Gold prices hit $1,740 this morning in a reaction to positive news out of the Euro zone. EU leaders endorsed new framework of a treaty which would implement a deficit control mechanism. This is an important step toward financial stability in the region.
By Mike Getlin
January 31, 2012 11:21 AM EST
International Business Times
Gold prices moved decisively higher this morning, reclaiming $1740 per ounce as silver added about 25 cents to reach $33.75. These moves come in reaction to positive news out of the EU, which caused some light selling in the US treasuries market.
EU leaders endorsed the framework of the new treaty yesterday which would implement a deficit control mechanism by which member states must maintain balanced budgets. Though this is clearly an important step toward financial stability in the region, it does not address the current reality of the staggering debt loads carried by many member states. As such, the agreement also includes the establishment of a roughly $650 billion permanent, full-time bailout fund. Of all the EU member states, only two abstained from the new agreement.
As we navigate increasingly strange global markets, it’s becoming more and more apparent that the Europe situation will continue to take center stage through the coming months. Greece must make a 14.5 billion euro bond payment on March 20th to stave off default. The funds to be used for this are part of a bailout package, the terms of which are still being furiously debated in Athens. EU representatives (lead by German influence) are demanding deeper write downs of existing Greek debt and even more spending cuts. The outcome of these negotiations will determine whether or not Greece defaults on its obligations, and likely whether or not Greece maintains its participation in the currency union.
At this point, positive news for Europe is positive news for gold. A solution in Greece would bolster the euro and prove to the markets that the EU is capable of dealing with its debt crisis in a way that supports long term confidence in the stability of the union. The strengthening euro would put sell pressure on the overbought US dollar, which would in turn drive gold higher. As all members of the European common market have a significant stake in the success of the Greek bailout, it seems increasingly unlikely that a default will be allowed to take place. Even the Germans know they are better off conceding some of their demands than watching Greece fall completely apart. Thus it’s likely that sometime between now and March 20th, an agreement will be struck that will do significant damage to the dollar and will thus push gold higher.
The question then is what happens if we’re wrong, and Greece does default. This is a much more difficult situation to model, because there would be two competing forces acting on the gold price. At first, a Greek default would batter the euro and drive the dollar higher in the short term. This could put sell pressure on gold. The only problem with this assumption is that it does not take into consideration the possible increase in demand for gold as a general disaster hedge. Flight to safety buying in this scenario could push gold much higher (cleanly over $2000 per ounce) even with a stronger dollar.
Then there is the question of what happens to the dollar after the dust settles. Sure the dollar could enjoy a period of high demand as people flee any exposure to the crumbling euro zone. Over the longer term however, a collapse in the EU economy would be catastrophic for our economy here in the US as well. Trade would shrivel, international investment would essentially cease, and US exports would be as good as dead. Does this sound like an environment where the US dollar could sustain high valuations? Add to that the fact that election year politics are hardly likely to yield any action to combat the growing deficits here at home, and you start to see how $2000 per ounce gold could just be the starting point from which the real run occurs.
Mike Getlin is Executive Vice President of Merit Financial, home to America's fastest growing physical gold IRA company. Please send comments or questions to meritprofiles@gmail.com.
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