Bullion Quarterly Q3, 2011

8/2/2019 Bullion Quarterly Q3, 2011

1/24

1

Synopsis

Friday, beginning of a new quarter is likely to be a crucial one for bullions. At the facet of

decelerate global economic growth, gold may possibly remain the safest bet among the

asset classes. Both Europe and USA economies are not out of the doldrums which could

come to the surface in the July to September quarter. If the Fed hints of infusing liquidity,

then precious metals will zoom or the vice versa. The Liquidity trap being the main

perpetrator, is apt to prop the yellow metal. However, silvers industrial demand part may

get a shock after global slump of manufacturing and industrial activities along with

descending investment demand. OurStatistical Analysisis also suggesting silver to take

a brief correction till $31 while gold may have a room to tick new high in the quarter

ahead.

In a nutshell, Gold to radiate at silvers dooms day

Strategy

Buying gold and selling silver would be the strategy to reap the benefit of likelyimproving ratio for the quarter ahead

Technical Recommendation

Q3, 2011: BULLION OUTLOOKKarvy comtrade Research Desk


2/24

BULLION QUARTERLY

Karvy Comtrade Ltd, Karvy Centre, 46, Avenue 4, Street 1, Banjara Hills, Hyderabad 500 034

Economic Backdrop

Last quarter the global economic conditions have perturbed investors sentiments. Some times there was a glimpse of

certain recovery while most of the time it remained under suspicion. From the United States to Europe, followed by

the Asia, most of the economies stumbled from higher inflation, food and commodities prices and a soaring crude

price. More specifically, after the Euro nations debt, it was the US which also came under microscope of debt burden.

Even, possibility to the US government shut down was raised concerning the debt ceiling to be breached.

Europes lingering debt crisis is still haunting investors mind. Starting with Portugal, who was sought to get 75

billion Euros bailout, it was Greece who became the first European country with largest debt burden. The Bank of

England said that the inflation remains uncomfortably high as the officials raised their forecasts for consumer prices

and cut their prediction for economic growth. Besides, S&P cut Greeces credit rating from B to BB-, renewing concern

that the regions debt crisis is escalating. Greece was set to sell 1.25 billion Euros in an auction of 182-day bills. A

further credit rating down gradation was likely to take place for Greece as the risk of default rises, would make the

country lowest rated country in Europe. The Greek government therefore endorsed an asset sale plan and 6 billion

Euros budget cuts to win the relief fund and arrest a market slide. However, ECB leaders and policy makers are

clashing over how to prevent the currencys regional debt with central bankers after floating the prospect of

extending maturities on Greek bonds. This implies the risk associated with bonds and sensitivity to interest rate will

change. However, after accepting the proposal, the EU might had withhold the next tranche of credit to Greece after a

report by an international panel of inspectors concluded that the debt laden country has missed all the fiscal targets

agreed in its rescue plan. However, Greek Prime minister promised he will press ahead with new austerity measures

even as he failed to win backing from opposition parties. Although Fitch ratings saw a chance for Greece to get theloan to avoid default, ECB opposed to extend Greek bond maturities while filling a hole of about $30 billion Euros

next year. ECB while keeping its interest rate unchanged at 1.25% has signaled a hike in July even as higher

borrowing cost may exacerbate the crisis thats threatening to push Greece towards a default. ECB has also showed

reluctance of rolling over its own Greek holdings while it has rejected any direct ECB participation in a second bailout

for Greece escalating a clash with government.

A restructuring of Greeces huge debt seemed to be off the table now, which was viewed as negative for the Euro as it

could prompt a flight away from Euro zone bonds and damage the EUs credibility. Spains regional and municipal

elections that have resulted in a blow to the countries ruling socialist party and could reveal the debt levels in thenation are above what was previously disclosed which boosted concern of debt. Fitch ratings lowered the outlook on

Belgiums credit rating to negative following S&Ps announcement that Italys debt rating was at risk of downgrade.


3/24

BULLION QUARTERLY


The Fed has kept the interest rate unchanged at the prior level to bolster the economic recovery and the $600 billion

asset purchase program will be ending on June. The Fed also said to continue a separate reinvestment about $17

billion a month in proceeds from its portfolio of mortgage securities to buy treasury debt. This should help keep rates

low on mortgages and other consumer loans housing sector continued to grow. The US treasuries have said Congress

must raise the $13.3 trillion debt ceiling to avoid a government default on loan. Hence monetary policy will be

remaining accommodative for at least the next couple of months. So, interest rate increment seems to be least

probable at present. On an attempt to raise the debt ceiling limit of the US, Obamas wish had been strongly opposed

by the republicans with out spending cut. Democrats favor spending cut or increase in tax over several years to lower

the deficit while republicans oppose the raising tax as not an option. Hence, Moodys investors service warned US

government to put US credit rating under review for downgrade if there is no progress on increasing the statutory

debt limit in coming days after manufacturing and consumer confidence cooled to point a slowing US recovery. US

jobless rate climbed to the highest level this year from 9 to 9.1% as payrolls increased by much less than projected,

added more evidence to a faltering economic recovery. Fed chairman also urged for another record monetary

stimulus to be needed to boost the growth momentum although reiterated that the increasing inflation is transitory.

As Fed is about to end its bond buying program, the US 10 year treasuries yield fell below 3% as the government

prepared to sell $13 billion worth of 30 years bonds on 9th June.

