HardAssetsInvestor

Written by Sumit Roy  |

November 29, 2011

Precious Metals Monitor: Gold At Crossroad As ECB Faces Quantitative Easing

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For the first time in months, the ECB was unable to sterilize its bond purchases. We discuss what that means for gold.

Price action in precious metals was modest this past week, as gold rebounded from just under the $1700/oz level to just above it. Investors continued to accumulate the metal as a safe haven against the sovereign debt crisis in Europe. Gold exchange-traded-fund holdings rose to a record 75.6 million troy ounces, up 300K week-over-week, according to data from Bloomberg.

Yet ironically, the sovereign debt crisis has also served to hold gold prices down, as some gold traders shy away from the metal, fearing a worst-case scenario in Europe that leads to panic selling across risk assets, including gold.

Taking a closer look at some key crisis indicators, Italian 10-year bond yields rose back above the 7 percent mark to last trade at 7.28 percent, just shy of their 7.47 percent euro-era record. Spanish 10-year bond yields fell to 6.39 percent, backing away from their 6.78 percent record.

The European Central Bank purchased €8.6 billion worth of sovereign debt last week, up from €8 billion the week before.

Meanwhile, the ECB failed to completely sterilize its bond purchase program for the first time since August, when it began buying Italian and Spanish bonds. Each week, the central bank offers deposits to banks in order to withdraw liquidity equal to the amount of its purchases from the banking system, keeping the money supply stable.

This past week, it was able to only withdraw €194 billion from its €203.5 billion target, for a shortfall of €9.5 billion. That shortfall essentially amounts to an expansion of the money supply, something the central bank has gone to great lengths to avoid. This isn’t the first time this has happened. The Wall Street Journal says there’s been a discrepancy six times since the program started last May. Analysts expect the shortfall to be made up next week.

But if it’s not, that could suggest that the ECB has reached the limits of its bond purchase program as it currently stands. The alternatives are that the central bank stops purchasing the bonds of Italy and Spain — which would likely send their interest rates surging (short-term bearish for gold) — or, it initiates a full-blown quantitative easing program like those in the U.S. and the U.K., in which the ECB actively expands its balance sheet (bullish for gold).

What course the European Central Bank (as well as the highly influential German government) chooses to take will play a significant role in determining the short- and medium-term trends for precious metals. Currently, we consider gold in a consolidative range with the potential for a retest of $1600 support, as discussed in last week’s edition of the Precious Metals Monitor.