Resurgence of Contagion Worries Lift Gold

Gold pushed through important short-term resistance at 1520.28 this morning, putting the yellow metal back above its 20- and 50-day moving averages. This week’s gains come in the wake of last week’s picture-perfect bounce from just in front of the 100-day moving average. While gold remains range bound, it continues to show remarkable resilience at a time of year when the market frequently experiences seasonal softness. If nothing else, the retracement back into the upper half the range reinforces the reaction low from early-May at 1462.25 as formidable support.

Gold’s buoyancy is largely attributable to the resurgence of contagion risks within the eurozone. As the EU/IMF/ECB continues to flail about trying to concoct a resolution to Greece’s second bailout dilemma, the market’s confidence in the troika is eroding. The absence of a cohesive plan for Greece has made it pretty obvious that the troika has no real plan for Portugal either, or any other distressed sovereign for that matter. Spurred by Moody’s downgrade of Portugal to junk status, yields are Portuguese sovereign debt have risen by more than 450 bps in less than 24-hours.

Source: Business Insider

As Joe Weisenthall of Business Insider points out: This is “a really mammoth collapse in confidence for a country that’s already been bailed out!” In fact, Portugal just finalized a €78 bln bailout 2-months ago; which drives home my point about waning confidence not just in the debt-ridden countries themselves, but in the European and international agencies seeking to save them. In fact, The Economist offered further illustration in an article yesterday entitled Spot the Pattern. The chart of 10-year Greek yields presented very clearly shows that the market has been increasingly less assuaged with every step European leaders take to avert disaster.

Interestingly, some of those European leaders have chosen to lash out at the rating agencies, even as Bloomberg reports that Ireland may too get downgraded to junk status despite a substantial bailout. There have been suggestions the Europe suspend sovereign debt ratings until the crisis is resolved, or that they do their own ratings. The ECB has already said that they would cherry-pick the most favorable ratings on distressed periphery debt. While there is plenty to fault about the rating agencies in the wake of the 2008 crisis, this all strikes me as quite desperate: If you don’t like the message…kill the messenger.

July 6 (MarketWatch) — The last financial crisis isn’t over, but we might as well start getting ready for the next one.

Sorry to be gloomy, but there it is.

Why? Here are 10 reasons.

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PG View: I think the most troubling of the 10 reasons is #6; which notes that Wall Street’s derivatives exposure has actually increased over the past 3-years by a whopping 35% from $183 trillion just before the Lehman collapse to $248 trillion today.

July 6 (Bloomberg) — Ireland’s credit rating may be cut to junk by Moody’s Investors Service after Portugal yesterday lost its investment grade rating, according to analysts.

Moody, which slashed Portugal to Ba2 from Baa1, in April lowered Ireland’s credit rating to the lowest investment grade Baa3 and left country’s outlook on negative.

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PG View: Contagion risks re-exert themselves as faith in EU/IMF/ECB troika’s ability to find a solution to Europe’s sovereign debt crisis wanes.

By Martin Wolf
July 5 (Financial Times) — The biggest question in any debt crisis is whether a credible path back to solvency can be found. For Greece, this now seems very unlikely. The same is true, to a lesser extent, for Ireland and Portugal. This raises three further questions. First, how big is any required restructuring? Second, who should bear the cost? Finally, is restructuring enough? If the answer to the last question is No, then one has to ask whether the currency union will last in its current form.

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Gold is firmer this morning amid heightened contagion concerns in Europe. With Greece’s second bailout still to be resolved, Portuguese yield spreads surged to record wides in the wake of yesterday’s downgrade. The yellow metal has now retraced more than half of the recent corrective retreat within the range and is trading back above its 20 and 50-day moving averages.

China acknowledged its local government debt problems following the warning from Moody’s that the magnitude of such debt is $540 bln larger than Beijing estimated just last week. Despite this new debt threat, the PBoC raised interest rates by 25bp today as efforts to curtail inflation continue. PBoC adviser Xia Bin said today’s rate move was “not enough,” suggesting that the tightening cycle that began late last year will continue.

President Obama has called party leaders to the White House on Thursday in the hopes of restarting stalled debt ceiling talks. The President rejected a proposed short-term deal that would have pushed the more substantive debt debate deeper into the campaign cycle, calling for a resolution within the next two-weeks.

The likelihood that China will continue to try and slow its economy, along with persistent debt woes in America and Europe have weighed on equities, increasing the appeal of gold as an alternative investment.