Aftermath of March temblor, Japan is still struggling. The industrial production dropped put a hindrance on

sustaining debt after S&P downgraded the nations outlook and hence BOJ kept their target rate intact. But after that

BOJ elevated their growth forecast betting on reconstruction work and have rejected monetary stimulus confirming

that the supply constraints are the main factors for depressing growth. Japans economy shrank more than expected

in the Q1 at an annualized rate of 3.5% while current account surplus plunged 69.5% and also logged a trade deficit

of 417.5 billion Yen in April as imports grew against a fall in exports due mainly to the impact of the worst

earthquake in March. But the Yen got appreciated as China purchases of Japans long term debt reached a record.

Peoples bank of China raised reserve requirements for the fifth time by 50 bps to a record 21 percent with effective

from May 18, 2011 this year to restrain prices, underscoring the risk that tightening measures will cause a slowdown

in growth momentum, impacted upon commodities prices.

Month of May was dominated by the minutes of the meeting of BOE and FOMC pared with Greece s debt crisis compel

the dollar to remain volatile. The FOMC meeting minutes on May18 showed no firm decisions rather told to need

more discussions was needed to normalize policy; however, the committees asset purchase program and the federal

fund target rate were warranted. It showed the current inflation is transitory and to unwind when commodity prices

increase abated. Fed officials are discussing strategy for how to remove stimulus, with majority favoring ending the


4/24

BULLION QUARTERLY


policy of reinvesting proceeds from maturing securities first before raising interest rate or selling assets. The minutes

of BOE said a majority of members concluded a rate hike wasn't warranted due to a lack of evidence that higher

inflation expectations were becoming ingrained in wage and price decisions and skepticism over the underlying

strength of the economy. Also, the central bank meant to up the size of its asset-purchase, or quantitative-easing

program from 200 billion pounds to 250 billion pounds.

Last but not the least, the Reserve Bank of India raised policy rates for the 10th times in 15 months, extending the

longest streak of monetary tightening in a decade. Further tightening of monetary policy was expected as core

inflation has hardened to 8.71 percent. So, there was need to have better price stability for sustaining growth in the

medium term. This rate hike will definitely be having some impact in term of postponing the investments. But if

inflation continues to remain at a high level, it will be having a dampening effect on growth in the medium term.

Precious Metals Price Movement

Bullions had a spectacular move in the last quarter and as what we mentioned in our Q2 report has been achieved.

Spot gold has clocked $1577.57 while the futures in the COMEX division have ticked $1577.70 on May 2, 2011. That

was the time when it was a scenario ofa new

day, a new highfor gold. The same has been

observed for the white metal also. Silver

futures neared $50 to tick its life high of

$49.845 on April 25th, 2011. Silver

overwhelmed gold in April followed by a shock

to shatter by more than 20% within a month.

Reasons behind this price uphill:

This price upsurge of bullions can be

attributed to the falling dollar index,

which in the month of April lost the

ground by 3.85% (from 75.86 to 72.93)

against the majors. But, after that dollar

index revived superbly by more than

2.50% (from 72.93 to 74.88) and put

precious metals under stress, due to

which both gold and silver slashed heavily

The asset purchase program worth $600

60

65

70

75

80

85

90

95

800

900

10001100

1200

1300

1400

1500

1600

Gold(LHS) Dollar Index(RHS)


5/24

BULLION QUARTERLY


billion will be ending on June which is nothing but an increase in money flow within the economy to spur the

inflation, which is a supportive factor for the metal as an alternative investment

Traders speculation over China would buy precious metals to diversify its three trillion foreign exchange

reserves, impacted upon the dollar and precious metals prices skyrocketed

The S&P credit agency sent shockwaves by downgrading the US medium and long term debt outlook from

stable to negative. This sent the dollar index lower and commodities prices made new highs

The staggering rise of silver price then wanedas the CME has raised initial margin for silver within a quick

succession from $16200 to

$21600 (with effective from

May 9, 2011). Speculators

were bound to unwind their

positions after this combative

decision has been announced;

silver got a big hit to start the

month of May. Billionaire

investor Paul Touradji sold all

of its shares (173000) in the

SPDR gold trust, valued at $24

million as per the filing to the

US Securities and Exchange

Commission led gold to retreat. However, the Central banks of Mexico, Russia and Thailand have increased their gold

reserves valued at $6 billion after the dollar plunged to its two years lowest.

Gold & Silver in Different Currencies

Strong gold and silver prices were seen sustaining their gains across key currencies. Normally, currency appreciation

leads the metals to retreat, i.e. Prices move inversely to currency appreciation. But, the past quarter has seen the rule

to be diverged. Although silver followed the stated hypothesis, gold did not. There are however economic reasons for

the rule to contradict. Since economic disruptions and a seeming weakness lead the manufacturing industries to stall,

metals related to it are also faltered, silver being one of them. Majorly, silver plunged in each currency as the CME

raised margin for speculators compelled them to liquidate their positions. Besides, the Greek dilemma remained

under concern which made the Euro to swing. Gold in such ambiguity remained a strong buy to keep protect

investors wealth, broke the conventional relationship.

10

15

2025

30

35

40

45

50

800

1000

1200

1400

1600

Gold(LHS) Silver(RHS)

CME

marginraised,

silver


6/24

BULLION QUARTERLY


It has been observed that year till date gold has been increasing in every currency. The dollar index depreciated by

more than 5 percent on the back of which gold lifted its price. But other currencies like, Euro, GBP, Canadian dollar,

Swedish Kroner and Frank which all have

appreciated against the benchmark, gold prices in

those currencies have actually improved. This

might be the impact of geo political turmoil from

Libya, rise in crude prices and inflation concern all

over the globe drove the prices. To keep wealth

protect from the attrition, safe haven buying came

to lead the prices up despite respective currencies

appreciated against the dollar.

