paribas SA said, citing trading patterns. Euro-dollar is in position to have completed its March rally, he wrote. A drop below $1.4625 would confirm a major top is in place and that euro-dollar is at the early stages of a long-term, multi-month decline potentially re- testing or breaking the $1.2330 October 2008 cycle low.

Speaking of the arch-enemy of the gold bulls, and his stance on rates, inflation, and related matters, Marketwatch relayed the Fed Chairman's words shortly after they were spoken, and had him vowing to keep a lid on inflationary pressures:

When the time comes, the Federal Reserve will raise interest rates to keep inflation under control, Fed Chairman Ben Bernanke said Monday, adding that that time could be far away. With the U.S. economy still very fragile and unemployment so high, inflation isn't a pressing problem right now, Bernanke said in a talk to a group of economists in Washington.  

Bernanke's talk was titled Frequently Asked Questions. The most frequently asked question for the Fed right now is: Will the Fed let inflation get out of hand?The answer is no, Bernanke said. The Fed is committed to keeping inflation low and will be able to do so.

However, inflation appears likely to remain subdued for some time. Bernanke said the Fed will be able to tighten monetary policy by raising interest rates even before its balance sheet shrinks back to a normal size. One important tool will be the ability of the Fed to pay interest on the reserves banks hold at the Fed. If necessary to prevent the economy from overheating, the Fed could raise the rate it pays to banks in order to entice them to deposit excess funds at the Fed, rather than lending them out.

Meanwhile, Bloomberg reports that the maintenance of ultra-low interest rates by the Fed is a prescription for the type of disaster that NYU Prof. Nouriel Roubini has recently warned about:

Federal Reserve Chairman Ben S. Bernanke is prescribing poison to the U.S. economy by keeping interest rates near zero and fueling a wave of speculative capital that may cause the next global crisis, former Morgan Stanley chief Asian economist Andy Xie said. There is a Chinese saying that one could quench the thirst by drinking poison, said Xie, who predicted in September 2006 that the U.S. economy would fall into a recession in 2008. Bernanke seems to be prescribing exactly this to the U.S. economy. The slower Bernanke raises interest rates, the bigger the next crisis.

The Korea Herald this morning put a damper on the frenzy surrounding the topic of gold being purchased by central banks. It had become the single most tired and frequently trotted-out topic by the uber gold bulls in recent weeks. Well, as we have already stated on numerous occasions, central bank policies regarding the management of reserves center more on the issues of percentage allocations, and are the subject of domestic comfort levels with a particular level of gold's presence. There is nothing special to be read into Portugal's 90% of reserves level of gold allocation, or that of Canada's practically 0% allocation. Both countries remain functional, thank you.

Could any number of second-tier banks buy more gold if they feel they have a need? Why sure. In fact, we think there is quite a list of small holders that could use a few more tones of the stuff. But, could Italy for example, be forced to mobilize a good chunk of its (large-ish) gold holdings if certain negative trends persist? Why, also sure. The very purpose of having bought gold to begin with, is just that. Use it if it is rainy outside. Any future purchases or sales of gold by central banks are certainly not going to be undertaken just because someone, anyone, is urging them to do so, from the sidelines.

We would also like to offer a perspective-based reminder that central banks had been viewed as the arch-nemesis of gold for decades, and were seen as committing pure evil by mobilizing that which they felt was present in their allocation pies at too rich a level (see Switzerland (!) and its 1.200 tonne gold sale).

These days, however, they have come to be seen as one's best new friends - just as long as they buy some of the stuff, please. Well, heresy. The sixth largest foreign exchange reserve holder on the planet, Korea, has chimed in on the idea of it being next in line (perhaps now that China has said: No Thanks.) to buy the IMF's, or any other gold:

The Bank of Korea, diversifying foreign-exchange reserves away from a falling dollar, said that additional gold holdings aren't attractive as most other central banks aren't buying and the metal offers no cash returns. There's an illusion in gold, Lee Eung-baek, head of the bank's reserve-management department, said in an interview. We follow the big trend. Gold isn't the trend. Out of more than 200 nations, how many countries have bought bullion?

Gold surged to a record this month after central banks including India added more of the metal to reserves, while funds and individuals boosted purchases to protect their wealth against the weaker dollar and potential increase in inflation.

Holding gold as part of reserves makes sense in terms of diversification, but I don't think many central banks want to balloon their holdings with it, said Jerry Yoshikoshi, a senior economist with Sumitomo Mitsui Banking Corp.

Since India and Russia with large reserves bought gold, there's speculation that Korea might buy it too, Lee said. But we are not classified in the same category. There's a slim chance that we will buy gold from the IMF, he said. Since the end of September, India, Mauritius and Sri Lanka bought more than half of the 403.3 tons of gold that the International Monetary Fund plans to sell to bolster its balance sheet. Bank Rossii, Russia's central bank, also increased its gold holdings by 2.6 percent in October.

The volatility on gold is too big, Lee said. And once gold is purchased, it's just kept in a safe and is not put up for sale even if prices rise. Many central banks remember bullion's ultra-bearish trend in the nineties, Sumitomo Mitsui's Yoshikoshi said. Gold tumbled as low as $251.95 an ounce during the decade, in August 1999. The recent rally is, for me, too much in an environment where aggravated inflation is hardly expected in the coming years, he said.  

Kind of like what the Fed Chief opined yesterday. No inflation at the moment, contained inflation as we go forward. No reason to buy gold? Far from it. However, do the slice and dice on the average level of central bank holdings (take the top 100 and run an average) and you will arrive at the same, reasonable, core 10% number which has been advocated by prudent advisors for years. Of course, the choice remains yours to make, provided there is also the recognition of the attendant risks of being over-weight.

Stay tuned.

Jon Nadler

Senior Analyst