There is significant political turmoil around the globe. The Eurozone is struggling with slow growth, weakness in the Italian banks and uncertainty about Donald Trump's policy toward NATO.
Gold has traditionally been a good hedge against political uncertainty, so the metal's poor performance is surprising at a time like this.
The real issue is the U.S dollar because when the dollar is strong gold is weak. Is this dollar strength justified and how long will it last?
I believe the dollar's strength is warranted and the Italian referendum may lead to more gold losses because weakness in the Eurozone will cause investors to flee the currency and boost the dollar index.
The Italian Referendum
Italy will have a referendum on its constitution this Sunday, the 4th of December. The proposal is aiming to streamline the nation's government and reduce political gridlock.
There are two reasons why this referendum may hurt gold prices if it passes.
1. The left-wing prime minister of Italy has promised to resign if the vote passes. His departure opens the doors for right-wing, Euroskeptic parties to gain a greater share of power.
This transfer of power may lead to Italy holding a vote on whether or not to remain in the eurozone - needless to say, the loss of such a large economy would be a deathblow to the monetary union.
2. The Italian banks are in a serious mess. These banks currently hold 1/3rd of all the bad debt in Europe and they need a bailout.
If the vote passes and the Italian government is replaced with a populist, anti-establishment party, will these banks be able to secure the money they need to survive?
Gold and The Dollar
In general, gold will move inversely to the dollar, and it is very hard for the metal to rally when the dollar is strong. This chart shows the component weightings of the dollar index.
As we see here, strength in the dollar depends disproportionately on weakness in the British pound and the euro.
For this reason, any boost in gold that comes as a result of problems in Europe will be defrayed by the resultant boost to the dollar index that comes from weakness in the euro. I think my thesis is proved by the short-lived gold rally following Brexit. The Brexit rally faded because dollar strength defrayed the political uncertainty.
If the Italian referendum passes, it will have an adverse impact on gold prices because it would hurt the euro and boost the dollar index as a result.
This may be a good opportunity to short the SPDR Gold Trust ETF (NYSEARCA:GLD).
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