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European Sovereign Debt Crisis Deepening - Risk of Contagion and Bond Market Crash

|Includes: SPDR Gold Trust ETF (GLD), SLV

There is a real sense of the “calm before the storm” in markets globally. Complacency reigns, despite signs that the sovereign debt crisis in Europe is deepening and that Japanese and US bond markets also look very vulnerable due to rising inflation, very large deficits and massive public debt. 

Gold in Japanese Yen – 6 Months (Daily) GoldCore
Gold in Japanese Yen – 6 Months (Daily)

The unfortunately named PIIGS have seen their bond yields rise sharply again in recent days. Greek, Irish and Portuguese bonds in particular have come under pressure on concerns of deepening economic contractions and possible defaults.

Greek bonds fell for a ninth day after a report showed the nation’s economy shrank for a 10th consecutive quarter. In less than 2 weeks, the yield on the Greek 10-year has risen sharply from 10.804% to 11.750%.

Greek 10 Year Bond Yield – 1 Year (Daily) GoldCore
Greek 10 Year Bond Yield – 1 Year (Daily)

Irish two-year notes fell sharply this morning, pushing the yield to the highest since the introduction of the euro in 1999. The yield increased 10 basis points to 7.26 percent in London after jumping as high as 7.56 percent. The Irish 10-year yield rose three basis points to 9.26 percent.

Peripheral sovereign bonds remain under pressure despite considerable support and outright purchases by the ECB. GoldCore
Ireland Government Bond 10 Year – 1 Year (Daily)

Sovereign debt issues are not confined to the eurozone and there is a real risk of the contagion spreading to other large debtor nations, including Japan and the US.

A Japanese minister denied overnight that there was any chance of a Japanese default on their massive government debt. Japanese bond prices came under selling pressure with the yield on the 10 year rising to 1.36% and gold prices in Japanese yen rising to JPY 115,000 near the recent nominal record of JPY 118,000 seen in December (see charts above and below).

Gold in yen terms is still more than 25% below the nominal high of 30 years ago which should give those calling gold a bubble pause for thought.

Gold in Japanese Yen – 40 Year (Quarterly) GoldCore
Gold in Japanese Yen – 40 Year (Quarterly)

US Treasuries have been sold by some of the largest investors (both private and sovereign) in the world recently (see news). These include large creditor nations Russia and China but also PIMCO, the largest bond fund in the world.

The estimated cost to service the US National Debt of $14.09 trillion is $240 billion for fiscal year 2011 alone. The US national debt now equals the value of the entire US economy in GDP terms.

This is making investors nervous and they are rightly demanding and will continue to demand higher interest rates for the increased risk of financing the US’ unsustainable fiscal and monetary policies.

The Obama administration’s budget is seen by many as being optimistic in the extreme based as it is on the hope of rapid economic growth after two years of sluggish growth. The unpartisan Congressional Budget Office however does not share that optimism and thinks that the economy will continue to struggle.

A global sovereign debt crisis is now quite possible. At the very least, we are likely to have a long period of rising interest rates which will depress economic growth.

Contrary to some misguided commentary, rising interest rates will benefit gold as was seen when interest rates rose sharply in the 1970s. It was only towards the end of the interest rate tightening cycle in 1980, when interest rates were higher than inflation, that gold prices began to fall.

Gold’s importance as financial insurance and the fact that it cannot go bankrupt or default will also be increasingly important in the years ahead.

As ever, it is best to be optimistic but realistic and to hope for the best but be prepared for less benign scenarios by diversifying accordingly.


Gold is trading at $1,372.00/oz, €1,015.62/oz and £854.62/oz.


Silver is trading at $30.72/oz, €22.74/oz and £19.14/oz.

Platinum Group Metals

Platinum is trading at $1,372.00/oz, palladium at $835.00/oz and rhodium at $2,400/oz.