• Canada building permits surged 20.9% in May, well above market expectations of +4.5%, largely offsetting Apr surprise plunge of 21.5%.
• China hikes lending rate 25bp to 6.56%. Fifth hike of the cycle, which began in Oct-10.
• President Obama has rejected a short-term debt deal; calls leaders to White House on Thursday in hope of restarting stalled talks.
• Major Greek bond holders are meeting in Paris today to discuss debt rollover plans
• German May orders +1.8% m/m, well above market expectations, vs positively revised +2.9% in Apr.
• UK shop price inflation rose to a 2.9% y/y pace, a 22-month high, driven largely by a sharp 5.7% jump in food prices.
• Japan leading index rebounded to +3.6 m/m in May; further evidence of post quake/tsunami “V” recovery.

July 5 (The Economist) — Here is a chart [see article] showing the yields on 10-year Greek debt over the past three months. See the pattern?

There’s a spike, followed by a decline, followed by a higher spike, followed by a decline to a higher trough, and so on. European leaders keep taking steps to avert disaster, and each time markets are less assuaged.

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July 4 (Time) — The first thing any insolvent private person is forced to do is relinquish the family silver. But other rules seem to apply to governments. Whether they’ve been living above their means for a few years or for decades, certain countries hold on tight to their assets, declare themselves unable to pay back their debts and turn to other countries for help.

The European Union has seen many an example of this. Right now, Greece is negotiating with the troika of the E.U., the European Central Bank (ECB) and the International Monetary Fund (IMF) for a new rescue package while Athens sits on an impressive 114-ton stash of gold, about what four large, fully loaded trucks could carry.

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The credit ratings agency Moody’s Investors Service has downgraded Portugal’s debt to junk status.

The agency said there was a growing risk the country would need a second bail-out before it was ready to borrow money from financial markets again.

Moody’s was concerned that if there was a second bail-out, private lenders might have to contribute.

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PG View: With Greece’s second bailout yet to be fully resolved — and Portugal’s first €78 bln bailout less than two months in the past — rumblings of a possible need for a second Portuguese bailout suggests that contagion risks persist.

June 5 (MarketWatch) — Gold futures rallied Tuesday as concerns about global debt problems fed investment demand for the precious metal, lifting prices by more than $30 an ounce.

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June 4 (MarketWatch) — Greece is at risk of missing a key budget target in June, European Union experts said in a report, a sign of the uphill struggle the country faces as it tries to get its deficit reduction plans back on track.

…Government revenue faces “significant” shortfalls that have only partially been offset by lower spending and delayed payments, the report says. “As a result, the quarterly performance criterion on the primary balance could be missed already in June.”

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PG View: Even as Greece moved to pass further austerity last month, tax revenues continued to crater due to previous austerity measures, general strikes and diminished tourism.

Gold Rises on Indication that China May Face its Own Debt Woes

June 5 (USAGOLD) — In recent years, China has become a major creditor to the rest of the world, as massive trade imbalances with the West — and in particular the United States — caused their foreign exchange reserves to swell. As of April, China held $1.1525 trillion in US debt. Only the Fed holds more, thanks to the past several years of quantitative easing. More recently, China has stepped up to be a white-knight for Europe, actively buying the debt of distressed periphery nations.

Now suddenly, analysts are increasingly concerned about the mounting debt burden of China itself. Not only are many of the foreign assets on China’s balance sheet of dubious quality, but Moody’s has warned that China’s local government debt may actually be $540 bln larger than the National Audit Office (NAO) estimated. Moody’s believes that 8% to 12% of the loans on the books of Chinese banks could eventually prove to be non-performing, and in the worst-case scenario the ratio could be as high as 10% to 18%. This has prompted speculation that a Chinese bank bailout may be in the offing.

If China withdraws from global credit markets to focus on internal problems, there are likely to be substantial worldwide repercussions. As we have already noted, China has already pulled back significantly from the US market. Such a move could also severely undermine Europe’s efforts to mitigate their sovereign debt crisis.

With Chinese inflation expected to top 6% in June (CPI will be released on 15-Jul), the deterioration of the Chinese balance sheet could hamstring the PBoC’s reaction to price risks. The PBoC has been moving to tighten monetary policy to reign in inflation, but higher yields might exacerbate the internal debt issues, raising servicing costs and threatening downgrades for Chinese banks. This could ultimately lead to a central government bailout of the banking system.

Does this sound at all familiar? Because, this is pretty much the same conundrum faced by Europe and the US. If it is proven that the primary creditor nation in the world right now faces its own debt crisis, we’re all in a heap of trouble.

July 4 (Erste Group) — Erste Group analysts, in their annual Gold report, find that investor demand for gold has increased tenfold in 10 years indicating that the commodity is entering a new phase of the gold bull market as China and India drive demand. The price of gold has also been affected by global monetary stimulus programmes and the exchange rate between gold and paper is expected to rise even further, with Erste analysts predicting that the next 12 month target for gold will be USD 2,000.

