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Blaming Euros, Don Cherry Style, for Gold Price Drop
December 8, 2011 by prospectingjournal · Leave a Comment
COMMENTARY – ProspectingJournal.com – With gold prices plummeting today, many North American gold bugs may start doing their best Don Cherry impersonations and blame Europeans for all of their woes. As the European Central Bank cut interest rates to 1% and increased money injections into European banks, gold prices slipped accordingly, as the ECB failed to ramp up bond buying.
Instead of ranting against the use of visors, flamboyant goal celebrations or dangerous stick work, a proper Coach’s Corner-esque rant is in order for those outside of the Eurozone who are today asking what happened to the value of their gold. And unlike many of Don Cherry’s rants, this time Europe deserves the criticism, specifically ECB President Mario Draghi… not Alexander Ovechkin.
Prior to the ECB’s lowering of interest rates by 25 basis points to 1%, gold was actually moving higher. Now at 1%, the interest rate is back to a previous low achieved after the Lehman Brothers failure. But now as markets sit in limbo waiting for the next move to come from the European Union Summit, each news soundbite seems to wreak havoc of its own.
Gold opened with a drop of around $30 per ounce, before stabilizing at nearly half of that loss as the reaction settled slightly. Silver, too, was hit with a drop of $0.45 to $32.63. In contrast, the U.S. dollar index rose 0.41% to $78.82 as the influx of European cash into the flailing eurozone economy raised the greenback’s value. The euro, however, tanked.
Not to be forgotten was the ECB’s announcement that allows banks to borrow more money for longer periods of time at a fixed rate, through its longer term financing operations of 36 months, (along with an expansion of collateral requirements). By loosening collateral rules, banks can borrow more from the ECB, as the three-year loans are unlimited. Draghi covered this action by stating, “(These measures) should ensure enhanced access of the banking sector to liquidity.”
So, essentially this just further proves that the ECB is a lender of last resort, not only for governments, but for the banks!
But, the effect on gold requires a bit of head scratching. Typically, a rate cut on its own makes for enough change in gold’s stability. Low rates are normally good for gold as rate cuts devalue currency. But the U.S. dollar and the euro have truly split from one another, with gold taking the same route as the euro, and not that of the dollar.
Should the ECB’s actions with the rate cut actually help the Eurozone, gold could bounce back. But then again, the strange correlation between gold and the euro could be the yellow metal’s demise, as the rate cut will most certainly devalue the euro and bring gold down with it. Primary logic is thrown out the window, as gold will most likely get trapped in its current trading range.
So, at this stage, it’s time for the leaders of Europe to bring on the start of their two-day summit, which from an investor’s point of view could hopefully bring about some solutions in the market’s favour. That said, it’s looking like the “bazooka plan” coming out of Brussels that many had hoped for ain’t gonna happen. The ECB has made it pretty clear that there won’t be a bond-buying extravaganza, and German Chancellor Angela Merkel pretty much told investors to simmer their hopes as well.
Sadly, while we must temper our expectations, the reality is that if the leaders of Europe don’t get their collective houses in order, then we’re probably in for some big time volatility. For gold holders, that could be a good thing, as eventually there will have to be a split from the current marriage gold has with the euro.
But more realistically, a cure-all solution won’t be in place by Friday, despite what they announce. These summits need to be judged with skepticism, on account of typical trumpeting of short term wins (and the subsequent ignoring of long term losses). These may be leaders of countries, but they aren’t super heroes. Governments won’t solve this debt crisis, and most likely this will result in another rise in prices for gold in 2012, quite possibly to the $2,000 per ounce level.
G. Joel Chury
ProspectingJournal.com