Q2 FY11 however has seen the different thing. The Euro, GBP and Japanese Yen all have appreciated against the

dollar but gold in all those currencies have

gained modestly. Euro zone debt crisis may

be one of the reasons to take the Euro

denominated gold at higher side. While

Japans tsunami and earthquake stalled the

economic growth, people might have shifted

to safer side like gold.

However, Q2 was not fare for the white

metal. After a fabulous start with the month

of April, it slashed more than 20 percent in the month of May as the CME raised speculative margin within quick

succession. Besides, manufacturing industries all over the globe from US to Germany, Euro Zone, China, Japan

faltered, waning the industrial demand part of the metal, which is another major reason for silver to retreat. So, with

currencies appreciation and due to fundamental reasons silver fell drastically.

Exchange operator CME Group Inc. (CME) cut the amount of collateral required to trade gold futures in a move that

may invite greater speculation in gold. As of close of business on June 20, 2011, speculators in the benchmark gold

contract must put up an initial margin of $6,075 per contract, down from $6,751. To keep the contract overnight,

these traders must maintain $4,500 of the initial margin, down from $5,001. CME also lowered the initial and

maintenance margin requirements for hedgers and exchange members, to $4,500 from $5,001 previously. When

price movement becomes less volatile, margins typically go down because the risk of the position also decreases. This

is the case with the decrease in gold margin requirements yesterday, CME said. The lower margins therefore, are a

boon for gold speculators, who can buy or sell more contracts with less cash.

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

DollarIndex

EURUSD GBPUSD USDJPY USDCAD USDSEK USDCHF

YTD Currency YTD Gold YTD Silver

-20%

-15%

-10%

-5%

0%

5%

10%

DollarIndex

EURUSD GBPUSD USDJPY USDCAD USDSEK USDCHF

Q2 Currency Q2 Gold Q2 Silver

Speculative Marginraised: silver plunged


7/24

BULLION QUARTERLY


Investment DemandGoldSPDR Gold Trust, the worlds largest gold backed exchange traded funds is one of the major indicators of the metals

investment demand. Originally listed on the New York Stock Exchange in November of 2004, and traded on NYSE

Area since December 13, 2007, SPDR

Gold Shares has been one of the fastest

growing ETFs in the US. The holdings of

the ETFs in the trust show the

underlying demand for gold since this is

designed to track the price of gold. A

part of the secular Bull Run in gold

prices can be attributed to this strong

alternative investment demand. Growth

of the holdings remained on a

continuous uptrend at the facet of

inflation and global economic

slowdown. However, the recent run out of holdings can be the result of investors short slightness to breach the

record $1577 level. Even, billionaire investors like Paul Touradji sold all of its shares (173000) in the SPDR gold

trust, valued at $24 million as per the filing to the US Securities and Exchange Commission led gold to retreat most

recently. However, the Central banks of Mexico, Russia and Thailand have increased their gold reserves valued at $6

billion after the dollar plunged to its two years lowest.

SilverLike SPDR, I-share silver holding is the worlds largest ETF holder. Silvers dream run was also influenced by the

uprising holdings of the trust. However,

the recent margin hike led the silver price

to shatter along with the holdings. At

present, this fall in investment demand is

the concern of investment demand for

silver to get back its sheen.

-

200

400

600

800

1,000

1,200

1,400

200

400

600

800

1,000

1,200

1,400

1,600

Q1'05

Q2'05

Q3'05

Q4'05

Q1'06

Q2'06

Q3'06

Q4'06

Q1'07

Q2'07

Q3'07

Q4'07

Q1'08

Q2'08

Q3'08

Q4'08

Q1'09

Q2'09

Q3'09

Q4'09

Q1'10

Q2'10

Q3'10

Q4'10

Q1'11

Q2'11-TillD

ate

SPDR Holdings(RHS) Comex Gold Spot(LHS)

0

2000

4000

6000

8000

10000

12000

0

5

10

15

20

25

30

35

40

I-share holding (RHS) Comex Silver Spot(LHS)


8/24

BULLION QUARTERLY


Volatility

With uncertainties hovering all over the globe and inflation being at the forefront, the yellow metal appears to be the

protector of wealth. Gold once again has proved the mythology to be less volatile than the pother asset classes in

economic crunch. Volatility is normally used to quantify the risk of the financial instrument over a specified period.

Investors care about volatility because price volatility represents opportunities to buy assets cheaply and sell when

overpriced. It also means a greater chance of a shortfall when certain cash flows from selling a security are needed at

a specific future date.

Volatility does not measure the direction of price

changes, merely their dispersion. This is because when

calculating standard deviation (or variance), all

differences are squared, so that negative and positive

differences are combined into one quantity. Two

instruments with different volatilities may have the

same expected return, but the instrument with higher

volatility will have larger swings in values over a given

period of time. For example, a lower volatility stock may

have an expected (average) return of 7%, with annual

volatility of 5%. This would indicate returns from

approximately negative 3% to positive 17% most

of the time (19 times out of 20, or 95% via a two

standard deviation rule). A higher volatility stock,

with the same expected return of 7% but with

annual volatility of 20%, would indicate returns

from approximately negative 33% to positive

47% most of the time (19 times out of 20, or

95%).

Comparing the volatility with other asset classes

like the safest US 10 years treasuries and the

equities, gold stood second (after Dow Jones) while silver as usual remained the most volatile asset for the year.

