Wednesday, August 3, 2011

Gold Sets Records "Growing Risk" of Eurozone Credit Crunch

London Gold Market Report
from Ben Traynor
Wednesday 3 August, 07:30 EDT


Gold Sets Dollar, Pound & Euro Records, "Growing Risk" of Eurozone Credit Crunch

THE DOLLAR gold price set a new intraday record of $1672 per ounce Wednesday morning – a 2.7% rise from last Friday's close.

The gold price at the London Fix meantime hit four figures in all three currencies for which it's set – the Dollar, Euro and Pound – for the first time in history on Monday afternoon.

The gold price repeated that feat this morning, where prices per ounce were $1667.50, £1016.77 and €1163.40 – a record in each currency.

Silver prices hovered around $41.15 per ounce Wednesday morning – 3.2% up for the week so far.
Stocks, commodities and US Treasury bonds all fell as fresh sovereign debt fears hit Italy and Spain.

"Looks like the crisis [will] just bounce back and forth between both sides of the Atlantic," says a Hong Kong gold dealer.

"This crisis, unfortunately, seems to be spreading to Italy and Spain," agrees Jesper Dannesboe, senior commodities strategist at Societe Generale.

The gold price "is reacting to this and that is the main driver right now."

Italian and Spanish government bonds sold off again Wednesday morning – sending borrowing costs higher. The yield on Italian 10 Year-debt rose to 6.26%, while the yield on 10-Year Spanish bonds hit 6.42%.

Spain's prime minister José Zapatero has postponed his summer holiday, while Italian finance minister Giulio Tremonti headed to Luxembourg Wednesday to hold emergency talks with Jean-Claude Juncker, chairman of the Eurozone finance ministers. 

"The risk of a credit crunch in Southern Europe is growing," says Huw van Steenis, head of EMEA banks and financial at Morgan Stanley.

However, the European Commission said Tuesday that it has no plans to bailout Italy and Spain – the Eurozone's third- and fourth-largest economies respectively – nor to rescue Cyprus, whose largest bank, the Bank of Cyprus, warned Monday there was an "imminent threat" the country would need assistance.

The European Financial Stability Facility – the Eurozone's ad-hoc bailout mechanism – was given powers to buy government bonds on the open market as part of the second Greek bailout announced last month. 

The EFSF has around €440 billion at its disposal. Spanish gross government debt, according to the International Monetary Fund, was €639 billion in 2010 – while the figure for Italy was €1.84 trillion.

"The costs of a bailout of those countries are stratospheric and could not be met with the planned resources," says Alessandro Giovannini, analyst at the Centre for European Policy Studies.

This could leave the European Central Bank – which announces its interest rate decision on Thursday – as "the only actor in the system that has sufficient power to do something," reckons Mark Wall, economist at Deutsche Bank.

The Swiss National Bank meantime cut is interest rate on Wednesday from 0.25% to "as close to zero as possible" in a measure designed to curb the strength of the "massively overvalued" Swiss Franc. The SNB added it will "take further measures against the strength of the Swiss Franc if necessary."

"Might be worth pointing out that the SNB has imposed negative interest rates before," says a note from Citi, citing the central bank's decision in 1972 to impose a charge of up to 10% per quarter on deposits. The SNB also imposed deposit charges in 1977 and 1979.

The gold price in Swiss Francs was around CHF1295 per ounce Wednesday morning – only 3.6% above its level this time last year. The US Dollar gold price, by contrast, has risen 40% over the same period.

Over in Washington, the debt ceiling deal has led to ratings agencies Fitch and Moody's maintaining their top notch triple-A ratings on US sovereign debt – although they say the outlook remains negative.

"We do think more needs to be done to ensure a reduction in the debt to GDP ratio," said Steven Hess, New York-based senior credit officer at Moody's.

Standard & Poor's, the third major ratings agency, is yet to say whether it will downgrade the US in light of the deal – which raised the debt ceiling to $16.4 trillion.

The deal will see around $2.4 trillion in spending cuts over the next decade. S&P said last month that it wanted the government to agree on $4 trillion in deficit reduction - adding there was a 50% chance it would downgrade the US within three months.

"If they stick to what they said, they would downgrade," says Mohamed El-Erian, chief executive of Pimco, the world's largest bond fund.

"But I suspect they are under tremendous pressure not to do so."

In Beijing, however, one ratings agency, Dagong, has downgraded US sovereign debt – for the second time in less than a year.

Last November, Dagong responded to the launch of QE2, the Federal Reserve's second round of quantitative easing, by downgrading the US from AA to A+. On Tuesday it knocked that rating down to A, citing America's "low economic growth, high deficit and... declining national solvency".

"It is natural that QE3 monetary policy will be enabled for the next step, which will throw the world economy into an overall crisis; the status of the US Dollar will be essentially shaken in this process."

China will continue to "seek diversification in the management of reserve assets," the country's central bank governor Zhou Xiaochuan said Wednesday.

China held $1.16 trillion of US government debt in May, according to US Treasury data.

Ben Traynor


Editor of Gold News, the analysis and investment research site from world-leading gold ownership service BullionVault, Ben Traynor was formerly editor of the Fleet Street Letter, the UK's longest-running investment letter. A Cambridge economics graduate, he is a professional writer and editor with a specialist interest in monetary economics.

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