Higher Interest Rates In China Might Reduce Demand For Gold

Gold delivery prices rose on Monday, even as spot gold prices declined slightly. Analysts had differing views on how gold could perform in 2011, with some predicting continued …

Gold delivery prices rose on Monday, even as spot gold prices declined slightly. Analysts had differing views on how gold could perform in 2011, with some predicting continued rising prices and others cautioning investors to refrain from overreliance on the precious metal. See the following article from The Street for more on this.

Gold prices shrugged off global rate hikes Monday as trading stayed light and the Eastern Seaboard coped with the aftermath of a blizzard.

Gold for February delivery added $2.40 to $1,382.90 an ounce at the Comex division of the New York Mercantile Exchange. The gold price Monday has traded as high as $1,387 and as low as $1,372.70.

The U.S. dollar index was losing 0.16% to $80.34 while the euro was slightly higher at $1.31 vs. the dollar. The spot gold price was down $2.10, according to Kitco’s gold index.

The greatly talked about and feared event of a rate hike in China happened with little fanfare for gold prices. The People’s Bank of China raised the one-year lending rate by 25 basis points to 5.81% on Christmas, the second time in more than two months, to fight inflation. The one-year deposit rate rose to 2.75%.

China had raised the amount banks must keep in their reserves six times this year in order to take money out of circulation, but November’s inflation reading was still 5.1% vs. a year ago.

The much more aggressive step of raising key interest rates had been long feared by gold investors. Higher interest rates make it more appealing to keep money in the bank, and a higher lending rate makes it less appealing to borrow. Both might hurt consumer demand for gold, despite the fact that China had been actively trying to promote it.

It remains to be seen how demand for trading vehicles like foreign exchange-traded funds or a recently approved gold mutual fund, both of which give investors exposure to the international gold marketplace, will be affected. According to Kitco’s exchange-rate tracker, the gold price fell 0.08% in yuan terms.

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China is the world’s largest gold producer and the second largest consumer of gold, importing 209.7 metric tons in the first 10 months of 2010, equivalent to 7.4 million ounces. While gold prices might be able to absorb a minor slowdown in gold demand, the long-term implication of an interest rate hike is positive real interest rates.

When inflation is high and rates are low, negative real interest rates ensue, which is typically a green light for gold prices. Gold becomes attractive when rates are negative because paper money is literally worth less and gold becomes a safer place to preserve wealth.

If rate hikes lead to positive real interest rates, gold becomes less seductive for investors.

China wasn’t the only country to raise rates this weekend. Russia raised the overnight deposit rate by 25 basis points to 2.75%, the first time in two years, and economists expect that Brazil, another booming emerging-market economy, will raise its interest rate in January.

Jon Nadler, senior analyst at Kitco.com, believes that one thorn in gold’s side in 2011 could be investment demand. “Overreliance in the gold market on investment [demand] presents some problems,” he says.

Nadler believes that a large part of why gold has hit new highs this year — the latest intraday high was $1,432.50 on Dec. 7 — is due to momentum investment buying, not fundamentals.

Investment demand can be fickle if “conditions change. … If in fact interest rates rise globally … that component alone could … induce some of the recently arrived hot money from hedge fund and ETF participation to seek other niches,” Nadler says.

Reaction to China was muted Monday by a blizzard on the East Coast of the U.S. and technical trading. Those traders still in the market will be looking to rebalance their portfolio headed into the new year, possibly dumping gold for profits, buying back positions on a pullback or adding gold to show they own it.

“Open interest in gold [is] still not growing [because of] profit-taking for year-end by funds and short-covering from traders,” noted George Gero, senior vice president at RBC Capital Markets.

Amid the technical landscape, North and South Korea are both ramping up their military rhetoric with North Korea bragging of its recent attack on Yeonpyeong and South Korea promising retaliation against any future attack. The latter is set to continue its recent series of military exercises.

Phil Streible, senior market strategist at Lind-Waldock, says he “wouldn’t be surprised if gold gets back above $1,400” if the conflict escalates. But any type of rally before 2011 will most likely prompt a wave of selling as traders and money managers lock in previously missed profits.

Silver prices closed down 7 cents to $29.25 while copper ended 2 cents higher to $4.28.

Currently, the Comex is showing no reading for platinum; palladium prices were adding $8 to $766.20. Both metals received some rough news over the weekend. Beijing is limiting the amount of cars it will allow to be registered in 2011 to 240,000, about a third of those registered in 2010. Both metals are used in catalytic converters used in the exhaust system of cars to limit noxious emissions.

Streible said that initially there could be downside to palladium and copper prices: “The average vehicle contains about 50 pounds of copper. … But I think that India, their auto demand is just as strong as China, and if you get any additional boost in there, you’re probably going to see prices come back, stabilize and move higher.”

Gold mining stocks, a risky but profitable way to buy gold, were trading mostly lower. Kinross Gold(AUY_) was down 0.76% at $18.39, while Freeport McMoRan Copper & Gold(GG_) was 0.65% higher at $118.94. Other gold stocks New Gold(NGD_) and Gold Fields(GFI_) were trading at $9.15 and $17.59, respectively.

Randgold Resources(GOLD_) was down 3.46% to $81.29. The company lowered its production guidance Thursday for the fourth quarter due to political upheaval in the Ivory Coast, where its Tongon mine was starting to ramp up production and due to growing pains at its Loulo mine complex.

This article has been republished from The Street. You can also view this article at
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