These two extremities have resulted in to highest return in silver and a stable rising return in gold as compared to all

other asset classes. After a huge fall in May, silver still is remaining the leading asset with highest return with gold

standing at the next. The CRB index, a bellwether for commodities, has advanced by 4.51% while gold has given two

times and silver has given four times return year till date. Equities however has had a mixed performance with Asian

stock at a negative return, precious metals are the only one sector to have the hedge against inflation and positive pay

off amid global uncertainties.

0%

5%

10%

15%20%

25%

30%

35%

40%

45%

2011-YTD 2 Years 1 Year

-0.80 -0.30 0.20 0.70 1.20

MSCI World

MSCI Asiapacific

MSCI US

DJIA

SENSEX

CRB

US 10Yr Bond

Gold

Silver

1 Year 2 Years 2011-YTD


9/24

BULLION QUARTERLY


Correlation

There are various asset classes with whom gold share a strong correlation, may it be positive or negative. For

example, gold and bond is internally related since both of them track one common factor: inflation. This factor

indicates how an asset is related to

gold and to what extent. These

relationships may change over a

specified time period from a long

time period. For example, Gold and

crude were positively related till

Q1, 2011. The drastic change came

in the Q2. From a positive relation

more than 60% for the last three

years, it has changed to a negative

33%. With rise in inflation the

bond yield fell while gold gained

and there by the strong negative

correlation is being seen between gold and bond yields. US treasuries yield fell as the bond buying program by Fed

approaches to an end. So, gold in contrary gained as both the bond yields and dollar index lost the ground.

-1 -0.5 0 0.5 1

Silver

Dollar Index

US 10YR Bond

Crude Oil

CRB Index

DJIA

Q2, 2011 2011-YTD 3 Years 5 years


10/24

BULLION QUARTERLY


Economic Outlook

The quarter ahead is a very crucial one for bullions. As the QE2 is cease to exist after June 2011, concern raise

whether this would result in crashes in stock and commodity market? It is quite likely that Fed will introduce QE3 by

the end of 2011 if weakness in the US economy continues to persist. However, this might not happen due to current

political mismatch between the Congress and Republicans. Thus, additional QE measures as well as an

accommodating monetary policy would be one of the few options remaining to support the US economy in the

coming months. If we end up with a recession, which will depend upon the fiscal and monetary policy chosen, it can

certainly be said that- Monetary stimulus will be more damaging. It has caused a worldwide commodities and energy

bubble - which is single-handedly damaging the U.S. economy by making it more and more expensive for consumers

to fill up their tanks. It is also likely to have contributed to the growing job-market malaise and with good reason of

Economic theory which suggests that when capital is very cheap, businesses will use more capital at the expense of

labor, reducing the demand for workers. Thats what led the US to have unemployment level at 9.1%. Calls for

another round of public spending "stimulus" will become deafening. Expect the same emotional call for a third round

of Fed purchases of government bonds aimed at holding down interest rates - to be created after the current round

ends on June 30. With this third round of quantitative easing - known as "QE3" - there may be a short-term boost to

the economy. But the benefits will be very limited - and will be quickly overwhelmed by spiraling inflation as energy,

commodities and other goods rise in price.

When the Fed chairman Ben Bernanke tells that the Fed must be vigilant in preserving its hard won credibility for

maintaining price stability in repeated attempts, in really engross us to ask whether it is just a feint or Fed is really

happy to see its credibility ebb away. By saying that the current rising inflation is just transitory, it implies that theyare actually not able to tame it as because the economy itself is weakening and Fed is mum in case of raising interest

rate since it may hamper the economic activities. To make it simple, US are under Liquidity Trap, in which

monetary policy is incapable to stimulate the economy further. Even at the near zero interest rate, where the cost of

borrowing money is essentially free, fails to encourage more spending or investment.

If prices are falling with nominal rate of interest at near zero, the real rate (nominal rate inflation), would still be

positive. In other words, saving cash for no nominal return would still leave you spending power in future, because

prices will be lower.

If incomes are falling, then people will save now in order to have something to spend later. Similarly, businesses are

unlikely to invest in new stock or greater productive capacity if their potential customers are getting poorer.


11/24

BULLION QUARTERLY


Forecasting of Economic scenario with Precious Metals Outlook

In recent times we have seen that US government has announced different sets of boost-up packages to counter-

balance the economic slowdown faced by its economy. We have also seen the continuous fall of prices of goods and

services along with adjustments of different monetary and fiscal policy measures to boost up the domestic demand aswell as the confidence levels of the investors. But still GDP is not moving at the rate that was expected. Being close

followers of economic activities the basic question that strike us is what is the need of these boost up packages

and despite of all these activities why GDP is not moving to the desired level?

Well, to start up with, let us introduce investment saving (IS) and liquidity preference money supply(LM) to describe

this paradoxical situation, where it fails to explain the current global slowdown scenario, where despite of fall in

successive rate of interest (nominal), GDP fails to reach its desired level. From the traditional theory, the hypothesis

said that, a government's deficit spending ("fiscal policy") has an effect similar to that of a lower saving rate or

increased private fixed investment, increasing the amount of demand for goods at each individual interest rate. Anincreased deficit by the national government shifts the IS curve to the right. This raises the equilibrium interest rate

and national income. The equilibrium level of national income in the IS-LM diagram is referred to as aggregate

demand.

According to the theory of demand we all

know that when there is a fall in price,

demand is supposed to increase. But in

recent times, things have started moving in

opposite direction implying the fact that

despite fall in price, demand is also falling

(growth of demand is falling). Isnt it

striking? Have a look in to the US inflation

since 2008, the year of housing bubble. So,

a fall in price coupled with a near zero

interest rate of 0.25 percent from

December 2008 laid the way to have

Quantitative Easing.

