Here's why I think gold pulled back from its June 21 high of
$1,266.50 per ounce to its July 7 low of 1,185. Traders began to
realize that the euro just isn't dead yet.
In May and early June, Europeans who thought the euro was
finished, dumped euros and bought gold. Then the EC and the
European Central Bank ((
)) signaled that they will protect the euro and the European banks
or die trying. The ECB's secondary market purchases of PIIGS
sovereign bonds, which began in May, helped send this message.
And so, at least some traders who bought gold because they
feared the end of the euro, sold gold and bought euros back.
While traders were skeptical about the initial announcement of
the Greek rescue, the ECB may have moved the markets as much if not
more. Despite the impressive $955 billion headline number for the
Greek rescue package that the EC announced May 9, the euro kept
falling and gold kept making new highs.
As the ECB continued its PIIGS sovereign bond purchases every
week, though, it became clear that these purchases are ongoing, not
a one time event. The euro bottomed on June 7. Furthermore, gold,
which made an intermediate high of $1,254.50 on June 7, can now be
seen to have struggled since then, and finally sold off July 1.
While the ECB purchases may have punished gold holders recently,
they should push gold prices higher in the long-term. The purchases
smack of "money printing" and amount to a backdoor aid package for
the financially weak PIIGS. They peg the debt of the issuing
countries to artificially high prices, and might even allow PIIGS
to issue new debt at artificially low rates - assuming the ECB
stood ready to buy bonds to support their prices. These things can
only lead to further debasement of the euro versus gold.
Moreover the rebound in the euro corresponds to at least a
possible topping in the dollar. It almost has to, given the Euro's
large weight in the Dollar Index. Some analysts suspect the Euro's
bounce means that the risk trade is back on, and maybe it is for at
least a little bit, given last week's corresponding bounce in
Europe's Moves Toward Bank Bailouts Also Prop Up the euro
The European bank stress tests also demonstrate Europe's
determination to save the euro by propping up European commercial
banks as well as the PIIGS. The guidelines say that European banks
may value Spanish Government bonds at 97% of par, and Greek bonds
at 87%. That way the banks can, well, lie about the value of these
assets and artificially prop up their equity. Of course, the banks
will say that if the bonds will pay off at par (and if the EC can
make that happen, they will) who needs to mark the bonds to
Allowing Europe's banks to value the weak sovereign debt at such
generous numbers, will also provide incentives for the banks to
keep holding these bonds rather than dump them. Therefore the
stress test guidelines provide a backdoor subsidy for the debt
issuing countries as it would help keep their borrowing rates
But, in addition to the subsidy for issuing countries, the
stress test guidelines matter because they indicate that Europe is
following the US playbook on stress tests and bank bailouts. Last
year, US regulators announced stress tests for US banks that would
supposedly show that the banks would stay "solvent" under various
As most readers know, these tests were ludicrously easy. Not
many analysts thought that the major banks (with the possible
exception of Wells Fargo (
)) were viable at the time - not without government assistance, at
least. But the stress tests provided a fig leaf to justify
government help through TARP, the alphabet soup of Fed lending
programs, and more lenient accounting treatments for banks'
The change in bank accounting also marked the US stock market
bottom in March 2009. Clearly the Europeans hope that European bank
bailouts will make the financial markets happy as well. And in the
short to medium term, if the US experience is any guide, the
bailouts may enable the euro bottom to hold (at least when measured
against other paper currencies) longer than many people think. Even
if, as in the US, European banks will continue to hold their fair
share of underwater assets. In other words, short-term measures
that kick the can down the road, can have important short-term
results, even if they don't solve long-term problems.
The European moves to bail out their banks tell you something
else: not to worry about those reports that the Bank for
International Settlements ((
)), is lending to commercial banks and taking gold as security,
under repurchase agreements. Some gold traders seemed to fear that
if the banks failed to make good on these loans, the BIS would dump
the gold collateral on the market. My response: the EU will not let
a big European bank fail anytime soon; that's the whole point of
their stress test charade. And if big European banks
start going down, I suspect the demand for gold would soar.
What Gold Investors Should Do
So what's an investor to do? Chartists note that the June top was
not much higher than the previous highs in December 2009, and point
to what looks like a double top. In response to this and the July 1
gold selloffs, gold timing newsletters turned understandably
bearish. Of course, the Hulbert Letter holds up this pessimistic
timer consensus as a contrary indicator, and calls it a buy signal.
Still, if you are a long gold, the chart has to concern you.
My thinking is, if you are a trader and you don't like gold's
double top (not to mention its closes below the 50 day moving
average), why not lighten up? The chart doesn't tell me that gold
is going higher anytime soon. But I wouldn't sell a core position,
because the European move only underscores the long-term weakness
of paper money around the world.
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