The Coin Analyst: Could Cyprus Be the Catalyst for Upward Momentum in Gold?

by Louis Golino for CoinWeek ………

Over the weekend we learned that the EU was giving the small country of Cyprus, with an economy smaller than that of any U.S. state, a bailout of 10 billion euros, or 13 billion dollars. Then we found out that based on an initial plan by European authorities that holders of bank accounts could lose up to 10% of their bank deposits to pay for the EU bank bailout through a bank deposit levy.

According to accounts on March 18 in Market Watch (www.marketwatch.com), those with under 100K euros would pay 3%, those with 100-500K in euros would pay 10%, and those with over half a million would pay 15%. The details were expected to be worked out later in the week, and banks in Cyprus will remain closed until Thursday to help prevent a bank run.

Cyprus is a kind of mini-Switzerland or Cayman Islands because it is a banking haven, and some of its largest depositors are foreigners, including large numbers of Russians and
reportedly, Russian organized crime members. Cyprus is also unusual because its banking sector is eight times the size of the economy, which is not the case in other European countries.

Germans and other well-off Europeans clearly did not want to bailout the Russian mafia, and other non-European depositors, which has a lot to do with the origins of the bank deposit levy.

Over the course of the day on March 18 most international markets seemed to largely take these developments in stride, and gold saw its first decent bounce in weeks, moving up about $15 for the day.

By the end of the day, the initial plans were beginning to change. The Euro Group issued a statement indicating that those with under 100,000 euros in bank accounts should be protected, though there is no guarantee of that happening, even though Cyprus actually has an FDIC-type guarantee on smaller deposits up to 100,000 euros.

Some people see the beginning of the end for the euro and even the European Union in these dramatic events, but we have learned over the last few years that it is wise not to count the Europeans out. To be sure, the EU economy remains mired in deep recession with very high unemployment levels. But the consensus over the last couple years is that the euro would disappear, and so far it is still worth 30% more than the dollar, which is a big part of why the EU economy is not doing well since the EU is an exporting economy.

UPDATE: On March 19, following strong pushback from Cypriot politicians and the public, and Russian government authorities, the Cypriot parliament rejected the bank levy plan.  That leaves the situation in limbo, as a bank ran may now be averted, but Cypriot banks could still collapse without funding from the EU.

For some the events in Cyprus could point to what may happen elsewhere in Europe, or even possibly here in the U.S. But each country has its own problems, and we will see whether Cyprus turns out to be some sort of banking or economic domino, portending more trouble down the line in other countries.

However the Cyprus bank crisis ends up playing out, these developments are forcing many people to think hard about how they protect their assets. Gold and other precious metals are obviously seen as safe havens of choice in such situations, and I would not be surprised to see physical gold premiums rising dramatically in Cyprus in the coming days and weeks, as they did in Greece during the worst moments of that crisis.

As I wrote recently, gold has been in the doldrums in 2013, which experts often see as bullish because when everyone is chasing an asset, it has usually peaked, or may even be approaching bubble status. But when sentiment is negative assets often move up.

The events in Cyprus have at least momentarily helped push gold up a little, and if we really do see something like bank runs, which I am not sure we will, there is little doubt the metal would continue advancing.

The Cypriots and the EU may be able to contain this crisis at least for a while, but the real danger is if something like this were to happen in a larger EU country like Italy that has serious economic problems, and a political class that seems largely unable or unwilling to face these problems, with the exception of outgoing Prime Minister Mario Monti, whose painful economic reforms were helping to get Italy on track.

The outlook for an EU-wide banking union to help support the euro currency also seems substantially diminished now.

In such an environment of ongoing banking crises coupled with long-term economic problems, the European Central Bank is likely to need to continue its version of quantitative easing. Mario Draghi, the Italian who heads the ECB, famously said he would do “whatever it takes” to defend the euro.

The European situation therefore does appear to provide good reasons for owning some gold.

At the same time, as I have argued many times, the world does not need to end for gold to go up in value, and of course if we really did find ourselves in a truly calamitous economic situation, things more practical than gold would probably be more in demand.

My point is that if the European and/or world economic environments deteriorate, investors are likely to seek haven in precious metals. But if instead we continue a slow but steady progression towards economic normalcy, as we appear to be in the U.S., precious metals will still be a useful asset class, as inflation rises due to improved economic activity.

Finally, for those who are more sophisticated investors than the average person, it is also useful to bear in mind that gold prices in currencies other than the U.S. dollar has done much better than gold in dollar terms, even this year. This is a point that Dennis Gartman, long-time commodities trader and author of the Gartman Letter, makes frequently.

Louis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, and a number of different coin web sites. His column for CoinWeek, “The Coin Analyst,” covers U.S. and world coins and precious metals. He collects U.S. and European coins and is a member of the ANA, PCGS, NGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.