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

2008 2009 2010 2011

Inflation

DeflationPricesFalling


12/24

BULLION QUARTERLY


Background

Where the economy breaks down

Depending on this, government is coming up with various stimulus packages (which shifts the IS curve from IS0 to IS1

to IS2) to keep r constant at r0 with continuous fall in inflation as well as nominal rate of interest (since r = i , with a

fall in to keep r constant, i is also falling, which implies peg r by decreasing i at the same rate of fall in ) as what

happening in US also.

According to IS-LM theory, with expansionary fiscal policy if r remains constant there should not be any crowding

out. So, GDP should have increased from Y0 to Y2. But actually what is happening right now is, GDP is not increasing

up to Y2. Somehow some leakages are taking place which resist GDP to increase up to the desired level. Thus the IS-

LM model fails to explain this crowding out theoretically.

To be more specific, Aggregate Demand Price Adjustment (AD-PA) or Aggregate Demand Inflation Adjustment

(AD - IA) is better to interpret such type of economic phenomenon.

Explanation

1. The AD curve is also referred as Aggregate Demand Inflation curve (ADI). AD denotes the relationshipbetween GDP and inflation instead of GDP and price

2. The price adjustment line is referred as the Inflation Adjustment line (IA). PA describes the behavior ofinflation rate in the economy.

r

LM0 (M0/P)

LM1 (M0/P1)

LM2 (M0/P2)

IS0 IS1IS2

r0

0 Y0 Y1 Y2 GDP

Figure 1

Vicious Cycleof Disinflation


13/24

BULLION QUARTERLY


The ADI curve

It is derived from two relationships

(A) A negative relationship between GDP (Y) and real interest rate (r). This is analogous to IS curve i.e.higher real interest rate leads to fall in investment demand, followed by fall in consumption demandand fall in net exports through an appreciation of domestic currency, all of which lead to fall in GDP

(Figure 3).

(B) A positive relationship between inflation () and real interest rate (r). It is based on the abse nce ofCentral Bank, which typically responds to increase in inflation by raising nominal interest rate and

vice-versa (Figure 2).

For a given expected rate of inflation policy makers can achieve a particular real rate by manipulating nominal rate.

Now when inflation increases Fed increases nominal interest rate (i t) at period t by enough to increase r t (real

interest rate at period t) which leads to lower spending which in turn leads to lower GDP, implying a negative

relationship between and GDP (Figure 4).

AD

r

r

GDP

GDP

Figure 2 Figure 3

Figure 4


14/24

BULLION QUARTERLY


PA line

It comes from Philips curve,

t= te+ (Yt Yt*) + t ; where,

= actual rate of inflation

= expected rate of inflation

= actual GDP

= potential GDP

= external shock, random in nature

( ) = output gap

It would be fixed in short run without external shock. Then, PA line is horizontal [for simplicity, otherwise

upward rising with ( ), > 0] with vertical intercept signifying the prevailing inflation rate in the

economy. PA may shift up or down depending on (Figure 5).

So, from the above figure it is clear that when Yt> Yt*, inflation increases and vice-versa.

Question arises, why do the repeated attempts of government to boost the economy by increasing government

spending or proving quantitative easing is not working?

Recall that downward slopping AD arises because of negative relationship between rt and GDP, and positive

relationship between rtand inflation. Also it= rt+ t, or rt = it- t.

This implies that the only way to get a positive relationship between rt and inflation is to move it in the same

direction as inflation by a larger magnitude than the change in inflation.

Figure 5

AD

/

t

PA/

PA

PA//

0 y*

Yt Y*

GDP

//


15/24

BULLION QUARTERLY


Because Yt < Y* firms will lower relative price to reduce inflation. Now, lower inflation will lead to a higher real

interest rate and will actually reduce investment (pessimism is another factor of lowering investment) and

thereby lowering GDP. This pushes Y further below Y* and sets off another series of negative shocks as firms

lower price again. In other words, economy gets trapped in a deflationary spiral that is very difficult to break

off.

Deflation Spiral or Recessionary

Trap or Liquidity Trap

t

1

it=0

Y1 Y0 Y*

PA

PA1

AD

GDP

Figure 6

As what is happening in US, given the i t

cannot be less than zero, the Fed has

been unable to lower it in response to a

fall in inflation rt = - t a

decrease in inflation would lead to an

increase in rt , which would lead to a

fall in GDP and vice-versa. Therefore,

once we have reached it = 0, we should

expect a positively slopped relation

between t and GDP, or the downward

slopping AD develops a kink at it = 0

which implies AD becomes upward

slopping (Figure 6). This is the

recessionary trap or deflationary spiral.

PA=PA

ADAD1

Y0 Y1 Y* GDP

AD2

PA

Figure 7

Policy prescription

(A) Slightly expansionary fiscal policy that moves

AD curve to AD1 and the economy output to Y1

(Figure7) will not be able to stop the deflationary

spiral. Any tax cut or spending has to raise the

output to or above Y* to break free of the

deflationary spiral.

So, this explanation suggests that inflation or

more precisely the promise of future inflation is

the medicine to cure the ill.

Higher inflation expectation will raise the actual

inflation rate in the economy and will help lower

real rate of interest when coupled with a fixed

nominal rate.


16/24

BULLION QUARTERLY


(B) When an economy is in liquidity trap, an increase in money supply fails to reduce the real rate of interest. If real

rate does not fall, consumption and investment cannot be stimulated and output will not rise.

