Regardless of what was discussed on the European policy maker party line on Wednesday, investment markets are still signaling that a Greek default is imminent. While Greek 2-year government bond yields came down from over 84% early in the day, they still closed essentially at Tuesday's level of 75%. As a result, it remains worthwhile to continue considering the implications of a Greek default on investment markets. In a post on Tuesday, I explored the potential impact on the stock market. This post will focus on gold.
I have been bullish on gold for some time. My primary thesis for owning gold remains intact, which is global currency debasement and competitive currency devaluation along with the persistent instability associated with financial crisis.
The events surrounding Greece should strengthen this thesis regardless of whether the country is bailed out or goes into default. If the eurozone comes together to bail out Greece, this implies the potential for continued fiscal instability and aggressively easy monetary policy in the months ahead. And if Greece defaults, this has the potential to lead to suddenly sharp currency devaluations along with unanticipated after shock effects that could motivate investors to shift toward safe havens such as gold. So from a secular perspective, gold should continue to receive support regardless of how the Greece situation plays out.
The larger question becomes what type of short-term shocks could we see for the gold price in the event of a Greek default. After all, gold is among the most liquid investments. Thus, if financial firms and/or hedge funds are forced to enter into a massive deleveraging, gold would likely be among the first assets thrown overboard in the liquidation process.
Looking back over history including the events surrounding the financial crisis in late 2008 is instructive in determining exactly what we might expect.
Gold began a secular bull market nearly a decade ago. Starting in early 2002, U.S. policy makers shifted to a weak U.S. dollar policy. And from that moment on, gold has steadily rallied. Almost continuously from early 2002 up until the financial crisis in 2008, gold as measured by the SPDR Gold Trust Shares (GLD) was locked in a sustained uptrend, including well tested support at its 300-day moving average (blue line on chart).
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Gold suffered a sharp pullback once the financial crisis descended on investment markets in 2008. After grazing the $100 level on the GLD on March 17, 2008, gold pulled back to $85 before making another run at the century mark in July 2008. The fact that gold rallied so sharply from August 2007 to March 2008 and was trading well above its 300-day moving average made this mid-2008 price consolidation not at all unexpected.
But from July 2008 on, gold entered into a sharp correction. It quickly sliced through its 300-day moving average support by August 2008. And after breaking this level, its next major support was at $69 on the GLD (orange line on chart), which had previously been a major level of resistance throughout 2006 and 2007.
The events that followed for gold were turbulent. After slicing through its 300-day moving average in August 2008, gold continued to decline through mid September, falling by -19%. But when Lehman Brothers collapsed, gold began to rally sharply higher for the rest of September and into October 2008, reclaiming the 300-day moving average along the way in posting a +16% advance. But gold then rolled back over once again, declining by -22% over the next month into early November 2008. Along the way, the GLD held convincingly at its $69 support level on two separate occasions.
Once it found its footing, a new major gold rally commenced. After bottoming in early November 2008, gold soon reclaimed its still upward sloping 300-day moving average. By early 2009, its 150-day moving average also turned higher and gold quickly took hold of this trend line for steady support over the next three years through today.
So what went on during this period of gold turbulence from August to November 2008? During this time, financial institutions were under enormous pressure to raise capital in order to survive. And as discussed in a previous post, many firms tossed gold overboard first given its liquid nature. But once the dust settled, opportunistic investors swiftly moved in and began purchasing gold at its suddenly discounted price. Thus, those investors that were able to tolerate the short-term turbulence in gold during the depths of the crisis in late 2008 have been handsomely rewarded in the years since.
Gold was not unique in experiencing this outcome in the days after the crisis. U.S. Treasury Inflation Protected Securities (TIPS) were also sold off dramatically in the post crisis liquidation, which is shown by the iShares Barclays TIPS Bond ETF (TIP) in the chart below. These along with nominal U.S. Treasuries are considered among the safest havens during times of crisis. And just as with gold, opportunistic investors stepped in after the liquidation process was complete to buy TIPS at deep bargain prices. These investors were also rewarded for maintaining or adding to positions during this difficult stretch.
Applying the Lessons Learned
The factors supportive of gold outweigh those that are against it. If Greece is bailed out once again, gold should continue to enjoy upside. And if Greece enters into a default that is managed in an orderly way where impacted financial institutions are not forced into massive deleveraging, this should also be supportive of gold.
The key episode that would likely lead to short-term turbulence in gold would be a disorderly Greek default. In this case, massive liquidation selling in gold could be expected over a period of days if not weeks. During such an event, maintaining a close watch on major support levels will be critical. For example, a -15% decline in the gold price would bring the GLD back to its 150-day moving average, which has been reliable support for the last three years and has proven an ideal entry point. And a -22% decline would push the GLD to its 300-day moving average, which provided reliable support for years prior to the financial crisis and would also represent an attractive purchase price. Both of these moving averages also happen to reside at previous resistance, which provides added strength to these support levels.
As a result, any liquidation selling associated with gold should not necessarily be viewed as a reason to panic but instead a potential buying opportunity. And maintaining a close watch on major support levels may provide particularly rewarding long-term entry points if they are reached along the way.
Disclosure: I am long GLD, TIP.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
