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Gold and Dollar Pop on Euro Debt Crisis
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By EconMatters
A year after Greece received a €110 billion ($158 billion) bailout package from the European Union (EU) and IMF, the resurgence of the European debt crisis serves to illustrate that you can not cure debt with more debt.
Greek debt is on its way to reach 157.7% of GDP this year, and will climb to 166.1% in 2012, according to the forecast by the European Commission (Fig. 1). The country also suffered a fresh sovereign debt downgrade from BB+ to B+ on Friday, May 20 by Fitch Rating, citing significant challenge to secure solvency of the state and sustained economic recovery.
U.S. - Looking Good By Comparison
Across the Atlantic Ocean, the U.S. has its own debt problems as well. The U.S. government hit the debt ceiling of $14.294 trillion on May 16. In the worst case scenario, if the lawmakers do not get it together by Aug. 2, the United States will no longer be able to pay its bills in full. But the general expectation is that the current Congress, most likely, would not try to make history this time around.
Furthermore, since the U.S. is ahead of Europe in this Great Recession cycle, U.S. economy is also further into the recovery phase. There are signs of increasing consumer spending, which fuels about 60-70% of the U.S. GDP. For instance, in the first quarter of 2011, American Express, MasterCard and Visa all reported increases in card spending as credit condition gradually loosens, and consumers start filling out credit cards application again in a slowly healing economy.
Most importantly, there’s a major difference between the U.S. debt situation and that of the Europe—the borrowing costs remain reasonable for the U.S. (Fig. 2) and there’s not an insolvency issue.
Risk Off - King Dollar & Gold
Comparing the U.S. with Europe, coupled with some bearish economic data indicating a coming global economic slowdown including the ever unrelenting China, investors are now piling on risk off trades—selling off equities and commodities and going into the traditional safe havens--U.S. dollar/Treasury and gold.
The euro depreciated to less than $1.40 for the first time since mid March on Monday, May 23, while gold, which typically has an inverse relationship with the Dollar, has now flipped into inverse with the Euro (Fig. 3).
Chapter 1 – Greece
The European debt crisis is set to be the topic du jour in the G8 meeting on May 26-27 in France, and Greece is just chapter 1 of the European debt saga.
Greek austerity measures have been met with intense domestic social and political resistance. But without a system wide total overhaul and reform, steep budget and spending cuts have failed to restore market confidence. The implied cost of borrowing on ten-year Greek bonds surged to 16.75%, a new euro record, more than twice the rate at the time of the bailout a year ago, while the country’s two-year bond yield is around 25%!
High debt along is not as bad if there’s enough growth and reasonable bond rate to repay and refinance debts. In the case of Greece, it is highly improbable that it could generate enough growth to afford the sky high premiums investors are asking to keep its debt afloat (Fig. 1).
Default, Haircut, Bailout or Exit?
Already 85% of international investors recently surveyed by Bloomberg said Greece will probably default, with smaller majorities predicting Portugal and Ireland will do the same.
Most economists believe Greece won’t be able to repay its €350 billion debt, so Greece is either going to default or need a new bailout. Many experts estimate a ‘haircut’, i.e., reducing the debt principal, of at least 50%, is required to get Greece debt under control.
Another drastic option is for Greece to exit Euro so it could devalue its currency to afford these debts. But that would involve a messy debt conversion process, and most likely a majority of the debt may still need to be paid back in euro.
High Exposure - ECB & European Banks
Further complicating the matter is that because of the bond-buying program put in place last year, the European Central Bank (ECB) is in effect the biggest holder of the Greek debt. According to LaRouchePAC (emphasis ours):
“Of the €330 billion of Greek debt, 11% of which is now held by European governments (through the EU110 billion bailout package) and the IMF, another 20% is held by the ECB through direct purchases. Greek banks themselves hold EU91 billion, which used this debt as collateral for liquidity from the ECB. Thus the ECB in reality holds a "notional" €200 billion lent to Greek banks. The ECB holds similar amounts of Portuguese, Irish, and Spanish debt. Thus the biggest loser in a 50% haircut on the debt will be …the ECB.”
Banks in France, Germany and UK have the largest exposure to Greek debt (Fig. 4). Goldman Sachs estimated that a 60% haircut would wipe out as much as 80% of Tier 1 capital at Greek banks. In order to avoid contagion, these banks would need “pre-emptive” capital injections.
So needless to say, a default or a big enough ‘haircut’ could eventually result in the insolvency of Greek banks as well as the ECB, while causing some potentially serious damage to the entire European banking system.
Chapter 2 - Ireland, Portugal, Spain & Italy?
Since Greece is the first of the three Euro Zone countries accepting the IMF-Europe rescue, given the similar debt and GDP projections (Fig. 1), future crisis could be expected to erupt in Ireland and Portugal, which followed Greece into the bailout fold, as well. In addition, Spain is another promising high debt candidate in line for a bailout, and Standard & Poor’s just cut the rating outlook for another PIIGS country--Italy--to negative on May 21.
Clashing Views in Europe
So far, there’s a wide divide within the European Union and the ECB on the Greek debt issue. European finance ministers, admitting rescue has failed, for the first time signaled “reprofiling” Greek bond maturities could be in the cards, i.e., extending Greece’s debt-repayment schedule without changing the principal and the interest rates.
However, ECB officials, clashing with European political leaders, have ruled out a Greek debt restructuring citing high risk of broad contagion.
Euro Chaos + End of QE2 = Dollar Gain
For now, the markets seem to be pricing in an eventual orderly resolution of the Greek debt crisis. As long as a unified and clear solution remains elusive to the Euro Zone, euro would continue to weaken against the dollar, while gold would prosper on fear and uncertainty.