Now, both consumption and investment depend on the expected real rate of interest, defined as the difference

between nominal rate of interest and expected rate of inflation. So, if you cannot get the expected rate of inflationdown by dropping nominal rate of interest, the only way is to raise expected inflation.

Precious Metals Price Forecasting

Gold-Crude Ratio

The main happening of the Q2 FY11 OPEC meeting and the failure of its members to reach an agreement on how to

deal with high oil prices which has posed the risk of destabilizing the economic recovery. Saudi Arabia, the groups

most powerful member, wanted to raise production, but others prior to the meeting signaled they didnt want to.

Saudi Arabia on one side saying that high prices are having an impact, and should be lowered to support the global

economy. On the other side, Iran believes the world is slowing down anyway, and increasing output may lower prices,

damaging its ability to fund domestic projects. The summer driving session which has already started, is expected to

demand more oil but the current economic situation is not supporting it. Unemployment remaining at 9% with the US

government facing the challenge to hit the debt ceiling, faltering global industrial and manufacturing sector is

therefore likely to demand lesser oil. Hence, this summer seems to be tuff for the US as well as for crude.

As we have already discussed the probable economic scenario, Gold may remain strong for the Q3. The summer

months although historically tend to be a weak period due to seasonal slowing demand and this year we have the

added spice of QE2 finishing at the end of June. These factors could have an impact on investor behavior but whether

this contradicts the seasonal factors after the May correction is to be seen. The overall factors like strong central bank

and investor demand, negative U.S. real yields and general uncertainties continues to put a floor under the market.

Historically theSeasonality Index for goldhas shown a traditionally quite summer and maximum relative strength

late in the calendar year. This is an average that can be

used to compare an actual observation relative to what it

would be if there was no seasonal variation. Traditionally

gold tends to trade weaker during the summer as demand

that had picked up during the Asian wedding season dries

up and much of the population turns its attention to their

holidays. This year however, things are a lot less

traditional and more uncertain. QE2 is to conclude at the

end of June, but it has been well telegraphed by the market.

90

92

94

9698

100

102

104

106

108

450

460

470

480

490

500

510

520

530

540

550

560

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Q3 Avg. Price Q3 SI Q2 SI


17/24

BULLION QUARTERLY


Of bigger concern is the Aug. 2 deadline, when, if a solution is not reached about how best to raise its constitutionally

mandated debt ceiling, the US will be unable to pay its bills in full.

The Gold-Crude ratio as shown below has remained in a downtrend from Jan, 2011 till April imply ing crudes

worthiness relative to gold. Q1 Fy11 has seen a strong positive correlation between gold and crude while therelationship has been disturbed in Q2. Since the Libyan issues took a back seat, oil retreated 12.50% in a single

quarter while gold gained 8.26% in the

same period leading the ratio to improve

from 13.23 to 16.52. Hence the divergence

in prices can be seen in the graph shown

below. Quarter ahead, as we have discussed

already, it can be expected that the

divergence to widen more and the ratio to

improve. We may expect the ratio to hit 18

with crude hovering around $90; gold is

therefore to touch $1620.

Gold-Silver Ratio

While both precious metals are typified as safe havens and hedges against inflation, silver accounts for a much larger

share of industrial demand than gold. Consequently, it will tend to out-perform gold as the global economic recovery

takes hold and under-perform once the economy slows. Thus, it can be a great proxy for 'risk', as a lower gold/silver

ratio promotes risk taking and a higher ratio suggests risk aversion. This is predominantly explained by silver's

typically lower margin requirement and greater volatility in the futures markets.

Interestingly, at the end of April the ratio made a fresh 28-year low around 31 and then saw a sharp rebound higher,

briefly touching 45. We expect Gold to out perform silver in this quarter and hence the ratio to improve.

12

12.5

13

13.5

14

14.5

15

15.5

16

16.5

17

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11

Gold/Crude Ratio


18/24

BULLION QUARTERLY


Statistical Estimation of Gold Price Forecast

Methodology:

Since gold share strong correlation with silver, crude oil, dollar, equities and bonds, here we have taken 1626

observations for each variable and have regressed those on gold. The Least Square Regression technique has been

used to find the golds projected price for the next quarter.

Regression Equation:

The regression equation thus came out considering gold as dependent variable and silver, crude oil, dollar index, Dow

Jones and US 10 year bond yield as independent variables, is as follows:

(Gold)P= 1369.66 + 29.74*(Silver)P + 0.868*(Crude Oil)P 3.727*Dollar Index- 0.021*DJIA - 127.402*US Bond

This equation indicates that gold price is positively correlated with silver and crude oil while negatively correlated

with the dollar index, DJIA and bond yields. This result can also be traced out from the Correlation Matrix given

below:

Correlation Matrix Gold Silver Crude Dollar DJIA US Bond

Gold 1.00

Silver 0.89 1.00

Crude 0.50 0.58 1.00

Dollar -0.60 -0.60 -0.76 1.00

DJIA -0.04 0.24 0.47 -0.34 1.00

US Bond -0.71 -0.46 -0.11 0.35 0.51 1.00

Data incorporated from Jan, 2005- YTD

Summary Output:

Measurement of Goodness of Fit:

Given below is the regression statistics table. Of greatest interest is the R-squarevalue. Being a multivariate model,

the Multiple Rwhich gives 95.65% of correlation between actual gold price and estimated gold price, is a good sign

of the models fit. When it is squared, gives the R square value of 0.9149,

meaning that 91.49% of the variation of estimated gold price around its mean

price is explained by the repressors (independent variables). More specifically,

the Adjusted R squarewhich is used in a multivariate model, also has given

more than 91% explanation of price variation.Overall, it can be concluded that the model estimates are highly significant in explaining more than 91% of the

metals price variation.

