Germany Moving The Right Way

It now looks more than likely that Germany will recommend an increase in the firepower of the eurozone’s rescue facilities at Friday’s meeting of finance ministers.  Initially, Germany steadfastly refused to sanction such a move, among other things fearing that it would make peripheral countries less likely to implement austerity measures with such a safety net in place. In reality though, with yields rising in peripheral nations, especially in Spain, then there can be little doubt that this is the correct course of action. Furthermore, with international partners, such as the IMF, having strongly pushed the eurozone to do more to help itself, it’s going to put EU leaders on a far more favourable footing internationally. As such, the IMF and others will be that little bit more amenable to offering the eurozone support. Whilst some may have taken comfort in the recent perceived pause in the eurozone crisis, it’s fair to say that many problems still persist and the move up in Spanish yields, creeping up towards the highs of the year are a reflection of this.  More Spanish austerity measures are due to be announced later this week.  Not for the first time, the euro has been resilient to recent developments, standing nearly unchanged vs. the dollar over the past week. 

Commentary

Struggling gold. After ten consecutive years of gains, gold is definitely struggling. Since last September’s record high above USD 1,900 an ounce, the price of gold has fallen 13% to around USD 1,650. The price action over the past three weeks ought to be particularly troubling for the gold bulls, especially the precipitous USD 90 collapse on the final day of February and the continued steady decline since then. All is not lost for those who retain a bullish disposition towards gold, although if it breaks through the USD 1,522 low set right at the end of last year then it will spell deep difficulty. Unfortunately for gold, the circumstances that perpetuated such a prolonged and pronounced bull run are now less evident. The fear of systemic global financial collapse and currency debasement that has been around over the last couple of years has diminished. With US banks now much better-capitalised and the US economy apparently looking healthier, some confidence has returned to the world’s main reserve currency. At the same time, there has been an increase in appetite for growth assets, which has weighed on no-yielding assets such as G4 government bonds, cash and also gold. A very high equity risk premium is one of the major reasons for this year’s surge in equities. Unsurprisingly, gold stocks have significantly underperformed. The share price of Newcrest, one of the world’s largest producers of gold, has fallen almost 20% in the past four weeks. Separately, India recently doubled the tariff on gold to 4% – gold represents a staggering 14% of their imports, and India accounts for around 25% of global gold demand. As a result of the tariff increase, gold demand in the country has waned appreciably, and a huge number of proprietors who are involved in the trade have closed and/or gone on strike, at least temporarily. For their part, excessive demand for gold in India is contributing to a large and expanding trade deficit, so it is little wonder that the government is targeting gold. India consumed 993 metric tons of gold last year, compared with 770 tons in China, according to calculations made by the World Gold Council. If China were to join India in making it much more expensive to buy gold, and if confidence in fiat currencies continued to improve, then gold bulls really would have a problem.

Funny Friday in forex. Friday was something of an oddity in the forex market, with the euro attempting to reach the 1.33 level against the dollar only to fade as the weekend closed in. We also witnessed a further widening in European peripheral yield spreads vis-a-vis German Bunds. More than anything else, the price action experienced in recent days is yet another illustration of the extent to which established relationships have been breaking down over the course of March. Once the Greece issue was seen to be sorted out, European markets enjoyed something of a break from worrying about sovereign debt-sustainability and related issues. Italian 10yr yields were happy to trade around the 4.80%-level for most of the month, in contrast to above 7.00% at the start of the year, although in recent days they have drifted back above 5.0%. Thursday’s preliminary PMI data for both Germany and France shifted the focus back to the growth side, with the move back into recession in Ireland also not a supportive factor for overall sentiment in Europe. Even so, the single currency did not fare too badly last week, especially against the likes of the yen. Furthermore, these moves have taken place at the same time as stocks have corrected. The S&P is down 1.2% from the peak seen last Monday, something which would have been taken as dollar positive on the basis of past dollar-stocks relationships. March has shown that the rules of FX have changed substantially, for the euro, the dollar and beyond.

Spanish suffering. With Greece apparently ‘sorted’, the focus of investor angst is progressively turning towards Spain. Here, the 10yr yield is back above 5.5%, having traded below 5% periodically earlier this month. Yields have been climbing despite the ECB’s massive liquidity injection into European banks courtesy of two huge LTROs. The fact that yields are high/rising at a time of plentiful liquidity ought to be extremely troubling. Spanish PM Rajoy must be extremely frustrated by these recent market developments. He has vowed to implement a very stringent diet of fiscal discipline, including handcuffing the errant regional governments; he has embarked on ambitious plans to reform the sclerotic labour market; and he has ordered Spanish banks to properly provision for deteriorating property values. Unfortunately, the economy is conspiring against his best endeavours – Spain is back in recession, property prices are plunging, and unemployment is a crippling 23%. His problem is not unlike that of Greece – imposing fiscal austerity at a time of very high debt and with the economy already in recession. This brings the justifiable concern that his task is looking near impossible.  Finally, the weekend’s elections saw Rajoy’s People’s party fail to remove the Socialists in Andalucia, leading to further political disappointment for the current government.
 
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