Gold Decline Highlights Intensity of Turmoil

by Ashraf Laidi CMC Markets Analyst

The intensification of the global equity sell-off is underlined by the $30 per ounce decline in the price of gold from last week’s $844 high as the global market route is reaching towards Asian borders, hence, threatening the notion of global growth and robust demand for commodities. A sharp reduction in risk appetite is waging a broad assault on carry trades, which previously backed high yielding currencies, gold and equities. Reports that Hong Kong-based HSBC bank will announce $1 billion in bad debts from US mortgages and China ’s decision to raise the reserve requirement for the ninth time this year have been catalysts to the overnight 3.9% decline in the Hang Seng Index following last week’s 5.5% selloff.

Unlike in recent equity market losses, which were confined to the US markets, the current market route has reached over to Europe and Asia (especially China ), which is the main catalyst to the sell-off in gold and oil.

Sharp reduction in risk appetite is boosting the dollar all major currencies with the exception of the Japanese yen as markets remain damaged by persistent flow of negative news on the banking sector and recent signs of slowdown from the previously robust technology sector. Thursday’s Congressional testimony from Fed Chairman Bernanke was notably dovish, triggering a steepening in the yield curve (widening of the 10-2 year spread), implying higher odds of further rate cuts.

While falling gold prices are a result of sharp unwinding of carry trades and a higher risks of a slowdown in China –as reflected in falling stocks and tighter monetary policy in China—oil prices are also falling on a weaker assessment for world growth, with the US in particular. WTI crude oil fell 82 cents to $95.50 per barrel, after hitting an all time high of $98.62 pb. Although the Saudi and Kuwaiti oil ministers raised the possibility of raising oil output, it is unclear which meetings they referred to. OPEC’s summits on Nov 17-18 and on Dec 5.

Euro drops on risk retreat

EURUSD loses ground as the retreat in risk appetite is increasingly becoming a global phenomenon, raising doubts of a slowdown in Europe . But even if Eurozone banks go unscathed from the reporting of mortgage-related losses, the euro comes under pressure as fund managers unwind the dollar-selling positions to meet losses in equity portfolios. Comments from Germany’s Finance minister indicating no cause for concern over the strong euro went largely ignored in the current turmoil, but the statements is an important signal from policy markets and politicians reflecting the tacit support for the strength of the currency.

Widespread risk aversion into the US session will call up interim support at 1.4525. Key foundation stands at 1.4475, which can be realized in the event that gold breaks below the $806 support. We anticipate further gold losses towards the $800 support, which is the 38% retracement of the Oct 4 low to the Nov 7 high. EURUSD upside capped at 1.4620.

EURGBP surges to a fresh 35-month at 70.46 pence as sterling’s high yielding status is pummeled during the current global turmoil. Further upside seen caped at 70.70, but any actions aimed at shoring up appetite (such as an emergency Fed cut or rumors of such) could weigh on the cross. Support climbs towards 70.20.

USDJPY breaks below 110 on Machimura’s green light

Comments from Japan's top government spokesman Nobutaka Machimura indicating that Japan would not intervene in currency markets and that "It's wrong to think a high yen is something bad for the Japanese economy” have accelerated the yen’s rally. The latest 200-point drop in USDJPY reflects the Machimura comments as well as the accumulation of past USDJPY net longs, which are now being unwound as a result of cascading execution of stops, especially amid the execution of margin calls. Another factor preventing Japan from intervening is the emerging global opposition against currency interventions, as the US and Europe wage their campaigns in pressuring China to refrain from dollar buying interventions.

USDJPY eyes the 108.97 low, which is the double bottom in May 2006 and September 2005. While subsequent losses are seen stabilizing near 108.20, there are no major technical support levels until 106.15, which is the 61.8% retracement of the move from the 1995 low to the 1998 high. While we do not rule out upward corrective moves to 109.70 and 110.50 during the US session, it is important to note that the lows in the European sessions have never proven to be the lows of the day in the current year.

Sterling drops 2 cents to 2-week lows

Dubious fundamentals in sterling have caught up with GBPUSD as the high yielding pair is under threat. We have long pointed to weakening UK fundamentals as the reason to sterling’s continued losses against non-USD currencies. The decline in gold and oil as well as the extension of equity losses towards UK shores is expected to prolog the correction towards $2.0635. A blaze in East London --near the financial district—is also weighing on sterling.

We could see sharper declines in the currency in the event that Tuesday’s release of Oct CPI remains under 2.0%. Wednesday’s release of the Bank of England inflation report and Thursday’s release of the Oct retail sales (expected at 0.1% from 0.6%) will also be crucial in determining the prospects for the currency and central bank policy. Upside capped at $2.073. Key support seen at 2.0630, followed by 2.06