A Greek Exit’s Impact on Gold
Unless I misunderstood the various speeches of most of the Eurozone financial leaders a few months ago, I am sure that they were absolutely emphatic that Greece would not exit from the euro. Now, it looks almost certain that Greece will exit the single currency. But, hang on a second, there are now talks that Greece should not depart from the euro and should abide by the latest austerity plans. Yes, the circus is back in town. Once again, EU finance ministers are meeting. As these star performers continue to debate the Greek crisis in a saga that has now gone on for more than two years, the fact remains that the European monetary union in its current form is filled with problems and practically everything these politicians tell the public is a lie. Greece is doomed and according to the newspaper Imerisia citing “reliable information,” the level of funds in Greece’s state coffers has fallen below 1.5 billion euros ($1.9 billion). If the state doesn’t receive predicted revenue for the rest of this month, it will find it difficult to pay for social services, pensions and public-sector wages, the newspaper said.
In the meantime, the German chancellor, Angela Merkel, said “solidarity for the euro” was threatened by the on-going political crisis in Athens. At last, someone has said something correct. But, then what would a Greek exit mean?
No doubt a Greek exit from the Eurozone would damage confidence in the single currency bloc and send yields on Eurozone government debt soaring, but this may be better than continually adding more debt to existing debt. However, in the event that Greece does exit the euro, Greeks who have left their life savings in euros in Greek banks will see the value of their money evaporate overnight as capital controls are suddenly introduced and their savings are forcibly converted to the Greek drachma overnight. It is estimated that the drachma could quickly devalue by between 20% and 50%.
As I have stated countless times, since the beginning of the crisis, nothing has been resolved in the Eurozone and different programmes of monetary stimulus have merely helped banks and financial institutions from collapsing. The monetary policies of the ECB have had no impact whatsoever on stimulating economic growth and lowering unemployment.
While Euro finance ministers continue to discuss the Greek crisis, unemployment is at its highest level ever in Europe since the creation of the euro. Also Spain has its own financial problems, Italy is fighting to stay afloat and France is already facing lengthening jobless queues and a growing disparity with Germany.
France now has a new leader, Francois Hollande. Socialist Hollande, who has called for higher taxes, increased spending and a delayed deficit-reduction effort, got about 52% of votes in the recent French election, against about 48%. Hollande is due to fly to Germany for his first meeting with German Chancellor Angela Merkel, an encounter that will be closely watched given the leaders’ very different views on how to handle the Eurozone debt crisis. Merkel publicly supported the incumbent Nicolas Sarkozy in France’s presidential elections. She forged a close working relationship with him as she sought to contain and resolve the crisis. On Sunday, Chancellor Angela Merkel’s party had its worst result in more than half a century in the northern German state of Schleswig-Holstein when they suffered a painful defeat in elections in Germany’s most populous state. The loss added to a growing sense that Merkel will struggle to continue to fight the debt crisis with austerity alone, and will be forced to concede some ground as the calls for growth initiatives grow stronger.
Meanwhile the news about the $2 billion trading loss made by J.P. Morgan Chase & Co. dominated the market on Friday. While the amount is a fraction of the potential write downs that may occur if Greece defaults and exits the Eurozone it is nevertheless, a sizeable trading loss and enough to offer the people concerned a promotion as well as a massive bonus.
The losses stemmed from trades at the bank’s chief investment office, where a single trader — dubbed the “London Whale” — was reported to have taken large positions for the bank in credit-default swaps.
In the Securities and Exchange Commission filing, the bank said its synthetic credit portfolio had proved to be riskier and more volatile than expected. J.P. Morgan said losses have been partially offset from sales in the chief investment office’s available-for-sale securities portfolio.
Trader Bruno Iksil had earned the nickname “the London Whale” in recent months by selling huge amounts of credit-default swaps to hedge funds, a strategy that soured in recent weeks.
While the bank may claim that their activities were solely in risk management, and that its bets were designed to hedge risk, we all know that in reality this is hogwash and the banks were taking huge speculative bets as they did with sub-prime mortgages. If the bank was indeed hedging then there would not be any loss as hedges act as a protection of another position. Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks. In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means that you can develop trading strategies where a loss in one investment is offset by a gain in another.
Since the beginning of May the price of gold has slipped by more than $100 from $1675 an ounce to $1550 an ounce while the dollar index has gained some 2.2% from 78.50 to 80.26. And, the EUR/USD dropped to as low as 1.2800. During this year, the euro has declined by approximately 3% against the greenback.
Despite the bullish fundamentals for gold, in the short-term most of the market participants have chosen the dollar, as well as German Bunds as the safe haven trades. And, as the dollar gains in value, dollar denominated commodities including other currencies will suffer.
Very few financial institutions consider gold to be money and as they bail out of euros and switch into other paper assets, the last thing on their minds is gold. The modern day trend with financial traders is to look for short-term gains and not preservation of wealth. Thus these massive inflows and outflows in the currency and bond markets will remain extremely volatile.
As I have mentioned countless times before, the problems in the Eurozone are far from being resolved and will only get worse before they get better. And, as far as gold is concerned, I remain as bullish as ever. We are in a period where political and financial corruption is at an all-time high. And, while the world needs a monetary system that functions, our leaders cannot be trusted. It is a disgrace that we have come to this. What example are we setting for future generations? If you are aware of this one simple fact, then you will realise that these people who run our governments and financial institutions have no concern of any individuals’ well-being. So, it is important to look after yourself and invest in hard assets that can protect your wealth, especially gold and silver.
Even though the long-term trend of gold remains intact, the short-term damage inflicted on the chart suggests that gold may trade to between $1525/oz to $1500/oz before prices rebound.