Contrasing Developments in Advanced and Emerging Economies are Bullish for Gold

Gold resumed its rally yesterday as US dollar weakened and Treasury yields slipped. The benchmark contract for gold soared to as high as 1400.2 before settling at 1398, up +0.95%. The contract extended further gains in Asian session today. Apart from improved market sentiment, strength in gold was supported by concerns in widening US deficits. In the longer term, contrasting economic outlooks in advanced and emerging economies will continue to support the metal. Crude oil initially jumped to a 1-week high of 89.49 but reversal was seen as led by decline in heating oil prices. Meteorologists forecast cold weather in the US will be less severe than previously expected and this would lower fuel demand. The front-month WTI contract finished the day at 88.61, up +0.93%.
Financial markets were at a 'risk-on' mode as China's use of RRR hike instead of rate hike signaled the government concerns about growth more than inflation. Although China may accelerate it tightening measures by raising interest rates early next year (probably in January/February), investors will likely enjoy the delay and seek higher-yield investments before rate hike comes true. In the US, 2 senators, Sherrod Brown and Olympia Snowe, requested to include a Chinese currency (RMB) manipulation bill in the tax legislation. In September, the House voted 348-79 to pass it currency bill allowing US companies to apply for duties against Chinese imports. Ohio Democrat Sherrod Brown said 'addressing Chinese currency manipulation is vital to getting our economy back on track'. If this amendment is voted and passed, China might be forced to make it currency more flexible. Appreciation in RMB would be negative for commodities in the near-term as it's considered as tightening. However, in the long-term, demand for imports (including commodities and other products) would increase as foreign goods appear less expensive for Chinese consumers.
While investors have been thrilled by anticipations that US growth will be boosted by the tax bill, Moody's warned that it will 'adversely' affect' the budget deficit and increase the chance of a negative outlook for US' credit rating. We believe concerns over US widening deficit pushed gold higher although 10-year Treasury yields initially soared to a 6-month high of 3.35% before declining to 3.28%.
After the financial crisis in 2008, advanced economies have been struggling to recover while growths in their emerging counterparts have remained robust. We believe macroeconomic developments and monetary stances in these '2 worlds' should benefit gold. As advanced economies need to revive growth, they generally adopt loose monetary policies. Most central banks keep interest rates at low levels while some implement quantitative easing measures – printing money. A low-rate environment is positive for gold as it reduces the opportunity of owning gold. QE does not only keep interest rates low but also weaken the country's currency, spurring demand for safe-haven assets and stores of value.
The emerging world is facing inflationary pressure. Headline CPI in China surged to 5.1% in November while that in India runs at above 8%. One of the reasons is that consumer price baskets in the emerging markets have a far heavier weighting to foods and energies than in the advanced economies. Certainly, the flood of capital inflows has exacerbated the problem. Domestic demand for gold in emerging markets has been surging for hedge against inflation.
On the data-front, UK's CPI probably stayed at 3.2% y/y in November and a reading above 3% should remain a headache for BOE policymakers. In the US, retail sales should have expanded +0.6% m/m in November, easing from +1.2% in the prior month. Excluding auto, the reading probably rose +0.7%, following a +0.4% gain in October. There will not be any change in monetary decisions at the FOMC meeting. Chairman Ben Bernanke will announce to leave the Fed funds rate unchanged at 0-0.25% and reiterate that policy rate will stay 'exceptionally low' for an 'extended period'. Brief evaluation on the impacts of the $600 billion program to purchase longer-term Treasury securities by the end of 2Q11 may be given.