U.S. budget standoff no saviour for gold

Reuters

* U.S. government shutdown holds gold in narrow range

* Volatility to pick up as U.S. debt deadline looms

* Worst case scenario needed to substantially lift gold

By Jan Harvey and Frank Tang

LONDON/NEW YORK, Oct 9 (Reuters) - Investors looking for asurge in gold prices as the U.S. government shutdown rumbles onand the deadline for raising the debt ceiling approaches arelikely to be disappointed.

While the threat of a U.S. debt default on Oct. 17 offersgold bulls a ray of hope, it will take a worse scenario than isenvisaged to lift prices after they plunged by more than a fifththis year.

The precious metal is often seen as a safe store of valueagainst inflation or financial market stress, and hit recordhighs during a 2011 stand-off over the debt ceiling that led toa credit ratings downgrade of the world's largest economy.

But times have changed. The metal is on track for itsfirst annual fall since 2001 after heavy selling by investorsbanking on a withdrawal of the bullion-friendly U.S. monetarystimulus programme.

The wider markets are calmer too, offering attractivealternatives. The S&P 500 is up 17.5 percent, hitting recordhighs last month, while European shares are 9 percent higher andyields on safe-haven U.S. 10-year Treasuries are up by half,suggesting keener appetite for risk.

"I don't think the conditions are the same as they were whenwe had that first downgrade of the U.S. debt outlook by ratingagencies in 2011, which really helped drive gold very stronglyupwards," Credit Suisse analyst Tom Kendall said.

"That was really at the height of the euro zone crisis aswell, and we were a long way from anyone talking about thewithdrawal of stimulus. I don't think conditions are the same asthey were to recreate that move of June, July 2011."

STALEMATE

Gold has traded in its narrowest monthly range since Marchsince the U.S. government shut non-essential services on October1, after failing to reach a deal on federal spending measures.

Volume in U.S. Comex gold futures this month so far was lessthan 150,000 lots, versus an average of 210,000 contracts forthe first nine months this year. Daily turnover slipped to aone-month low at 96,000 on Monday, underlying a lack ofcommitment by institutional investors, traders said.

The precious metal has consistently failed to benefit fromprevious U.S. government shutdowns.

However if the stalemate, currently in its second week, goeson long enough to damage U.S. growth prospects, the Fed couldprolong monetary stimulus, potentially lifting gold.

The U.S. central bank's quantitative easing policy, unveiledin 2008, was a key driver of higher gold prices during thefinancial crisis. The programme kept up pressure on long-terminterest rates, cutting the cost of holding gold, while fuellingfears of burgeoning inflation down the line.

"The longer the shutdown goes on, the bigger the problems weare going to have in the economy," said Ed Moy, chief strategistof Morgan Gold, which offers retirement accounts that includeprecious metals coins and bars.

"The Fed will likely want to see what the impact of theshutdown is going to be before it tapers its stimulus," saidMoy, also a former head of the U.S. Mint.

NERVOUS

But few expect the shutdown to go that far. More importantlyfor gold, policymakers are even less likely to threaten a U.S.debt default, analysts say.

"Almost everybody thinks that it will be solved and therewill be no default, but still people are nervous," said BillO'Neill, partner of commodities investment firm LOGIC Advisorsin Upper Saddle River, New Jersey.

"There is a certain caution in people's mind, and that's whythere's no aggressive selling pressure...You're certainly notgoing to go short against it."

The U.S. Treasury has said it will hit the nation's $16.7trillion debt cap by Oct. 17. When it does so, because theTreasury won't be able to add to the national debt, bills willhave to be paid with incoming revenues and cash on hand.

In the event of a default, the government would have to cutspending overnight by about a third. If investors lost theircool, stock markets and other financial assets could tumble asthey bolt towards cash, while gold could potentially surge.

However, few are betting on such a scenario. If talks tolift the ceiling go down to the wire, gold prices are likely torise, but they would have to go seriously wrong to put much of adent in gold's overall losses for the year.

"I think investors assume that a rise in the debt ceilingwill be approved and that any stand-off will be temporary,"economist Caroline Bain of the Economist Intelligence Unit said."There could be some gold buying, but unless a U.S. defaultscenario really starts to seem probable, I don't see a wholesalemove into gold."

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