Wow, the market is unpredictable. While the S&P 500 and its tracking exchange traded fund, SPY, has risen nearly 20% from the summer lows of 2011, and stocks such as Apple (AAPL) are up over 30% in the last year. Still, the recent sell-off in most of the broader indexes has been brutal.
I wrote several weeks ago that Gold was ready to make a big move. My reason for thinking that gold, and its tracking exchange traded fund, GLD, would continue to rise, was because I thought governments and Central Banks would likely step-up fiscal and monetary actions as the growth outlook continued to deteriorated. While all traders have good calls and bad ones, gold spiked nearly 5% in the next couple days, and has held up over the last month, even as the dollar has risen and most major commodities, such as oil, have continued to be weak.
As we can see, while gold prices have remained weak over the past several months, gold prices have consistently moved higher over the last month, and another reverse head and shoulders pattern has formed.
This is why I thought it was interesting read the recent commentary about how the price of gold is overvalued. Several commentators, such Jack Albina, CIO of noted bank and wealth manager Harris bank, claimed that with deflation and falling asset prices, gold was likely 15-20% overvalued.
Obviously, well most major commodities such as oil and copper, have risen significantly over the last decade. Still, oil and agricultural prices have been steadily declining for nearly two months, and its obvious that with the 10 year treasury pricing in a 1.5% yield, and the TIPS market pricing in 0 inflation over the next year, most traders and investors are pricing modest to low near-term inflation expectations.
This is why I think it's so interesting that gold prices have held up very well over the last month, despite the significant deterioration in the growth outlook, and near-term inflation expectations. While, obviously gold has traditionally been very heavily correlated with inflation, the gold market seems to be already pricing in further fiscal and monetary action.
This past week the largest recent bailout of a banking system in 3 years was announced, and few traders and investors think the $100 billion dollar pledge to Spanish Banks will be the last of several likely continued bailouts of the PIIGS and these country's banking systems, since Spanish yields have only minimal since the recent bailout was announced several days ago.
The recent $100 billion dollar pledge to the Spanish banking system now brings the total amount of money pledged by the EU and IMF, since 2010, to $500 billion dollars.
What is most interesting to me about this recent $100 billion dollar pledge, is that it isn't funded, and Italy, whose bonds are trading at unsustainable rates, is suppose to fund 22% of the bailout. Obviously, Italy cannot continue to borrow at 5% to lend money to Spain at 3%. It is almost as if since the EU has pledged this money Spanish banks can write checks with money these financial institutions don't have until the ECB and Euro-Zone member nations actually provide the funds. While, obviously, the ECB wouldn't make a commitment of this size without the financial backing of the Euro-Zone member nations, it is also likely that the IMF, which already a huge holder of Greek debt, likely signed off on this recent bailout package as well.
If the ECB is going to continue to propose massive new bailouts, EU member nations will likely obviously have to provide better funding mechanisms for future bailouts. With the European economy having deteriorated significantly over the last several months, recent downgrades of Austrian and German Banks, and major G-8 nations such as Italy seeing its debt trade at unsustainable levels, the market is obviously expecting this money to need to be borrowed, since the ECB doesn't have the power to print money.
Currencies do not have to depreciate because of money being circulated right now. If China and the U.S., through the IMF, begin to backstop the ECB and provide liquidity to Europe, the markets will likely price in a significant devaluation of most major currencies because the continued increase of the money supply. These massive bailouts be needed if the money was never going to be circulated, and just because money is not lent into the economy, doesn't mean a massive increase in the money supply should not devalue a currency.
Also, while debt to GDP levels in the U.S. are dropping today, and growth in China remains weak, putting pressure on leading industrial commodities such as copper, China's growth rate is still expected to be in the high single digits, and U.S. spending levels are not coming down. The recent jobs data in the U.S. has been poor as well, despite recent solid earnings reports from Companies such as GE, Caterpillar (CAT), and Citigroup (C).
Essentially, while the pressures on gold prices are coming from an increasing dollar and weak commodity prices because of lower growth expectations in the U.S. and most emerging markets, these are likely to be short-term trends. Long-term, the U.S. dollar will likely remain weak because of the demographics of the U.S. population, and the country's nearly 16 trillion dollar debt.
Also, if the IMF continues to backstop European debt, it will likely put pressure on the dollar as well, since the U.S. is the largest contributor to the this monetary organization. Also, Europe being China's biggest trade partner, China is also likely to being significantly involved in continued IMF efforts in Europe as well.
Even though money is not aggressively being lent into the economy today, and most leading commodity prices continue to drop, gold prices are likely reflecting the increase in money being printed, as well as the likelihood that governments and Central Banks around the world will likely continue to back stop each country's respective debt. If the Euro-Zone debt crisis becomes a global debt problem, the dollar will not likely continue to rise.
The gold market appears to be pricing in a lack of confidence in governments and Central Banks around the world. Demand for the treasuries and the dollar has been strong up to this point because of the belief that the Europe faces a European debt crisis. However, Italy cannot continue to borrow at 5% to lend money to Spain at 3%, and if the IMF is forced to continue to get increasingly involved in backstopping the ECB and Euro-Zone member nations, the dollar is not likely to remain a safe heaven.
To conclude, the rally in the dollar and current decline in prices of most major commodities such as copper and oil, has prevented gold from rallying significantly over the last several months. Gold has fallen since the beginning of the year, still countries such as China continue to be net buyers, and individual spending on gold is higher year-over-year.
With most emerging market economies such as Brazil and China seeing a significant deterioration in these country's growth outlook, contagion from the European debt crisis appears to be building. With the IMF likely to continue to provide liquidity to the ECB, the European debt crisis could quickly begin to look like more like a global debt crisis in the coming months.