Why The Safe-Haven Bid For Gold Is Not Coming

Includes: GLD, PHYS, SLV
by: Boris Mikanikrezai

This article asks the question of why the yellow metal is not rising while the US debt ceiling deadline is on October 17 and the US government shutdown has already begun since October 1.

First, about the shutdown

The gold's reaction has been in line with its reaction in the past. According to a recent Barclays report, "looking at gold's immediate price response following the 17 occasions of government shutdown since 1976, on average, prices have risen a modest 0.3% on the first day of the shutdown; on Tuesday, prices fell by 3.1%. In the week before the shutdown, on average, prices have fallen by 0.4%; this time, prices are down 1.4%". Consequently, investors should not be surprised by the fact that gold has not reacted that much to the US government shutdown.

Second, about the debt ceiling crisis

In this case, the gold reaction has been more disappointing. Indeed, during the previous US debt ceiling crisis of 2011, gold surged sharply.

Gold during the US debt ceiling crisis of 2011

Gold during the US debt ceiling crisis of 2013

Source: Stockcharts

As seen above, gold (NYSEARCA:GLD) rose by a whopping 12% from $1,486.50 on July 1, 2011 (one month before the US debt ceiling deadline) to $1,665.60 on August 3, 2011 (the date when The Treasury increased the national debt by $238 billion).

This time, from September 17, 2013 (one month before the debt ceiling debate), gold has risen slightly by 1.50%. Why do gold reactions seem to be so different?

(1) During the summer of 2011, gold was not only influenced by the US debt ceiling debate but also by the Sovereign debt situation in Europe. As a matter of fact, gold continued to push much higher after the Debt Ceiling Agreement was reached on August 2, 2011. Gold rose by roughly 15% from $1,665.60 on August 3, 2011 to $1,920.00 on September 6, 2011 as demand for gold ETFs (NYSEARCA:PHYS) surged significantly. Meanwhile, silver (NYSEARCA:SLV) rose slighltly by 2.50% during the same period.

Investors need to remember that July 2011 was a phase of renewed tensions in the Eurozone. On July 13, 2011, Moody's cut the sovereign debt rating of Portugal to A1. On July 23, European banks undergo "stress tests" to evaluate their ability to absorb losses in the case of greater financial turmoil. Of the 91 institutions tested, 17 barely pass and 7 fail.

Then, the situation became worse in August.

Let's start with a few critical events. On August10, the Bank of England cut its 2011 growth forecast for Britain due to a deteriorating in global growth prospects. On August 24, Standard & Poor's cut the sovereign debt rating of Ireland to AA-.

Now let's take a look at the Credit default swaps (CDS) in Europe to better understand how aggravated the situation became. As seen below, in August 2011, the CDS exceeded levels observed in May 2010 (Phase 1 of the crisis). Moreover, government bond volatility shot up to levels not seen since the aftermath of Lehman Brothers in September 2008 and Eurozone government bond spreads over German bonds surged.

Source: Bloomberg

Today, even though the Eurozone crisis is not yet over, the mood seems to be positive. Indeed, the European Commission reported on October 4 that Eurozone morale rose for fifth month in row, reaching a 2- year high in September.

If we look at the CDS in the Eurozone, we can see that the current situation is far better than in the summer of 2011.

Source: Bloomberg

(2)One of the biggest catalysts for gold was the fact that Standard & Poor's downgraded the US's AAA credit rating on August 6, 2011. This could also justify the strong rally in gold even though the US avoided default. The move undermined investor confidence in the US economy and the US dollar's reserve currency.

Today, it seems to be quite different as Marie Cavanaugh, S&P's managing director, said recently that the standoff over funding the government and increasing the debt ceiling limit is "unlikely to change" Standard & Poor's US credit rating.

To sum up

I still believe there is more room for gold upside because the looming US debt ceiling is a bullish factor for gold.

Nonetheless, the upside potential for gold should not be as big as it was during the summer of 2011 (+30% from July 1, 2011 to September 6, 2011) because first we are seeing optimism in Eurozone and second the odds of a US credit rating downgrade are small.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.