Gold prices hit a new high above $1600 on Monday as a result of a powerful cocktail of economic uncertainty, difficult US deficit ceiling negotiations, European Union sovereign debt concerns and the threat of contagion to the banking sector.
Taken singly, the US debt ceiling impasse or the ongoing EU sovereign debt crisis would be sufficient to trigger a gold rally. But together, the affect on gold prices is even more bullish, as investors become wary of USD and EUR assets and seek a safe haven in gold. Based on this, we believe the bullion rally is likely to continue until tangible progress is made on relieving at least one of the sovereign debt issues.
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On Friday, the results of a stress test of European banks were released. Eight of the 90 European banks surveyed by the European Banking Authority failed the stress test, well below market expectations, that as many as 15 lenders would need more capital to withstand a prolonged recession. In spite of massive bailout packages being discussed by the Euro Zone Leaders in Brussels next week, the Euro zone still looks very unstable and Italian and Spanish government bond yields have risen sharply. Ongoing uncertainty over the ability of European officials to agree on a second aid program for Greece and stop contagion from Greece's troubles spreading to other countries such as Spain and Italy continues to worry investors.
The European debt crisis is definitely not going to go away. If Greece defaults then it seems likely that Ireland and Portugal would follow suit almost immediately, and then the pressures on the much more significant economies of Italy and Spain would be close to overwhelming. European banks could crash and with the interconnections within the global banking system, many non-European banks could collapse as well.
The market's focus now appears centred on US economic issues, with slightly less emphasis on EU sovereign risk issues. Congress must raise the $14.3 trillion limit on America's borrowing by 2nd August or the government will run out of money to pay all its bills. The White House and Republicans are wrangling over spending cuts and higher taxes in addressing how to bring down the deficit.
The longer the US debt-ceiling talks drag on, the more supportive they are for gold. If agreement cannot be reached on raising the ceiling and, failing a Presidential "bending of the rules", the U.S. itself could go into technical default in two weeks' time and the psychological financial repercussions of this could be enormous. One suspects that a compromise will be reached at the 11th hour, but if discussions continue beyond the deadline, the United States could be stripped of its top-notch credit rating.
Gold is re-emerging as an international store of value and investors and individuals who recognise this will continue to buy gold bullion. It seems that in these times of tumultuous change, more people and banks around the world are becoming less comfortable holding dollars and would rather invest in gold.
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