“Since the first Gold Report five years ago, the gold price increased by +140 %. The long-term target of USD 2,300 which experts forecasted three years ago, could even be considered too conservative now”, commented Ronald Stöferle, Erste Group’s gold analyst.

Gold benefits from unsolved debt crisis
Given that the majority of debt has neither been written off nor paid off, the problem of excessive debt is still waiting to be resolved. This is why the low real interest rates will stay low which provides the perfect environment for gold. There are only a few ways out of the debt trap: growing out of one’s debt much like the USA did after WWII, or alternatively drastic spending cuts and rigid budget consolidation like Scandinavia in the 1990s.

Massive tax hikes, the creation of inflation, the depreciation of the currency or ultimately, national bankruptcy are amongst the most painful options. We expect gold to benefit in practically all of these scenarios.

It is also often forgotten that China and India remained the most important factors on the demand side. The higher gold affinity in combination with the increase in disposable income will definitely have a positive effect on gold demand. By 2020 emerging markets will generate 50% of global GDP, up from 19% in 2000.

Price level still attractive – no bubble in sight
In 2000 investor demand accounted for only 4.8% of total demand, while by 2010 that share had increased to almost 40%. According to Erste Group analysts, this indicates a clearly strong upward trend reversal and heralds a new phase of the bull market. It can be expected that institutional investors will dominate the next stage of the gold bull market. Especially insurance companies and pension funds should step up their gold allocation, seeing as the correlation to equities and especially to bonds is low or even negative. Gold is well known as a safe haven as it has never lost its value. The clear downwards trend of most currencies compared to gold is clearly illustrated by the graph. This trend might not mitigate very soon. We expect the gold price upswing to continue“, said Stöferle.

Gold, as antagonist of uncovered paper currencies, remains an excellent hedge against worst-case scenarios. Moreover, there is a clear correlation between the gold price and trust. A falling gold price would therefore relate to rising or at least stabilising trust. We believe that the trust lost in the past years will not be regained anytime soon, and that therefore gold still commands an excellent risk/return profile.

Gold pillar of a clever investment strategy
Gold should be part of every portfolio because of diversification and insurance aspects. Numerous studies prove that gold as portfolio module reduces overall risk and improves the performance. About 5 to 10% of the portfolio should be allocated to gold. In contrast to shares or bonds, there are no liabilities attached to gold. As such gold is highly recommendable for reasons of diversification. “We still expect the gold price to rise at least to the inflation-adjusted all-time-high of USD 2,300/ounce (dating from 1980) at the end of the bull market”, forecasted Stöferle. Some historical comparisons suggest even higher spheres. Stöferle explains, why gold does not pay any interest, “Gold is pure ownership without any liabilities towards any person or institution. It does not contain any counterpart risk.” In particular the previous month have shown a clear trend which is in favour of gold as an asset class. Gold has been more and more regarded as money of the purest water and increasingly less as commodity.

Returning to the gold standard?
The thought of a currency not pegged to gold would have probably been absurd 100 years ago. Today even the thought that back in 1971 every 35 US dollars were backed by one ounce of gold is absurd. „A return to the gold standard is not realistic at the moment. At least the discussion about it restarts“, said Stöferle. „Before implementing concrete measures, the strain must still increase“. Various studies on currencies show an interesting phenomenon: the stronger the gold pegging, the lower inflation.

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Full report (PDF): In Gold We Trust

PG View: Yet another piece of excellent and comprehensive analysis on gold by the Erste Group.

The European Central Bank will continue to accept Greek debt as collateral for loans unless all the major credit rating agencies it uses declare it to be in default, said a senior finance official.

The ECB would rely on the principle of using the best rating available from the agencies – Standard & Poor’s, Moody’s and Fitch – the official said. The comments came after S&P on Monday became the first agency to warn that a plan, pushed by France and endorsed by Germany, for banks to roll over their holdings of Greek debt into new bonds would constitute a “selective default”.

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PG View: So the ECB will cherry-pick the rating they like on Greek bonds, I suppose the next step is that the ECB will just do their own ratings…

July 5 (MarketWatch) — Given all the possible permutations of the continuing debt dilemmas in both the United States and Europe, finding a way to profit from the potential effect they’ll have on the markets is a complex challenge. Indeed, the current global landscape is fraught with so many cross-currents that calculating potential causalities is becoming less of a science and much more of an art.

…Given our view that the U.S. and Europe will continue to inflate their way out of these debt crises, printing money and debasing their currencies, we tend to favor precious metals — but we wouldn’t look to buy just yet.

