-- Posted Tuesday, 16 December 2008 | | Source: GoldSeek.com
The Morning Gold Report by Peter A. Grant
Dec 16 a.m. (USAGOLD) -- Gold remains well bid after six consecutive sessions of gains as the market awaits today's Fed announcement on rates. There is much anticipation about the FOMC decision, but the target rate has become largely irrelevant.
The effective rate of Fed funds has been trading significantly below the current target rate of 1.0% for some time now. Another 50bp cut to the target rate today is likely, although Fed funds futures suggest a better than 50/50 chance of a 75bp cut. Such a move is rather meaningless with the effective rate already at 0.10% to 0.20%. I mean, how much lower can the effective rate go?
The reason the effective rate is so far below the target rate is because the Fed has been actively supplying massive amounts of reserves to the system, and then paying interest on those reserves. Nonetheless the credit markets remain extremely tight.
In fact, banks like Citigroup have been reducing customer credit lines and raising interest rates. Citigroup said that it planned to raise the effective interest rates its customers pay by 2-3% on average. This comes at the same time that their borrowing rates have plummeted.
The Fed is likely to detail plans for quantitative easing in their statement, a practice that is already underway. The Fed has also indicated that it would be buying treasuries, mortgage backed securities and asset back securities in an ongoing effort to free up lending in specific segments of the market. Hopefully more details on that program will be forthcoming as well.
Over the past several weeks we've heard increased talk of a short squeeze in gold futures on COMEX. There has been a rather significant reduction in the gold contango (upward sloping forward curve) and there has been periodic backwardation.
A similar situation happened two years ago when the LME defaulted on its nickel contract. The LME simply imposed backwardation limits and changed the terms of delivery, allowing shorts to delay delivery and pay a daily penalty of about 1% to longs demanding delivery.
From the LME website back in 2006: Those with short positions in nickel falling prompt on Friday 18 August 2006, and on subsequent prompt dates until further notice, who are unable to effect physical delivery and/or unable to borrow metal at a backwardation of no more than $300.00 per tonne per day, shall be able to defer delivery for a day at a penalty of $300.00 per tonne. Those with long positions for prompt on those days who are subject to deferred delivery shall be entitled to compensation of $300.00 per tonne per day.
The LME claimed that their first priority was to "ensure that trading remains orderly" rather than fulfillment of the contracts taken by longs in good faith. But if you can't get the metal, in that instance nickel, you can't get the metal and most of the contracts apparently ended up being settled in cash. One has to wonder how the gold market might react as this tumultuous year winds down.
The price of nickel surged to new highs going into the default, moderated subsequently and then set new highs again before the end of the year. It's going to be interesting to see how this all shakes out in the gold market over the next several weeks.
It is also worth noting that gold tends to have a positive bias in December anyway as gold leases come due and depositors are looking for their gold back. Given the current global financial situation, I think more depositors are going to be demanding the return of their gold and will probably be less likely to lease it out again any time soon.
Mike Kosares recently recounted a gold industry legend regarding Vatican bank gold leases, which were handled through the Rothschild's. All lent gold had to be repaid and within Vatican walls by midnight Christmas Eve. Mike noted that he'd never seen this story verified in the mainstream press but at the very least it is an interesting sidelight this time of year. It is likely that the Vatican will not be the only gold lender exercising a bit more caution under present circumstances.
A rather favorable technical picture for gold has emerged as a result of the recent gains. The yellow metal has now retraced more than 61.8% of the decline from 930.10 (10-Oct high) to 681.65 (23-Oct low), suggesting potential for a return to that 930.10 high.
Resistance at 850.00/856.93 remains intact at this point. This area is defined by the old all-time high from Jan-80 as well as the 50% retracement level of the entire decline from 1032.20 (17-Mar peak) to 681.65. A push through this zone would lend additional credence to the 930.10 objective, establishing an interim target at 898.29 (61.8% of the decline from 1032.20 to 681.65).
Recent price gains above the 20, 50 and 100-day moving averages bolster the bullish scenario further. Gold is also trading comfortably back above the 20 and 100-week moving averages. The 200-day MA and 50-week MA offer additional resistance at 861.50 and 871.53 respectively.
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