Gold Price Swoons $23.30 to $1,131.25 on Flight to U.S. Dollar

The gold price dove lower, dropping $23.30 to close at $1,131.25, as investors liquidated all investments tied to the price of gold against the backdrop of a strengthening U.S. dollar. Gold mining stocks were sold aggressively, evidenced by the 4% decline in the Market Vectors Gold Mining ETF (GDX) and the 2.7% decline in Canada’s S&P/TSX Global Gold Index. Both indices declined for the fourth straight day as the U.S. Dollar reached its highest level in over a month as measured by the Dollar Index (DXY). The largest gold producer in the world, Barrick Gold (ABX), declined 4.5% today and is now lower by 15.6% from its December 2 high print.

The rise in the dollar came as Fitch Ratings reduced Greece’s sovereign debt rating one notch to BBB+, the third-lowest investment grade, and moved its outlook on Greece to negative. This move by Fitch comes just one day after Standard & Poors placed the sovereign debt of Greece on watch for a potential downgrade - stemming from concern that the European nation may have difficulty repaying various debt commitments. Greek stocks and government bonds fell significantly on the news, with two-year note yields having their largest one day advance since August of 1998. As risks have risen in foreign markets, investors have sought the relative safety of U.S. government bonds and the world’s reserve currency, the U.S. dollar, leading to declines in the dollar-denominated gold price and virtually the entire commodities complex.

Adding further pressure to the price of gold were comments from the head of the Bank of Korea’s reserve-management department, Lee Eung Baek, who stated that “There’s an illusion in gold. We follow the big trend. Gold isn’t the trend. Out of more than 200 nations, how many countries have bought bullion?” He went on to say that “Like other central banks, we have been increasing the types of currencies consisting of the reserves outside the dollar,” and went on to say that gold “offers little value,” with “no cash returns.” Given that South Korea has the fifty-sixth largest holdings of gold reserves in the world at $270.9 billion as of November 2009, there was speculation that it may follow in the footsteps of India, Mauritius, and Sri Lanka by purchasing gold from the IMF and further diversifying its foreign exchange reserves. Commenting on this speculation, Mr. Baek stated that “Since India and Russia with large reserves bought gold, there’s speculation that Korea might buy it too. But we are not classified in the same category. There’s a slim chance that we will buy gold” from the IMF. He added that “The volatility on gold is too big. And once gold is purchased, it’s just kept in a safe and is not put up for sale even if prices rise.”

The sell-off in inflation beneficiaries was given extra fuel by the deflationary news out of Dubai related to their debt default of two weeks ago. Nakheel PJSC, the property developer owned by Dubai World, the investment arm of Dubai, reported a first-half loss of 13.4 billion dirhams ($3.65 billion), according to a document obtained by Bloomberg News. Nakheel owns numerous real estate properties in Dubai whose value has declined considerably. Concern is rising that the developer may default on its $3.52 billion bond and speculation is swirling as to how and when the United Arab Emirates will rescue this troubled state-owned enterprise.

Moody’s Investors Service, one of the three largest rating agencies along with Fitch and S&P, reduced the credit rating of DP World Ltd., the largest port operator in the Middle East and another Dubai World unit, to junk status. While much uncertainty remains regarding the ultimate consequences of the Dubai debt situation, market participants have chosen to shoot first and ask questions later - indicative by the flight to safety in the U.S. dollar and the liquidation of risk assets such as stocks and commodities.

Reflation beneficiaries, led by the gold price, were punished today with basic materials equities being the worst performing sector after the gold mining stocks. How violent the unwinding of the dollar carry trade becomes is being hotly debated as longer-term macro fundamentals clash with shorter-term trading adjustments.