Gold Prices test $1600, Euro Ministers "Concerned about Banking Crisis" as Economic Growth Stalls

Gold Prices dropped below $1600 per ounce for the second time in 24 hours on Tuesday morning – testing a level first hit on the way up back in July – before rebounding, while stocks and commodities rallied and government bond prices fell following news that EU ministers are contemplating a European bank recapitalization.

Gold Prices fell nearly 5% from peak to trough on Tuesday. Also on Tuesday, outflows from the world's largest Gold ETF – the SPDR Gold Trust (ticker GLD) – saw the gross tonnage of gold held to back its shares fall to its lowest level since July 14.

"Gold has not performed as well as might be expected in the last two weeks given the world's economic woes," says one bullion dealer in London.

"Yesterday's moves," adds a note from UBS, "highlight the difficulty of making sense of the gold market in the current shaky environment... volatile price action is clearly going to persist."

Silver Prices meantime dropped to $28.46 this morning – 9.4% down on this week's high.

European finance ministers – who met in Luxembourg earlier this week – are considering plans to recapitalize the continent's banking sector, the Financial Times reported on Tuesday.

"Everyone [at the meeting] said the big concern is that worrying developments on the financial markets will escalate into a banking crisis," said German finance minister Wolfgang Schaeuble.

Schaeuble denied there was any discussion at the meeting of proposals to increase the purchasing power of the European Financial Stability Facility – the Eurozone's €440 billion bailout fund – by using leverage.

"We have to restore confidence quickly," Antonio Borges, Europe director at the International Monetary Fund, said on Wednesday.

"Many investors have become far more risk averse than they were before...[the IMF is] offering to be co-operative and to work alongside [Eurozone governments]."

"Another drying up of liquidity...would be bearish for all commodities, including gold," says marc Ground, commodities strategist at Standard Bank.

"However, we believe that central banks are better prepared, and more willing, to avoid a repeat of 2008. As a result, the risk remains, but it is not as acute as it was in 2008."

Ratings agency Moody's announced Tuesday that it has downgraded Italian government debt by three notches – from Aa2 to A2 – citing "the sustained and non-cyclical erosion of confidence in the wholesale finance environment for Euro sovereigns."

Fellow rating agency Standard & Poor's last month downgraded Italy one notch from A+ to A. Both ratings agencies maintain a negative outlook for Italy's credit rating.

Moody's said yesterday it "expects fewer countries below Aaa to retain high ratings", adding that "all but the strongest Euro area sovereigns are likely to face sustained negative pressure".

Despite the downgrade, the benchmark yield on 10-Year Italian government bonds remained below 5.6% Wednesday morning – compared to a September high of 5.76%. Italian 10-Year bond yields breached 6% in August – prompting the European Central Bank that month to begin buying them on the open market, along with Spanish bonds.

Jean-Claude Trichet – who steps down as ECB president at the end of October – said yesterday that it is the responsibility of Eurozone governments, not of the ECB, to ensure financial stability. The ECB's Governing Council will meet tomorrow to decide interest rate policy – the last such meeting of Trichet's tenure. 

Eurozone GDP meantime grew at 0.2% in the second quarter of the year – down from 0.8% in Q1 – according to official data published Wednesday.

Here in London meantime, the Bank of England's Monetary Policy Committee will also announce its latest decisions on Thursday. 

The MPC – which has kept its interest rate at 0.5% since March 2009 – is reportedly under increased pressure to consider further quantitative easing measures, following this morning's downward revision of second quarter UK growth to 0.1%, half the rate previously reported.

Over in the US, the Federal Reserve will "continue to closely monitor economic developments and is prepared to take further action as appropriate," Fed chairman Ben Bernanke told Congress on Tuesday.

Bernanke said the Fed "now expects a somewhat slower pace of economic growth" than its economists previously forecast.

"Gold Prices will continue to be driven in large measure by the evolution of US real interest rates," said a note from Goldman Sachs yesterday.

"With our US economic outlook pointing for continued low levels of US real rates in 2012, we continue to recommend long trading positions in gold."

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