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Economic Review

7/19/2010

Can the price of Gold withstand yet another bout of artificial selling pressure, where this time it is a desperate European nation playing with fire in the Swap market.

The price of Gold suffered a mild set back over the past few weeks as it dipped below the $1,200 mark last Friday.  Some may attribute the recent set-back to tame inflation numbers or the lack of industrial demand due to quiet summer markets (e.g. seasonality pressure on the metal) but the real followers of Gold know that its strength has more been its value as a safe haven asset in light of the questionable value of the world’s major currencies. 

So why the sell off ?  Market news has reported that one or a few European sovereigns have turned to the swap market to sell large amounts of gold in order to raise cash and improve the liquidity of their credit markets.  An interesting part of the swap market is that the seller agrees to buy back the asset at a future date, where the sale is more of a lending of the asset in return for near term cash. 

In the US capital markets, investors can sometimes predict the future level of interest rates given the activities of major money center banks in the swap markets.  If major players see a future drop in interest rates, they tend to swap into variable rate liabilities; where at some point at lower rates they can reverse their exposures.

The danger with the recent Gold swap activities is that the sovereign nation is most likely selling the gold reserves out of desperation to avoid chaos in their financial markets and not because they think the price of Gold is going down.  If the price of Gold can somehow rally over the medium term, this swap activity could become a major problem for the seller.

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