Regression Statistics

Multiple R 0.956519

R Square 0.914928

Adjusted R Square 0.914665

Standard Error 88.75617

Observations 1625


19/24

BULLION QUARTERLY


Interpretation of Regression Coefficient Table

The regression output of most interest is the following table of coefficients and associated output. Let j denote the

population coefficient of the jth regressor (intercept, silver, crude, dollar index, DJIA, US bond). Then,

Column "Coefficient" gives the least squares estimates of j.

Column "Standard error" gives the standard errors (i.e. the estimated standard deviation) of the least squares

estimates bj of j

Column "t Stat" gives the computed t-statistic for H0: j = 0 against H1: j 0

Column "P-value" gives the p-value for test of H0: j = 0 against H1: j 0. This equals the Pr{|t| > t-Stat}where t is a

t-distributed random variable with n-k degrees of freedom and t-Stat is the computed value of the t-statistic given in

the previous column. Note that, this p-value is for a two-sided test. For a one-sided test divide this p-value by 2 (also

checking the sign of the t-Stat).

Columns "Lower 95%" and "Upper 95%" values define a 95% confidence interval for j

Testing of Zero Slope Coefficient

The coefficient of silver has estimated standard error of 0.4748, t-statistic of 62.64 and p-value of 2.5E-70. It is

therefore statistically significant at 95% significance level as p < 0.05. The same can be observed in all other

independent variables. Hence, we can say that the model is statistically significant.

Regression Coefficients Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 1369.66 73.5277 18.62781 2.53E-70 1225.441 1513.879

Silver 29.74701 0.4748 62.64946 0 28.816 30.678Crude 0.868769 0.1830 4.746167 0.005695 0.510 1.228

Dollar -3.72712 0.7816 -4.76855 0.005105 -5.260 -2.194

DJIA -0.02117 0.0025 -8.44694 6.56E-17 -0.026 -0.016

US Bond -127.402 5.5911 -22.7865 6.5E-100 -138.368 -116.435


20/24

BULLION QUARTERLY


Overall significance of the Model Fit: Analysis of Variance (ANOVA)

The ANOVA table splits the total sum of square in to two parts: Residual (or error) sum of square and Regression (or

explained) sum of square. The following table gives the estimate of the models overall fit. The column l abeled F

gives the overall F-test.

To test the null hypothesis H0: all of the regression coefficients are equal to zero

Against, alternative hypothesis H1: at least one of the regression coefficients is not equal to zero

The F value is the ratio of the mean regression sum of squares divided by the mean residual sum of squares. Its value

will range from zero to an arbitrarily large number. The column labeled significant F has the associated probability

that the null hypothesis for the full model is true. For example, if Prob(F) has a value of 0.010 then there is 1 chance in

100 that all of the regression

parameters are zero. This low a value

would imply that at least some of the

regression parameters are nonzero

and that the regression equation does

have some validity in fitting the data. Since, in our model the value is less than 0.01 we reject the null hypothesis at

99% level of significance. Alternatively, we accept the alternative hypothesis and therefore can conclude that the

regression equation does have validity in fitting the data, i.e. the independent variables are not purely random

with respect to the dependent variable.

ANOVA Table df SS MS F Significance F

Regression 5 137165215.4 27433043 3482.386 0

Residual 1619 12753927.72 7877.658

Total 1624 149919143.1

Summary: The above model projects

gold prices are as follows:

JULY: $1578

AUG: $1596

SEP: $1602/60


21/24

BULLION QUARTERLY


Statistical Estimation of Silver Price Forecast

The same data period has been considered for silver price forecasting. Methodology being the same as gold, the result

obtained is as follows:

Multiple R standing at 93.75% shows a good fit of the model while the independent variables are able to define

87.90% of price variation is silver as given by the Adjusted R

square. Overall, it can be concluded that the model estimates are

highly significant in explaining more than 87% of the metals

price variation.

The Regression Coefficients are also supporting the models

trueness. The t statistic is a measure of the likelihood that the actual value of the parameter is not zero. The larger

the absolute value of t, the less likely that the actual value of the parameter could be zero. The computed probability

of t-statistic being very low satisfies the less likelihood of the parameter could be zero. P-values for all the

independent variables except crude oil are far below 0.05. Hence they are statistically significant. We can concludethat Crude oil being statistically insignificant is not efficientenough to explain silvers price variation.

Regression Coefficients Coefficients Standard Error t Stat P-value Lower 95% Upper 95%

Intercept -29.9341 2.16915329 -13.7999 4.86E-41 -34.1888 -25.6795

Gold 0.023821 0.000379881 62.70785 0 0.023076 0.024567

Crude 0.009839 0.005209513 1.888699 0.059111 -0.00038 0.020057

Dollar 0.090421 0.022161792 4.080042 0.032292 0.046952 0.13389

DJIA 0.00112 6.69284E-05 16.73844 3.94E-58 0.000989 0.001252

US Bond 1.122982 0.179675185 6.250069 0.000244 0.770562 1.475402

As already discussed, the probability

of F-test is less than 0.05 even less

than 0.01 and hence the model is

having a overall good fit and therefore

can conclude that the regression

equation does have validity in fitting the data, i.e. the independent variables are not purely random with

respect to the dependent variable.

The Regression equation thus obtained is:

(Silver)P= -29.39 + 0.023*(Gold)P + 0.0098*(Crude Oil)P+ 0.09*Dollar Index+ 0.00112*DJIA+ 1.122*US Bond

While substituting values for the variables, the above equation thus gives the silver price to be $30.785 for the

next quarter.

