Strange can be the relationships between different assets and stores of value. In times of a recession one could expect people to be attracted to the yellow metal due to its intrinsic value. However, and strangely too, the sight of a looming recession in Europe has had a contrary impact on Gold.
The entire European region, including the UK and Switzerland, has just slashed interest rates in tandem in anticipation of a depressed economic scenario. While the ECB’s rate cut of half a percentage point to 3.25% was expected, Bank of England’s cut of a full percentage point came as a surprise. Such a steep cut in the UK last happened in 1933. Moreover the interest rate was close to this level last in 1954, when it was at 3%. This knee jerk reaction is suggestive of the fact that the UK is headed for a deep recession. This rate is still way above the US interest rates and the Bank of England can be expected to roll it down further in the near future especially as the economic conditions in the UK are being considered as much worse than that in the US. House prices in UK continue to tumble and reportedly fell by a record 15% in October. This is the biggest slide in house prices since 1983. UK is further expected to lower its rates to 1.5% by mid 2009 in a phased manner.
The scenario for most of the European nations seems to be negative as well. Industrial output in Spain fell 8.8% in September compared to the same period in the previous year. Weakening global demand for capital goods pushed orders from Germany down 8% against the expected 2.5%. This signifies a weakened Euro zone, from where most German orders emanate. In an official statement early this week, the European Commission stated that the $12.2 trillion Euro economy is already likely in a technical recession and growth is expected to slump to 0.1% next year. If this happens, this will be the worst economic scenario the economy has faced since 1992, when the output in the nations of the zone shrank by 0.7%.
It is important to note that most central bankers are risking rate cuts in the face of inflation, in the expectation that softening commodity prices will cool off inflation. UK inflation figure was over 5% in September as against the central bank’s targeted rate of 2%. Should inflation spurt, fears of stagflation can set in where negative or slowing growth is accompanied by rising prices! Ouch that hurts!
The coordinated rates cuts in the Euro region have led to a firming up of the US dollar. A rising US dollar seems to have made gold holders nervous about the metal’s value stagnating versus the dollar, making them dump the yellow metal in favor of the greenback. The rise in the dollar is also linked to the expectations that the US will recover faster than the Euro zone as also to salute the new King – Obama.
Up ahead, the currency markets can be expected to be choppy, with each piece of news affecting currency markets in unexpected ways leaving us with the job of finding the explanations and justifying the movements.