Gold drops as economic optimism boosts dollar

Pre-produced parts of watches on display at a plant of gold refiner & bar manufacturer Argor-Heraeus in the Swiss town of Mendrisio, March 1, 2012

By Amanda Cooper

LONDON | Tue Mar 20, 2012 9:45am EDT

(Reuters) - Gold fell on Tuesday, hurt by strength in the dollar which profited from the growing view in the market that the U.S. economy is on a firmer footing, ending a three-day rally in the bullion price.
The dollar benefited from wariness in the market stemming from talks between Italy's government and unions on the reforms needed to turn around the euro zone's third largest economy, which kept the euro under pressure and dented equities.
Data from the United States in the last couple of weeks has suggested the economy is recovering more quickly than anticipated, lessening the need for the Federal Reserve to buy government bonds to anchor interest rates and support growth.
Adding to the negative mood in gold was a sharp rise in benchmark 10-year U.S. Treasury yields, which have gained more than a third of a percentage point in less than a week, while holdings of the metals in exchange-traded products staged their largest one-day drop since late January.
Spot gold was down 0.65 percent on the day at $1,649.69 an ounce by 1325 GMT, having slid by nearly 3 percent so far this month.
"At the moment, it's not looking great for gold. On the one hand you have the strengthening dollar against the euro hitting the market and you also don't have that much support from the physical market," RBS analyst Nikos Kavalis said.

"We are seeing fairly weak conditions for gold, you can see it in the price. At the same time, we are still standing by our bullish call for the market. We think prices can, and will, go higher later in the year, so I would say at current prices, we would definitely be buyers," he added.
Gold's correlation with Treasuries has reversed in the last week, meaning the bullion price is more likely to move in tandem with Treasury prices than against them.

YIELD APPEAL
A rise in yields increases the appeal of the U.S. dollar for foreign investors, which in turn delivers a double blow to gold, which tends to fall when the dollar strengthens as non-U.S. investors sell their bullion holdings to take greater profit on their position in their local currency and secondly increases the so-called "opportunity cost" of owning the metal.
When interest rates are low, investors forfeit less of a premium for holding gold, which bears no yield or dividend, rather than stocks or bonds. An environment of rising rates increases this opportunity cost.
Holdings of gold in the world's major ETPs saw their largest one-day outflow in two months on Tuesday, falling by over 56,000 ounces to 70.843 million ounces, reflecting some of the desire among investors to hold assets that profit strongly from an upswing in the business cycle, such as equities.
A strike by the jeweler industry in India, the world's largest gold consumer, in protest against a government plan to raise the import duty on bullion, has cut physical demand noticeably this week.
Anne-Laure Tremblay, an analyst at BNP Paribas, said while there were some headwinds for gold in the short-term, she was maintaining her price forecast for this year at $1,850.00/oz.

"Beyond the short term, we remain positive on gold's outlook as the fundamentals are still solid. These include high liquidity, low interest rates and sovereign debt concerns," she said.
In other precious metals, silver fell by 2.8 percent to $32.28 an ounce, while U.S. May silver futures were down 1.9 percent at $32.30.
Platinum fell 1.1 percent to $1,657.00 an ounce while palladium fell 1.0 percent to $695.00 an ounce.

(Reporting by Amanda Cooper; editing by Elaine Hardcastle)