Regression Statistics

Multiple R 0.937569

R Square 0.879035

Adjusted R Square 0.878662

Standard Error 2.511933

Observations 1626

ANOVA Table df SS MS F Significance F

Regression 5 74281.05458 14856.21 2354.464 0

Residual 1620 10221.88673 6.309807

Total 1625 84502.94131


22/24

BULLION QUARTERLY


Technical Analysis

Gold

Source: Bloomberg and KCTL Research

Recent wave: Minute b of Minor wave 4 of intermediate wave (5) of primary wave 5.

KCTL Outlook in gold for this quarter is on positive note as intermediate wave 5 of primary 5 is in action. We are

presuming that the minute c is in progress which may take gold prices initially down till 1470 (23.6% retracement of

the range $1154-1576). But, if market breaches the said support level then it is likely to taste next support level of

1430 (38.2% retracement of the given range and also swing high of minor wave 1). So a correction in the gold prices

is possible in the starting of this quarter. However, the impulsion is positive and therefore we expect that the said

correction may not last long and gold prices may remain bullish for the coming quarter. After minor wave 4, minor

wave 5 might come into action which may drive gold prices higher till $1577 and $1620.

As per the above Elliot wave count we expect gold prices may remain in the band of $1430-1620. Initially prices

may come down till 1470-1450 levels and then it may bounce back till $1577 to $1630.


23/24

BULLION QUARTERLY


Silver

Source: Bloomberg and KCTL Research

We are at a juncture which is finding us hard to say primary wave 5 is over and also presuming the bullish trend of

silver is yet to make its end. Therefore, we from KCTL research is making the wave count on Silver and believe small

wave degrees are to be closely inspected. The chart stated in this report is shown from the resumption point of

primary wave 5. Emphatically, four intermediate waves (1), (2), (3) and (4) of primary wave 5 have already been

discussed. This would have been also easy to complete intermediate wave (5) or primary wave 5. However, if we go

with the views of ending primary wave 5 then we may have to turn completely bearish for the coming one quarter

or one year. Hence, this deviousness has to scrutinize properly and we are waiting for the market to react and let it

decide the trend by its own. Nevertheless, it is very important to discuss the crucial levels. Going by the wave count

we believe market should not breach intermediate (4) of primary wave 5. In this regard the major support should

be seen at $30.00 (weekly close). Until then readjusting the count is not viable. However, if market clears $30.00

levels perhaps the correction could extend until $26.00 (ending of minute i).

The above analysis tells us the coming quarter should respect the crucial support of $30.00 and $26.00. Now, if

silver sustains above the said support levels then it is inevitable that market should rebound which should push this

commodity to move on the higher side till $40.00 by the end of coming quarter. Only on break of $40.00 the next

resistance should be extended till $45.00. The technical chart also pattern suggests market to hover within $26.00

to $45 for the coming quarter.


24/24

BULLION QUARTERLY

Karvy Comtrade Ltd Karvy Centre 46 Avenue 4 Street 1 Banjara Hills Hyderabad 500 034

TECHNICAL RECOMMENDATIONS

U.S Spot Gold SELL at 1510-20 TP 1470/1450 SL 1560 ( Present scenario)

BUY at 1450-30 TP 1577 then 1630 SL 1390 ( Quarterly recommendation)

MCX GoldSELL at 22250-22350 TARGET: 20900, 20600 SL above 2300

BUY at 20500-20750 TARGET: 22800 23200 SL below 19900

U.S Spot Silver BUY at $31-33 TP 40 then $44 SL below 26.00

MCX Silver SELL at 54000/54500 TARGET: 50000, 48000,47000 SL above 57000 (Present scenario)

BUY at 47000/48000 TARGET: 52000, 57000, 65000 SL below 44000(Quarterly recommendation)

Prepared By:

Aurobinda Prasad - Head of Research [email protected]

Subhrasom De - Fundamental [email protected]

Nikky Joshi - Technical [email protected]

To unsubscribe please mail us [email protected]

Disclaimer

The report contains the opinions of the author that are not to be construed as investment advice. The author, directors andother employees of Karvy, and its affiliates, cannot be held responsible for the accuracy of the information presentedherein or for the results of the positions taken based on the opinions expressed above. The above-mentioned opinions arebased on the information which is believed to be accurate and no assurance can be given for the accuracy of thisinformation. There is risk of loss in trading in derivatives. The author, directors and other employees of Karvy and itsaffiliates cannot be held responsible for any losses in trading.

Commodity derivatives trading involve substantial risk. The valuation of the underlying may fluctuate, and as a result,clients may lose their entire original investment. In no event should the content of this research report be construed as anexpress or an implied promise, guarantee or implication by, or from, Karvy Comtrade that you will profit or that losses can,

or will be, limited in any manner whatsoever. Past results are no indication of future performance. The informationprovided in this report is intended solely for informative purposes and is obtained from sources believed to be reliable.Information is in no way guaranteed. No guarantee of any kind is implied or possible where projections of futureconditions are attempted.

We do not offer any sort of portfolio advisory, portfolio management, or investment advisory services. The reports are onlyfor information purposes and not to be construed as investment advice.

For a detailed disclaimer please go to following URLs:

http://www.karvycomtrade.com/disclaimer.asp
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.karvycomtrade.com/disclaimer.asphttp://www.karvycomtrade.com/disclaimer.aspmailto:[email protected]:[email protected]:[email protected]:[email protected]

Documents

Bullion Quarterly Q3, 2011