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Liquidity Constrain will force Rate Cut & Expansion of ECB Balance Sheet – Gold will Dumped – April 22-26

April 22, 2013

Last week in  one  of my  post I had  pointed  out that  Bundesbank President Weidmann has rung the alarm bell with his statement that ECB is flexible, which means that it is now close to a rate cut, as poor economic data is not sustainable. NEXT MPS is due in May. In his talk he hinted that rate adjustment could be a possibility if required. But what was more stunning is that he admitted that Euro Zone Recovery May Take Decade, which is absolutely true because normally officials only paint the positive side of the story. Buba President is admitting that problem will stay for a very long period, dismissing views by politicians that the crisis is over.

Recent event in Cyprus, which is 0.2 pct of Euro region economy has yet shown evidence that European financial system is a suspect, as region’s banking system is in total mess. Current bank lending rates clearly indicates that there is a sever liquidity problem, as banks are not keen to get unnecessarily exposed. Bank’s Capital is still unresolved issue and European Bank require sizable amount of rescue funds. Last week there was a noise about a major bank failure in France, but somehow the matter did not get enough media attention for unknown reason. So better watch out for the news about more banks problem in the Euro-zone region.

High unemployment in Euro-zone is the worrying factor, which is comparatively far more than USA or any other developed nation. ECB is responsible for price stability in the 17-nation Euro-zone region that uses Euro and is required to keep inflation target under control, it’s responsibility also includes maintaining its financial system stable. Whereas, every country in the Euro-zones region has its own responsibility to stimulate economy to increase growth that may help in reducing alarmingly high unemployment rate. 

Hence, growth is the real challenge that ECB faces because region’s economy is constantly drifting towards recession and fear of deflation is on the rise. Austerity is one big factor that is causing decline in growth, employment and revenue collection. Policy makers demand for sever austerity measures by slashing spending to reduce deficit makes little or no sense because the timing is inappropriate and it is not the right recipe to correct the problem. 

However, it seems that the policy makers have realized their mistake, as G20 finance ministers in its meeting in Washington are no more willing to take harsh austerity measures to check the deficit imbalance. Probably realizing that US economy is gaining from FED’s monetary stimulus package and now Japan has made strong commitment to increase the size of balance sheet by doubling its asset purchase program.        

Therefore in my view, since inflation in Euro-zone is well below the target level of 2 pct, rate cut to reduce the cost of borrowing in near term and soon after, another round of liquidity injection by increasing the size of ECB balance sheet looks a good possibility. This may not be good development for Euro and with combination of improving US economy. Euro surge would provide another good opportunity to take profit and short Euro, which will ultimately take another deep dive. 

Meanwhile, focus after re-election of Italian President will should to shift towards economic happenings. We could see Euro making some gains this week, unless we here some more bad news from Europe.Its going to be a busy week in terms of data release. Market will be watching release of US existing home sales and home sales that will give a feel about housing market activity.  As the week progress US Durable Good data, US Unemployment Claim and US GDP data will provide further direction about the economy. Another batch of release of good US economic data could counter Euros strength. 



GOLD @ $ 1405 = Gold is surely on the declining trend and $ 1800-$1900 is history. After the Cyprus events that is has to offload gold from its reserves, it is now obvious that gold all holding nation loaded with debt will have to sell gold from their kitty to manage funding. Policy makers are not naive that they are not aware of the market reaction if they ask debt nation holding gold to generate funding through sale of gold. 

It is now becoming very common that banks and financial institution are forced to sell or offer gold as collateral to mange funding. Neither there is threat of currency collapse that will force Central Banks to rush for gold, which is dead asset and offers nothing in return. Based on global Central Bank gold holding of roughly 18 pct or nearly 31.000 tonnes of gold, if we calculate @ highs of over $ 1900 and now trading at $ 1400, on market to market basis, current book value of Central Bank holding has declined by almost USD 2.7 Trillion to roughly USD 7.65 Trillion from USD 10.35 Trillion.

Lot of people talk of gold as inflation hedge. Interestingly with fear of inflation creeping up and possibility of unwinding of FED’s asset purchase program, demand for US Dollar will rise and US currency will be costly so holding of gold as an asset would be expensive  proposition, instead quite a few Central Bank may be planning to reduce their gold holdings. 

It all leads to weak Central Banks demand for gold, where as physical demand is surely on the rise, but watch out, once the gap is filled, in the absence of Central Bank buying gold will once again be clobbered, as occasion bounce back will provide opportunity to push gold to new lows. 

This week gold may hold around $ 1385 levels and only break would risk for a test of $ 1365-70 zones. However, bias remains on the upside break of $ 1420 would see a push towards $ 1435-40 zones. But I do not see move beyond $ 1450-55 and see risk for sell off around $ 1435-40 zones.

EURO @ 1.3151 = I am expecting 1.2970 hold and a break of 1.3140-50 will pave way for 1.3210. However, any move towards 1.3250 should be good opportunity to sell Euro for another fall towards 1.30 zones. Range for the week 1.2940-1.3280.

GBP @ 1.5230 =  Support is around 1.5140, break would see fall extending towards 1.5070. On the up break of 1.5320 will encourage for a test of 1.5390. Range for the week 1.5050 1.5450.

JPY @ 99.45 = If 98.70 surrenders we could see a test of 98.20. There is a possibility that this week break of 99.98 would see a extention of rally towards 100.60 or possible move towards 101.50. Range for the week 98.20 – 101.80.

AUD 1.0275 = Australian currency will remain under pressure and should be capped around 1.0350-75. Break of 1.0210 would see fall extending towards 1.0158-80 levels. Range for the week 1.0150 – 1.0370

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