Ten-year anniversary of the launch of euro coins and notes

While Saturday marks the ten-year anniversary of the launch of euro coins and notes, the ongoing sovereign debt crisis promises to be one of the most important storylines for the global economy as 2012 begins.

The crisis has led to a situation now where “the euro is at risk of unraveling,” according to a report by Reuters that examined the history and shortcomings of the currency. ”How could it all have gone so wrong?” the article asks.

In the report, Reuters included extensive commentary from many former European officials who contributed to the euro’s development in order to help answer its question.

“The single currency would not have sparked the euro zone debt crisis, they argued, if the pro-European dynamic that led to its creation had continued into its first decade,” the report noted. “But instead of launching an economic and political integration of Europe, the low interest rates and easy money that arrived with the euro led peripheral states on a path of profligacy, widening the gap with frugal, export-oriented economies of the north.”

“Most of all,” Reuters added, “some of the architects now admit that after the first few euphoric years, it became clear the euro itself was a flawed concept, laying a single currency over a group of countries that stuck to national sovereignty over their economies.”

Gold, along with the other precious metals, succumbed to the downward pressure from concerns over Eurozone liquidity

Gold, along with the other precious metals, succumbed to the downward pressure from concerns over Eurozone liquidity. Adding to gold and platinum’s woes has been a bout of year-end selling in Japan due to a new taxation law coming into force from 1 January. Bullion retailers will be required to report physical gold and platinum transactions with the general public, in excess of ¥2m, to tax authorities.

Gold has broken short term support and is vulnerable to a test of 1560

Developments over the past week in both China and India could have bearish implications for the price of gold, according to a recent report by TD Securities.

In a note to clients this morning, precious metals strategist Steve Scacalossi wrote that “After the Christmas weekend the precious metals complex drifted lower. Gold opened right on it’s day highs and never looked back with a deluge of sell orders towards $1,607. This is somewhat surprising given news yesterday out of China where the head of research for the Peoples Bank of China was quoted as saying that the country should buy more gold when prices are relatively low. Support for gold is at $1,575 and then major support at $1,500 as per today’s chart.”

The TD strategist added that “In other news, China has restricted gold spot and futures trading to the Shanghai Gold Exchange and Shanghai Futures Exchange as part of efforts to crack down on illegal buying and selling of commodities.”

As for India, Scacalossi noted that ““Indian gold demand may drop as much as 50% in December after a plunge in the reminbi drives up local prices. Imports may total 35-40 tons this month compared with 70-75 tons a year ago as per the Bombay Bullion Association.”

From a technical perspective, he contended that “Gold has broken short term support and is vulnerable to a test of 1560.”

Drying up of liquidity poses a serious risk to all commodities, including gold

Precious metals, with gold taking the lead as usual, have lost ground as concerns over the Eurozone debt crisis have resurfaced putting upward pressure on the dollar. The higher-than-expected demand for ECB loans (€489bn was borrowed, analysts expected €293bn) has reignited worries over European liquidity. Our barometer of Eurozone money market liquidity (the Euribor/OIS 3-month spread) remains at elevated levels—a drying up of liquidity poses a serious risk to all commodities, including gold.

Liquidity in the Gold space remains light

Liquidity in the Gold space remains light. A much better-than-expected government bond auction in Spain this morning provided strength to the Euro, aiding precious metals marginally higher.

As pointed out yesterday, physical demand remains healthy especially from Thailand and India with the gold price below $1,600. This should support gold on approach $1,560. We maintain that gold below its 200day MA at $1,621, should continue to struggle. Gold support is at $1,565 and $1,550. Resistance is $1,606 and $1,609.

Gold physical demand rebounds

Physical demand for gold has increased substantially over the past few days providing some support as investment demand temporarily retreats. Long liquidation in COMEX gold continued last week, driving the gold price to as low as $1,560. The net speculative length for COMEX gold has declined 51 tonnes to 612 tonnes during the week ending 13 December. At the same time, speculative shorts increased by 11 tonnes to 88 tonnes, leaving the net speculative position long at 525 tonnes. This net position has steadily declined from the highs of 930 tonnes seen in August.

As a percentage of open interest, the net speculative position is now at 24.9%, well below the average of 30% seen over the past three years. In the futures market, deleveraging continues.
Furthermore, while ETF holdings remain close to all-time highs at 75.4m oz, it saw a relatively sizeable decline of 468K oz since Wednesday. While investors are trimming gold long positions, physical demand has picked up substantially since the start of last week. This segment of the market has showed little interest in buying substantial volumes of gold with the price above $1,700 (partly due to the weakness of local currencies, most notably the INR). However, with gold below $1,600, demand has picked up substantially. Indian buying interest has picked up handsomely, but so did buying interest in places like Thailand, Indonesia and China. At the same time, gold scrap sales, though present, remain very sporadic.

This physical demand is evident in the pick-up of our Standard Bank Gold Physical Flow Index (GPFI), which briefly pushed below zero late November, which has now rebounded, indicating that physical demand remains in place, albeit at lower levels than during the period August
to October. We expect this physical demand to support the gold price below $1,600.

Gold is finding good support on approach of $1,560

Gold is finding good support on approach of $1,560. Market activity for gold remains unchanged from yesterday - with the metal below its 200day MA at $1,620 we expect the metal to struggle. We also expect this 200d MA to provide resistance now.

We note that while we expect resistance to a rally the next few days, we still believe the metal will move higher in early 2012 and record all-time highs once again. Physical market demand continues to improve. The demand is not stellar, but much stronger than a week ago. This stronger demand from Asia is reflected in the SGE premium over spot which moved from around $3/oz at the start of the week to $10/oz this morning.

With the possibility of S&P downgrading a number of European countries, we would be surprised to see substantial buying activity within the next few days. The biggest immediate risk to precious metals in general, and gold in particular is not the actual downgrade, but as with the downgrade of the US, a further rise in global economic uncertainty and policy risk. In an environment where confidence is fragile already, the liquidity premium may rise further, especially in Europe, which would be bearish for gold. Also, we would expect the euro to weaken more relative to the dollar, which in the short term would impact on gold and other precious metals negatively.

We believe gold should find support within the $1,510 to $1,560 range. Gold support is at $1,565 and $1,550.