Market adjustment to parity

Gold ended just above the $800 levels on 14 August 2008 but the selling continued into Asian trade and we saw gold fell below the $800 psychological supports to the $790 regions. Gold could head towards the 790 and perhaps 770 supports very soon; and the key uptrend support around 750 as the next important level to look at.

Financial institutions are unwinding massive precious metals positions to rebalance their portfolio from credit derivatives losses in their books. With liquidations from large funds, freefall mode in precious metals are even squeezing out some long term investors. It seems like precious metals are trading close to or below their cost of production as of now.

At this juncture, the fundamentals that are driving the markets.

Firstly, the balance has clearly tilted. The markets are expecting inflation to moderate as commodity prices have declined sharply from their highs. Although this may not be reflected immediately with regards to CPI figures, the markets have already begun pricing in such as scenario in advance. A moderation in inflation could then give central bankers more leeway to focus on reviving a slowing economy and perhaps hold off any interest rate hikes in the near-term.

Secondly, we need to understand that the weakness in the markets have somewhat shifted to the Eurozone and other regions. When the credit crisis began, the focus was on the U.S. and the dollar began weakening as banks started announcing more and more writedowns. That pushed the dollar to new lows and propped other currencies to record highs, particularly the euro. But what we are experiencing now seemed to have turned around after the Eurozone began announcing that their economy has contracted in the second quarter of 2008 and as a result, the euro is now on a downward spiral and at risk of further sales.

The U.S. is certainly not out of the doldrums yet but the weakness in Eurozone and other regions have weighed on other currencies and thus propped the dollar higher. So, in relative terms, we are perhaps experiencing an adjustment to parity as other economies adjust lower on earlier U.S. weakness. Not that the U.S. has recovered.