…The bottom line is that investors should recognize the inherent long-term weakness of the major fiat currencies, and begin diversifying at least some percentage of their funds into hard assets, closely watching where major support levels develop for gold in order to identify the prime entry points.

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PG View: The “just not yet” in this article stems from the authors’ see “potential for a continued sell-off in stocks through the summer” and perceive there to be risk of a corresponding deleveraging sell-off in gold. I would argue that the deleveraging break of 2008 actually make a repeat less likely, as investors may be increasingly quick to move into the safety of gold.

July 5 (The Economic Times) — China’s local government debt may be 3.5 trillion yuan ($540 billion) larger than auditors estimated, potentially putting banks on the hook for deeper losses that could threaten their credit ratings, Moody’s said on Tuesday.

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July 4 (Bloomberg) — Republicans might accept a “mini” deal with the Obama administration on raising the debt limit, Senator John Cornyn of Texas, a Republican leader, said yesterday on “Fox News Sunday.”

…Even so, the White House rejected a short-term extension of the debt limit, deputy communications director Jen Psaki said.

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July 4 (Bloomberg) — Standard & Poor’s and Fitch Ratings may enable European Central Bank President Jean-Claude Trichet to support a private investor rollover of Greek debt by saying a default rating would be partial and temporary.

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Gold has moved decisively back above the $1500 level. While the Greek crisis is far from being resolved, the sense that the immediate default risk has passed has allowed inflation concerns to return to the fore. The resurgence in oil prices is helping to underpin the yellow metal.

The rating agencies continue to suggest that any rollover of Greek debt would likely be deemed a selective default. However, S&P and Fitch have indicated that any default rating for Greece may be partial and temporary. This may provide the necessary cover for the ECB, as any prohibition in accepting Greek bonds as collateral could be brief. Representatives of the eurozone banks will meet in Paris on Wednesday to discuss the details of the French rollover plan.

• Eurozone -1.1% m/m in May, below market expectations, vs +0.7% in Apr.
• UK Jun services PMI 53.9, above market expectations, vs 53.8 in May.
• Eurozone Jun services PMI revised lower to 53.7 from 54.2 initially, vs 56.0 in May. Composite revised lower to 53.3 from 53.6, vs 53.8 in May.
• Riksbank hiked repo rate by 0.25% points to 2.00%.
• Moody’s says China’s local government debt may be $540 bln larger than auditor estimated.

A SPECULATION ABOUT TIM GEITHNER POTENTIALLY RESIGNING AS TREASURY SECRETARY

Remember the childhood card game “Old Maid?” The object of the game was to pass cards artfully enough so that you would not be stuck with the hoary “Old Maid” card in the end. Upon reading about Treasury secretary Tim Geithner’s sudden “soft” announcement that he was leaving the Obama administration, I couldn’t help but think he might be attempting to avoid being stuck with the card.

Presidential administrations always have turnover. However, the turnover in the Obama economic team seems more profound than in previous administrations. Andrew Mellon, for example, served as Secretary of the Treasury for over a decade with two different presidents — and his tenure was only the third longest. Geithner has been there about two and a half years.

One wonders if he might know something the Obama administration isn’t telling us, like, for example, what might be the likely outcome for the federal government post QE2? As mentioned here last week, the government is borrowing something like 70% to 80% of its needs from the Federal Reserve at a time when the program providing those funds is about to be abandoned, and no one else seems overly eager to pick up the slack.

So what happens when that support is removed? I don’t think anyone knows. Maybe Geither has an inkling. Then, of course, there is the obvious concern about the wrangle in Congress over budgetary matters actually shutting down the federal government, and what that might do to the nation’s credit rating. (The Minnesota state government shut down today, and interestingly enough, it shut down over the very same deadlock on taxes and spending now engaging Congress.) If Geithner can just get Congress to pass an extension — and that is all it is — he can escape relatively unscathed from a career point of view.

In my view, another crisis will be required to inaugurate QE3, or whatever they choose to call the next go around, and perhaps Geithner has had his share of crises, and doesn’t want to stick around for the next one (which could be considerably worse than the last one, if people like George Soros are to be believed). In fact, he mentioned something along these lines to close associates. It has been grueling. Geithner’s crisis though is the same “crisis” that hit the economy in 2008, and the same “crisis” that the next Treasury secretary will face. (Initial speculation has JP Morgan’s Jamie Diamond and NY Times Paul Krugman on the inside track.)

