Gold’s Euro Link: Short-Term Traders Beware

Bullion Vault
Will a threatened Euro affect the Gold Price? Short-term traders beware…!

JEAN-CLAUDE TRICHET, head of the European Central Bank, this week dismissed talk of Greece exiting the Euro as their national currency, writes Julian Phillips of the Gold Forecaster.

The fact that Trichet felt it necessary to issue such a statement meant that the prospect was being discussed outside the European Central Bank. The European Union is considering sanctions against Greece to bring it into line. Stress is high in the Eurozone!

Short-term traders in the gold market, particularly those in the US Comex Gold Futures market, should take heed. They have traded on the back of the Euro/Dollar exchange rate pulling the higher when the Dollar fell, and pulling it down when the Dollar rose. But if there is a danger of any part of the Eurozone splintering off from the 16-nation currency union, then the Euro would weaken heavily. And it may well occur when the Dollar is weakening, too.

With both currencies weakening at the same time, the market rates would give a semblance of stability to the exchange rate, and so persuade short-term traders not to move the .

This relationship would belie the dangers to the currency world. Which way would you jump with your Gold Investment?

Like the perceived ‘link’ between the oil price and gold, a relationship that was abandoned by short-term traders when the oil price spiked and then fell by almost four-fifths in mid-to-late 2008, the inverse relationship between the Dollar and gold likewise is based on poor fundamentals. It is also due to head the same way.

When gold "de-couples" from its Euro/Dollar link, gold rises with the Dollar, as it did in late 2008 and early 2009, throwing traders into a near-panic. Will you be ready when this happens again?

In 1999 the Euro arrived in the global monetary system to great fanfare. The Deutsche Mark disappeared; the French Franc disappeared alongside many other European national currencies, including the Greek Drachma. In their place, came the Euro.

What happened in reality was that the days of fixed exchange rates returned without the hassle of different currencies. Diverse economies in the Eurozone were joined together without national boundaries, allowing trade funds and capital to flow unfettered by European borders. As a result, the strong got stronger and the weaker more vulnerable to these flows. But many benefits have come with the system, as employment opportunities abounded and a pool of cheap labor was able to access jobs all over Europe. Capital flowed to where it was used most efficiently.

In addition, the strength of the zone has grown enormously as it became an economic bloc bigger than the US in population and hopes to equal and outrank the States economically in the future.

But what did not happen with the arrival of the Euro was a change in national cultures and national economic "shapes". Spain still gained its growth from being a holiday country, like Greece. Germany with its remarkable engineering and high quality manufacturing enhanced its economic power within this zone, drawing to itself new markets within Europe. All went well until the credit crunch when national pressures hurt the poorer Mediterranean nations in particular, such as Greece (downgraded thanks to its huge budget deficit) and Spain (where unemployment is now at 20%).

The rules of the Eurozone were meant to be so strict that each nation had to comply with a set of Balance of Payments criteria, ensuring a healthy economy in the face of capital flows. But these rules were broken and economic pressures grown. The clash between national economic behavior of the past and these rules has not been diminished, for as always, national interests are placed before Eurozone interests.

But the Euro in the last decade has established itself as an accepted currency having gained the confidence of its users there and abroad. Backed by 15% minimum gold levels, it is deemed a sound currency.

Is the Euro structurally sound? The success of the last decade tells us that it is. But it wasn’t until the last two years that it faced any crisis. We are told that the full reported impact of the ‘credit-crunch’ is not known, but that it is far more severe than thought.

Eastern Europe’s debts are still capable of destroying European banks. Talk that Switzerland is facing unbearable strains in its banking system because of these debts abounds still. It is clear that from the European Central Bank down, institutions are struggling to cope with the crisis and rectify their balance sheets away from public eyes.

Whether the monetary union will survive or not is not the point. The point is that the Euro is visibly another ‘paper’ currency that is vulnerable, just as any other is. Within the Eurozone it will survive many crises, because there is no alternative on the street. A look at Zimbabwe tells us just how far a people can be made to use a currency that has lost credibility, but outside it, its use is more sensitive and reactive to the confidence it inspires.

Even at its inception doubts surrounded the Euro. Joining together a group of nations with such a long-term, divisive history, stretched credibility when they vowed monetary cooperation under one currency. Political action and assertiveness, when national interests are at stake, made us feel that this Eurozone is weak. If a Euro crisis really struck, few doubt that national interests would overwhelm Eurozone ones.

The European Parliament rulings will only be accepted when it suits each member, but what if it doesn’t? That’s why talk of Greece leaving the zone has arisen.

Is the Euro under stress? Yes, but not yet at a point where member nations would withdraw from the union. It will come under more and more pressure though as the pressures facing the Dollar show themselves to be the same against the Euro. The sapping of manufacturing strength from the US is also happening to Europe. These problems are bound to continue over time until China is the economic driving force worldwide. The Socialist nature of Europe will delay the pain, but it will come.

There has to be a point when the Eurozone rules are broken to such an extent that the ECB has to act against member nations. To date this has not happened because breaches of those rules have been ‘managed’ (i.e. ignored). But the day when they are too great a set of breaches is on the way. Then what?

History shows us that the wealth structure of Europe has been as it is now for many decades if not centuries. Old money is not as patriotic as it may seem. It may not be that mobile, but the liquid portion of that money is, and it is certainly not nationalistic. Pragmatic money will find a safe home so it can survive.

A look at the time zones in which each gold market is situated helps us to appreciate when the citizens and institutions of those blocs act in the gold market. Asia is active from the time the US closes through the night. Europe opens at around 0700hrs GMT. The States starts dealing at around 1300 hrs GMT (1 hour before the doors of the New York markets open).

With the gold market running 24-hours a day, moves in the tell us which way each one is facing. A phenomenon of the last year has been to see the Asian and Middle Eastern markets lifting the ahead of Europe. Without pushing the up too much, you can see the vigor and lack of it during these times. More and more frequently rises have begun in Asia with Europe following through.

But ‘old money’ wealth is well spread across the globe, particularly in Europe and the UK. Nevertheless, it is apparent that gold is being favored more and more by such wealth. Europeans are at the forefront of the expected investment demand poised to enter the gold market in 2010.

They don’t have to wait for a Euro breakdown or lesser crisis; they will act ahead of it. They won’t chase prices; what’s the point? They want to Buy Gold in volume and with such a scant supply of it, relative to paper currencies; it is too easy to chase a price up without getting the volumes you want.

So yes, a ‘threatened’ Euro will affect the .

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