With chaos in the Euro Zone, and as inflation trade comes off with the end of QE2, from a technical perspective, euro most likely would test 1.375 in June, 1.35 in two month, and 1.30 in the next four months, with strong support at 1.35 levels (See Chart).
Gold - Caught Between End of QE2 & Euro Chaos
Gold, on the other hand, will be facing conflicting market forces as the end of QE2 in June is deflationary for gold (Goldman Sachs' new found risk-on commodity bull notwithstanding), while the European debt crisis buoys gold buying. I'd expect markets would figure out gold's direction in the next four months or so.
From a technical point-of-view (See Chart), gold is in an upward momentum at the moment, and the next resistance should be at $1,550 with major resistance at $1,600, which would be a good point to short the yellow metal.
However, overall, I think gold would resume the historical inverse relationship with the dollar, barring any end-of-world-like events such as a war or multiple sovereign defaults. On that thesis, look for gold to test the downside of $1,500 in June/July with major support at $1,400. And the time to get out of gold would be when major central banks like the U.S. Federal Reserve and the ECB all start to raise interest rates.
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There are signs of increasing consumer spending, which fuels about 60-70% of the U.S. GDP
Hey Keynesian, this is ZeroHedge not Yahoo Finance. Consumer spending does not equal economic growth.
Shouldn't have used the word "pop" in relation to gold. I meant when gold prices climb.
sry
Once again, because I went on too long.
I think we can all agree that this will end poorly for the public. No matter what you do, make sure you are on the opposite side of the trade from them.
Technical analysis will fail you during these times if you allow it to supercede logic.
Abandon logic and miss the trade of a lifetime.
I don't believe in fundamental analysis with this much liquidity flooding the markets, and with derivatives dwarfing the underlying markets.
I don't believe in technical analysis in manipulated markets, except to measure the manipulation.
Everything is being manipulated, but nothing more so than gold. This is End Game, where multiple cascading defaults change all the rules. There is too much debt to keep things afloat, and the default insurance just ties all the life boats together.
Therefore, despite being an interesting article, I respectfully disagree.
Gold has shown incredibly strong price action since May 2 in the face of an historic assault on the markets. After decades of selling, central banks are quietly amassing gold, and the rules regarding gold, like it being proposed for acceptance as good collateral by the EU, lays the ground work for a gold standard. I don't agree with all the traditional arguments against a gold standard being impractical, because we have computers and paper currency could easily be backed by gold. End Game is the gold standard. It's coming, and nothing is going to stop it. All historic analysis, both fundamental or technical is useless in predicting the details of this Black Swan event. History tells us it is coming, but it doesn't tell us how.
Two ideas:
1. They keep blowing the bubble in silver and popping it because they want to wear you out and condition your mind not to act when their slow acquisiton of gold turns into panicked buying. When gold pops, people will be so frazzled by silver raids, that they will do the wrong thing. If gold pops, don't do what the public does. The media will SCREAM it is a bubble. When in your experience has the media been adverse to a bubble? That's how you know it's time.
2. The G-20 met in mid April in Wash. D.C. The went home and exactly 2 weeks later, the assault on the silver market began. An 18 month trend in the Dollar/Euro reversed and margin calls just happen to coincide (wink). Even central bankers need a face to face to do historic things. In the coming soverign default crisis, look for them to meet. The will fly home, meet with the politicians in their countries, and meet with their counterparts in banking. When all arms of the conspiracy report back with a green light, they will wait some more for the time to be right (guaranteed it will be a Friday). Three, Two, One, cue media complicity. "Fed Saves World Economy with Gold Standard." They won't mention the Fed created the problem in the first place. With silver, it took about two weeks after the G-2 to execute the plan.
One final thought. If I read another article mentioning gold highs in today's dollars vs previous historic highs, I am going to choke. The nation states and banks of the world were not bankrupt back then, and they weren't swimming in a Sargasso Sea of debt obligations so complex they can't be sorted out and so large they dwarf the world economy.
This is End Game, the biggest opportunity in your trading life. Don't look to history for where gold prices will go. Previous collapses of currencies all involved some other currencies to flee too. There is nowhere to flee this time. What will be the price of gold? What is the value of a seat in a lifeboat on the Titanic? The only history that is relevant is the one teaching us that this level of debt was inescapable during much simpler times. It is doubly so today.
+1
Euro Chaos + End of QE2 = Dollar Gain = QE3
Again, same shit article that keeps appearing with this simple formula: Words, Chart, some more words inside a chart. Enough already. You Bitchez bore me...
Silver and oil and stocks (oh my)
http://deadcatbouncing.blogspot.com/
Rising US interest rates in the face of a soon-to-be $16T+ deficit is not in the cards, except as part of a planned default scenario, which is highly doubtful. Congresscritters move only when the election cycle is over, not before. The status quo must be maintained at all costs; QEn is a certainty, even though it may be disguised. Obama's Cloward-Piven Strategy is working too well; entitlements have already tanked any future economic growth, since policies that would enable growth through limitation of government power will be voted down by the "entitled" electorate. No austerity will ever be permitted by the corruptocrats; we all will go down together. Welcome to the Marxist/Fascist end game.
OK, when interest rates are sustained at over 10% and unemployment is at 4%, I'll short the yellow metal.
Um, isnt the dollar down today? Yes, EUR down, dollar up, that is the conventional wisdom. I dont see it happening that way.
Dollar is more or less trading sideways, but gold and silver continue to gain ground because they are perceived as competing currencies. And now for some hilarity.
Click below to see a graphic illustration of bankster's dirty hierarchy of needs:
http://thesilvergoldhedge.blogspot.com/2011/05/banksters-dirty-hierarchy...
just fuck off