The big fear that the European debt crisis could cause a repeat of the financial carnage seen in 2008 post Lehman’s bankruptcy and AIG’s bailout has seemingly been averted. For weeks, the market has waited to see how Greek debt would be adjusted, and whether such an adjustment would trigger a “credit event” that would shoot shockwaves through the global financial system. Today the world is sighing in relief that a 50% haircut on Greek debt has been agreed to, and that the ISDA has ruled that this cut is “voluntary.” Combined with news that European banks will set forth recapitalization plans of around $100 billion by mid-December, and that the EFSF has been leveraged to $1.4 trillion, has eased market concerns that the European banking system was set to implode.
For all investors, this news is a welcome relief. Gold and silver investors who held through this turbulance have been rewarded with a welcome upsurge in the price of both metals. Unfortunately, silver remains well off its high hit in May of just under $50 per troy ounce, and gold remains $200 below its all-time high of just over $1,900 per troy ounce. However, with the threat of a panic selling situation off the table, the outlook for gold and silver can now move back to more fundamental issues.
Silver Investors Still Need to Eye Recession Concerns
The fundamental outlook of silver depends on the health of the global economy, and the growing interest in silver as a store of value. It is still to early too say with any degree of certainty that the global economy is not heading for another recession. Today saw U.S. GDP in the third quarter come in at a relatively strong 2.5%. However, recent data the world over continue to point to an uncertain economic picture. With most European countries tightening their fiscal belts, and the same occuring in the U.S., the headwinds to growth from reduced fiscal spending will be difficult to overcome. Offsetting, investment demand for silver as a monetary substitute continues to grow. Indicative of this trend has been the record-setting sales of U.S. mint silver eagles this year.
Gold Price Movements Likely Depends on U.S. Dollar
The primary driver of gold will likely be its ongoing negative correlation with the U.S. dollar. While the congressional “Super Committe,” tasked with cutting the U.S. budget deficit by $3 trillion as part of the Budget Austerity Act passed earlier this year, scrambles to come up with anything that will pass a fractured Congress, the U.S. continues to spend approximately $4 billion a day more than it takes in. In fact, the U.S. debt to GDP is expected to hit 100% by the end of this month. Given the fact that Italy is facing the wrath of bond vigilantes with a debt to GDP of 120%, the U.S. is clearly seeing a prologue to its future.
With the worst threat of the European debt crisis, seemingly past, the US dollar’s safe haven status will likely recede. Going forward, greater attention will be paid to the U.S.’s sizable fiscal deficits and trade deficits. The negative implication for the US dollar from these twin economic imbalances are unmistakable, and insofar as gold maintains its negative correlation with the USD, gold future price action seems promising.
Europe Issues Not Yet Finished and China Concerns Await
Today’s announcements from Europe are clearly welcome, but the worst case scenario can’t be completley written off. There is still a possibility that Italy will require a bailout. Any such eventuality will again raise concerns of Italy requiring a reduction in its debt that would again be “voluntary” and not trigger a “credit event.” Furthermore, while Greece’s fiscal position will undoubtably be aided by the reduction in its debt burden, the country continues to reel from a stagnating economy and ever sterner fiscal austerity measures. There is not yet certainty that Greece has turned the corner. If conditions materially worsen, Greece could yet require further reductions in its debt burden that would once again need to be “voluntary” and not trigger a “credit event.”
China continues to lurk in the background with a potential property asset price bubble. Authorities in China continue to combat the real estate surge and high levels of inflation, and there is no guarantee that a hard landing will be avoided. Like the U.S. in 2008, and Europe today, a full blown crisis in China could lead to a high level in volatility for gold and silver.
In the end, the volatility markets have experienced over the last few weeks point to an inherently unstable global financial system. The house of cards that is Europe continues to stand, with the help of a little glue and tape. While the world remains faced with numerous challenges, most pale in comparison to another full-fledged global banking sector meltdown. For now, investors should welcome some calm seas where factors other than such arcane financial tidbits such as CDS and ISDA can be focused upon.