Meanwhile, the President, after admonishing Congress for suggesting a recess for a long July 4th weekend without resolving the debt ceiling crisis, decided to take a break at Camp David. Go figure. One wonders with all the stress swirling around Washington these days, if anyone is up to the job. Perhaps, the stress originates in trying to sell the public on a spending cut program that appears ridiculous on its face, i.e., one trillion dollars over the next ten years (or more, so we are artfully told). That’s $100 billion per year against a deficit of $1.5 trillion per year — as a best case scenario. In this case, Democrats and Republicans alike share the blame for attempting another bandaid solution that the public is supposed to swallow as compelling.

As it stands, this price dip for gold has its attractions. Our volumes as mentioned in a recent e-mail are very strong with most of the buying from high net worth investors who are making purchases in five and six figures. It appears that gold buyers (a) like the cheaper pricing, and (b) have their doubts about the ability of governments near and far to deal with the gathering storm.

Ultimately the essential problem reduces to sovereign debt and that includes the sovereign debt of the United States. Perhaps members of the Obama team have seen enough to warrant a healthy concern about whether or not the problems can be resolved and who is going to take the blame when inevitably the other shoe falls.

If you watched “Too Big to Fail” you know there is little in the dealing with these problems to redeem itself. In the end, no one wants to get stuck with the “Old Maid,” least of all young Treasury Secretaries who have the bulk of their career ahead of them. Perhaps it’s “time to git while the gittin’s good.”

MK

P.S. The other interesting piece of news today is the announcement by Greece’s central bank that it was buying gold. A bankrupt country finds enough capital to buy 1000 ounces of gold; there’s a subtle message there for the world to ponder. Once again, does someone there know something the rest of us don’t?

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Gold fell to new 6-week lows amid heightened risk appetite, stemming from a sense of relief in the market that a Greek default seems to have been averted — at least for the time being. New austerity measures for Greece were successfully shepherded through Parliament earlier in the week, while France and Germany moved closer to a deal on rolling-over their Greek debt in a way that might avoid creating a credit event in the eyes of the rating agencies.

With the European sovereign debt crisis perhaps moved to the back-burner to simmer for a while, focus will shift to the US fiscal crisis and the debt ceiling debate. The dollar remains defensive within its recent range, despite continued upward pressure on yields. This may prove to be a limiting factor on the downside for gold.

• US ISM rose to 55.3 in Jun, above market expectations, vs 53.5 May.
• US construction spending -0.6% in May, below market expectations, vs negatively revised -0.6% Apr.
• University of Michigan sentiment (final) slipped to 71.5 in Jun, below market expectations, vs 71.8 prelim.
• UK manufacturing PMI unexpectedly fell to 51.3 in Jun, a new 21-month low, vs negatively revised 52.0 in May.
• Eurozone unemployment steady at 9.9% in May.
• Eurozone manufacturing PMI confirmed at 52.0 in Jun, unch from prelim reading, vs 54.6 in May.
• Swiss PMI fell to 53.4 in Jun, below market expectations, vs 57.8 in May.

June 30 (Reuters) — In the Greek capital, gold is marking a divide between the “haves” and a growing number of “have nots.”

Many ordinary Greeks who prospered after the Mediterranean country entered the euro a decade ago are now being forced to sell their family treasures just to make ends meet.

“These are not poor folks. They are ordinary, middle-class Greeks: a woman with three kids who needs to sell her wedding jewelry just to send her kids to school.”

That is one side of the coin. On the other, many wealthy Greeks, worried by the political paralysis gripping their country, are pulling money out of the bank and buying gold, regarded as the ultimate safe haven in times of uncertainty.

Banks have lost around 8 percent of their deposits this year, with outflows accelerating in May and June as anxiety grew at the government’s dwindling parliamentary support, according to credit ratings agency Moody’s.

But the rest was due to wealthier Greeks, fearful of an impending financial collapse should the country default, sending money abroad, stashing it in safety deposit boxes, or buying gold coins, Moody’s said.

“The people with money are no longer buying land, they are buying gold and silver,” said Verykokaki. “Greeks are ignorant. It’s stupid because if they take the money from the bank, the banks won’t have enough to go around.”

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JK Comment: I find the comment by Verykokaki interesting….perhaps something missed in the translation. Yes, if the whole of the country moves away from the banking system, it will collapse….but can one honestly just stand by and hope it doesn’t happen, thereby risking everything?…and I certainly wouldn’t call protecting yourself against the possibility, “ignorant.” It seems this is a little bit of a chicken and egg argument. Is the banking system in Greece failing because Greeks are worried its going to fail (a crisis of confidence), or was it already failing, prompting this flight? In either event, I’m sure those who are fortunate enough to own gold, the “have’s” as this article states it, don’t feel ignorant at all.