Gold Price Easing on Solvency Solution Potential

The gold price demonstrated a subdued sensitivity to mixed news flow affirming positive quarterly earnings reports and US stock advancements coupled with some hope for resolving or delaying US solvency issues. Currently trading in the range of $1,589 per troy ounce, the price has declined slightly following levels as high as $1,605 overnight.

Policymakers in the United States made forward steps in negotiations on increasing the debt ceiling and European officials discussed a plan to halt the region’s debt crisis by providing additional assistance to Greece, minimizing the contagion from spreading to other members of the PIIGS.

US debt

With some degree of irony, the credit-rating agencies, which some observers feel enabled the current financial crisis, warned that the US could lose the AAA rating it has had since 1917. Both Moody’s and Standard & Poor’s threatened to downgrade US debt unless the US raised its debt ceiling once again, permitting the US to spend more and go further into debt. Increasing the debt limit would involve circulating more dollars, which would dilute the value and accordingly lift the gold price, adding to gains this year. Failure to raise the debt ceiling could lead to default by the US Government further eroding investor confidence in the dollar, providing further stimulus for the long term bullish trend upwards in gold prices.

The Obama administration signaled it may accept a short-term increase in the $14.3 trillion debt limit if it is combined with a major agreement to cut the deficit. As the administration and congressional Republicans continued to resist raising the government’s debt ceiling, S&P contended, “the reverberations of the showdown may be deep and wide.” Analysts have projected negative effects on corporate borrowers, structured finance, public finance borrowers, the financial services industry, as well as global capital markets and economies.

If S&P concludes that Congress and the administration have not accomplished a sufficiently credible solution to an escalating federal government debt burden they have cautioned that ratings may in fact be lowered on the US by one or more notches into the ‘AA’ category in the next three months. This could quickly result in an additional tailwind to the price of gold, as a weaker dollar will inevitably lift the gold price.

The ratings agency cautions that although the risk of a payment default on US Government debt obligations as a result of not raising the debt ceiling is small, it is increasing. Any default or suspension of scheduled debt service payments, however brief, could lead to revised long-term and short-term ratings to selective default (SD).

Moody’s vice president and senior credit officer John Puchalla issued commentary in a statement, “Perhaps because of the uncertainties related to European sovereign debt, the fallout from the US housing slump, incremental regulations and a federal debt-ceiling showdown, US companies have been stockpiling liquidity. In some sectors, companies have increased layoffs and furloughs to protect earnings and cash flow in the event economic conditions weaken further.”

Weaker US economic news flow

Weaker jobless numbers as unemployment claims rose 10,000 to 418,000 in the most recent week, slightly worse than the 410,000 estimate. Layoffs remain stubbornly high though longer term trends may be improving if only slightly. Deepening worries about debt crisis contagion in the euro zone, uncertainties around US growth in the second half and its impact on the currency, are likely to increase central banks’ appetite for gold.

Asian demand

Gold buying in Asia, home of major gold consumers China and India, picked up as price-sensitive buyers returned to the market after prices eased from record highs. The World Gold Council contends these 2 countries alone, are attributable for up 57 percent of first-quarter global consumer demand for gold. China’s exuberance for gold prompted the central bank to step up sales this year of gold and silver Panda Coins.

In India, the wedding season in mid-August is anticipated to provide upward pressure on gold demand as it underscores a value in dowry and gifts. The World Gold Council data indicates that India is the leading global gold importer, obtaining 286 tonnes of gold overseas in the first quarter, up nearly 10 percent from a year ago. This represents an annual increase of 72 percent for the country that imported 959 tonnes of gold last year.

Gold prices are 12 percent higher in dollar terms so far in 2011 and some would consider it to be the best performing currency in the world in the last 12 months. Last week’s World Gold Council quarterly report shows that physical gold prices outperformed most major asset classes, including commodities, throughout the quarter with a low average volatility of 13.4 percent for the quarter, well below a long-term 20-year average of 15.8 percent.