The Coin Analyst: The European Crisis Helps to Create a New Normal in Precious Metals
by Louis Golino for Coin Week
These are definitely interesting times for a precious metal analyst, or anyone trying to make sense of where precious metal prices are headed.
Gold and other precious metals are traditionally viewed as safe haven investments, and as assets that help to diversify a financial portfolio because they are inversely correlated with stocks. They normally move up when stocks are down, and vice-versa.
But the global financial situation is changing all that. During the past three years, for example, gold has often moved up on the same days that stocks closed higher.
In part, that has been a function of dollar strength or weakness. When the dollar is stronger against the euro, yen, and other currencies, investors choose the safety of the dollar in the form of U.S. Treasury bonds. This is what is known as “risk off” periods.
But when the dollar is down, investors have tended to buy more stocks and gold, seeking higher yields than what they can get on Treasury bonds, which is essentially nothing. This is what the experts call “risk on.”
These days all eyes are on Europe and its debt and banking crises that threaten the future of the euro, Europe’s economies, and the global economic and financial system.
Last year whenever Greeks were protesting against austerity measures, gold tended to increase in value, as investors sought the perceived safety of precious metals.
Better-off Greeks lined up to purchase gold coins at highly inflated premiums because they worried that their paper euros would become virtually worthless.
But things have changed, and now gold often declines on the very days when it used to go up. This is an example of what I think of as “the new normal” in precious metals.
Since gold’s major correction last month, it has tended to go down on days when stocks are also down. This is often correctly attributed to a liquidity crunch, as investors seek to cover their equity losses with gold profits.
It also has something to do with increased margin requirements. In fact, this week the Commodities Futures Trading Commission decided to move forward with rules which seek to limit commodity speculation by making it harder to hedge in the form of derivatives.
It is confusing to see gold decline on days when the European crisis seems further away from resolution. But in the “new normal” world this is perhaps best understood with the “risk on/risk off” paradigm.
Precious metals actually increase in value on days when the European seem to be getting their acts together perhaps because increased global financial stability provides the space for riskier assets to flourish, and because the euro strengthens on those days.
Whenever it looks like the sky is falling, investors seek dollar safety, but when the world seems like a relatively safer place, precious metals are seen as a better choice.
This may be partly because increased financial stability helps spur global growth, which will result in higher inflation, and precious metals are still seen as a hedge against inflation.
On October 18 news reports suggested that Europe’s leaders were moving towards an almost $3 trillion rescue fund for countries like Greece and Italy, which have unsustainable levels of debt. This helped gold reverse earlier losses.
The conventional wisdom among Europe watchers is that the crisis will end with a disorderly Greek default, Greece leaving the euro, and ultimately the demise of the euro and perhaps even of the European Union itself.
As someone who has studied Europe closely for decades, I would suggest not underestimating the determination of Europe’s leaders to solve this crisis.
Greece will almost surely eventually default in one form or another, but that is something that can be managed, if handled carefully. An Italian default is another story.
Patrick Heller, who writes for Numismatic News, predicted recently that the euro could fail in the next couple weeks. There have also been rumors that the European banking system faces imminent collapse.
I am highly doubtful that either of those events will take place any time soon, and perhaps at all.
To be sure, the Europeans have been slow to fully understand the dimensions of their crisis, and their policy responses over the past two years have tended to be insufficient to say the least. Germany, in particular, has been seen as dragging its feet.
But again, I would not count the Europeans out. The cost of failure is simply too high, and the major countries of the EU are still very wealthy and wish to remain so.
They will eventually do whatever it takes to defend the euro and their own economic future. The wildcard is whether they will do it in time, that is, before serious damage is done to the euro, the EU, and the world financial system.
The EU plans to hold a key summit this coming Sunday, October 23, when leaders may approve the massive EU rescue fund. If things go as planned, which is definitely not assured, I think that the euro will strengthen and precious metals and stocks could both experience major rallies next week. They also could all decline substantially if an agreement is not reached.
German officials are downplaying the chances of a grand bargain that resolves the crisis.
There are plenty of other clouds on the precious metals and EU horizons. For example, France may be about to lose its AAA credit rating because of its high debt and deficit ratios and the pressure that bailing out other European countries would place on its banking system.
In addition, many metal watchers seem to be virtually certain that U.S. economic weakness will result in another round of asset purchases by the Federal Reserve, “QE 3,” as it is termed.
But this week Fed Chairman Ben Bernanke said that its may be necessary to use monetary policy to deflate asset bubbles, so those counting on QE 3 may be disappointed.
It is not easy to reach agreement among 17 sovereign EU countries, and each of them has a domestic populace that helps shape policy.
In Germany, for example, public opinion is strongly against bailing out what it sees as its profligate southern neighbors.
But Germany will do whatever it takes because it simply has no choice. If it abandoned the euro, its economy would go into a tailspin because a new Deutschmark would be vastly stronger than the euro and that would be very harmful for German exports, which are the motor of the German economy.
Similarly, Greece can’t afford to leave the euro because it would result in high inflation and a collapse of the banking system and economy.
So don’t count the euro out just yet, and expect gold and other precious metals to continue to act in counter-intuitive ways.
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 Coin Week, “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.