by Amine Bouchentouf
While all eyes are now turning to Greece's weekend election, the problem has grown more acute than just one nation. The European crisis has entered a dangerous new phase that could make the 2008 financial crisis look like a walk in the park. For the last three years now, Europe has essentially been the walking wounded — it's not a matter of whether it's going to fall, it's a matter of when it's going to fall. And it looks like the day of reckoning is slowly creeping up on the old continent.
The Greek Situation
It's now dinner-table talk that Greece is insolvent and has no way of ever repaying its debts to international markets. What's even more alarming is that the austerity measures are not working, and they have actually exacerbated the economic situation in Greece. The country's GDP is contracting by double digits and there is no real industry or economic activity to prop up the country. Even worse is that tourism figures — a significant contributor to the country — are down to historic lows.
Some in the market argued (incorrectly as it turned out) that Greece's tourism sector would help the country get back on its feet. However, tourists — just like international investors — are completely spooked by what's going on in the country. Many tourists simply don't feel safe visiting the country, let alone spending time and money there.
The British Airport Association reports drastic drops from U.K. visitors to Greece, with figures reaching 12 to 15 percent declines. And it's hard to blame tourists for not wanting to visit. Riots are routine, government and official buildings are regularly attacked and burned, and the mood is simply tense and ugly. And to add literal insult to injury, just last week a member of Greece's Parliamentary Nationalist party slapped a female colleague on live television, an image that flooded media outlets around the world.
Faced with a dire economic situation, the country will be voting later this week on whether to remain in the eurozone. If Greece does, in fact, decide to leave the eurozone, default on its debts and re-establish the drachma as its currency, the impact on international markets will be catastrophic and unpredictable. There's also the potential for a domino effect that other countries may follow suit. Even if Greece opts for remaining within the confines of the eurozone, the situation is now much bigger than Greece and more lethal.
Dangerous New Turn
If Greece were a unique problem, it would present a quasi-insurmountable challenge to the European Union. Simply dealing with a case like Greece is proving to be an issue that none of the creators of the eurozone had envisioned. The existential problem now facing Europe is that Greece isn't the only problem. They're now faced with similar dire economic conditions in countries such as Portugal, Spain and even Italy.
During the last couple of weeks, the euro crisis entered a dangerous new zone. Spain, which seemed to be managing the crisis, began to implode and took center stage this month. The government acknowledged it would be missing its budget deficits for this year and next year as well. As a result, Fitch Ratings downgraded Spanish bonds by three notches, meaning the market has serious doubts that Spain will be able to honor its commitments. Surging yield on the country's 10-year bonds reaffirm the market's belief.
In addition, the government was forced to bail out one of its largest banks, Bankia, to the tune of 25 billion euros after it began facing a classic "run on the bank." But things didn't stop there as the Spanish government itself necessitated a bailout: Over the weekend, Spain accepted aid from the European Union to bail out its banking and financial system to the tune of more than 100 billion euros! Instead of comforting investors, the sheer magnitude of the bailout spooked the market, which sent those Spanish yields to record highs.
Plan Of Action
It's fairly clear that the market has lost confidence in the European economy and political situation. Europe is an integral part of the global economy and, if and when Europe goes down, it will drag down other economies and markets. Already we're seeing commodities at yearly lows as a result of decreased economic activity. Copper is flirting with yearly lows, and the price of scrap metal (a key indicator of industrial activity) is down 30 percent year-over-year.
Faced with uncertainty in Europe, I cannot recommend going long industrial commodities at the moment. The road ahead is too uncertain and the risks too great to make a high-level conviction for commodities right now. The most prudent strategy is an aggressive monitoring approach: Keep a close eye on events in Europe and monitor all news coming out of the region.
I will also make the case for gold bullion, gold certificates and gold ETFs, but it is hard to give an exact timing. If Europe does blow up, gold prices should drop initially, as investors will liquidate all risk assets. However, just like we saw in 2008, gold is a safe-haven asset for the long term and will eventually rebound.
The most suitable strategy at the moment is to determine when the crisis has reached a level dangerous enough for gold to stage a massive rally. Other than gold, I would remain underweight industrial commodities for the time being.
Disclosure: The author is long gold.