Gold overwhelmed by deflationary pressures

Gold futures briefly fell through the $1,600 level on Wednesday after the Fed announced that it would extend its Operation Twist program from June through the end of 2012, swapping $267 billion of shorter-maturity debt for longer-dated debt, though no QE3. Gold futures retreated 0.46%. On Thursday, gold, stocks, commodities and the EUR/USD all reacted badly to the weak economic data from China, Europe and the U.S. Gold futures plunged 3.1% to $1,565.50, the S&P fell 2.2%, the Stoxx dropped 0.37%, CRB Commodities Index fell 2.1%, while the EUR/USD sank 1.3%. VIX surged 16.5% on Thursday to 20.08, back to the level of 9 May. Gold futures are now under-water for the year, after falling 3.8% so far this week, the worst weekly performance since the week ending 16 December.

The market was reacting to the weaker economic growth data, and the likelihood of deflation, which would hurt gold price. The Euro-area "flash" manufacturing PMI fell from 45.1 in May to 44.8 this month, the lowest level in three years. The preliminary reading of the HSBC Chinese PMI index was 48 in June, the eighth month below the 50 level, which signals contraction. On Thursday, U.S. initial unemployment claims were 387,000 in the week ending 16 June, higher than the 383,000 level polled by Bloomberg. The Philly Fed Factory index plunged to -16.6, the lowest level since August, 2011. The U.S. existing home sales also fell in May, confirming the lower revision by the Fed for growth in 2012, a higher revision of unemployment rate, and the extension of the Operation Twist program.

On a more positive note, Bank Rossii, the Central Bank of Russia, announced that it increased the gold reserves by 500,000 troy ounces during May. As of 15 June, gold ETP holdings grew by 9 tonnes for the week to 2,413 tonnes, just 30 tonnes lower than the peak reached in mid-March, according to Barclays.

From the Fed's speech on June 20, the central bank stand ready to stimulate more should economic conditions deteriorate. In the case of the U.S., more easing or not will depend on the pace of job growth.

Next week, important events to watch will be the U.S. durable goods order next Wednesday, the initial jobless claims next Thursday, and the June 28 to 29  EU Summit.

About the Author
Austin Kiddle

Austin Kiddle is a director of the London-based gold broker Sharps Pixley Ltd.

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