Gold reached new record highs, but what’s after a compromise to lift the US debt ceiling?

Last week we wrote, there were indications that gold might consolidate. However, this was not the case. Gold already rose to a new record high on Monday. The reason was that both parties in the US congress failed to reach a compromise over the weekend. There was not only a disagreement between the parties but also within the Republican Party. Members of the Tea Party wing in the House did not support the bill of House majority leader Boehner. A vote in the House had to be postponed to Friday, which strained nerves of already jittery investors further. After the House passed the bill, it was immediately rejected in the Senate with the majority of the Democratic Party. Gold reached a new record high on Friday at 1,631$/oz but closed below the high of the day.

At the time of writing this blog article, ABC has reported that both have reached a last minute compromise. The fundamental opposition of the Tea Party supporters has indeed elevated the risk that no compromise might be found to lift the debt ceiling right in time. However, on the other hand, financial and commodity markets also appear not to understand the rules of political bargaining. If a subject is treated rather emotional and less rational, like the public debt, then agreeing on a compromise too early could backfire. Political leaders could be criticized by there own supporters as being too soft to the other side. And given the deep rift within the Republican Party, Mr. Boehner, could not accept a compromise before the last minute.

According to the unconfirmed ABC report, the debt ceiling would be lifted beyond the presidential election in 2012 and more than 1 trillion US dollar budget cuts should be implemented over the next 10 years. Lifting the debt ceiling beyond the 2012 presidential election as demanded by president Obahma should be a time span long enough to calm financial markets. The stock market might rebound after suffering last week on fears of a possible default of the US Treasury. If economic data released during the coming week is not preventing a recovery of the stock markets, then money might flow back into risky assets. However, this time gold is probably not profiting from flows into risky assets. Investors might take profit on some of the gold bought since the start of July.

However, gold had not only been bought as a safe haven because investors feared a possible default of the US Treasury. A main reason was also the debt crisis in the eurozone and the threat of a contagion to Italy. After the EU leaders agreed on a rescue package at the summit on July 21, it lasted less than one week that the crisis is back on the radar screens of investors and traders. If there would be a reward for stupid comments and demands, German politicians would lead the nomination lists. First, Germany’s demands pushed up the yields on bonds of the peripheral countries. After finding a compromise that also the European Financial Stability Facility should be allowed to buy Greek debt in the secondary market, which is essentially a participation of private investors to fund the rescheduling of Greek debt, German finance minister Schaeuble wrote in a letter that the EFSF should be allowed to buy bonds only if the ECB approves the purchases in the case of financial turmoil. This comment pushed yields of Spanish and Italian bonds higher. Thus, a debt auction of Italy the same day disappointed the markets and the yield on 10yr Italian BTPs rose over the 6% level. The rise of yields on peripheral government bonds was another factor that gold reached another high last Wednesday.

As Germany’s government is sabotaging a solution of the eurozone debt crisis, the downside risk for gold appears to be limited.

Economic data released in the US last Friday disappointed. The US GDP growth in the second quarter was only 1.3% annualized while the consensus was looking for a growth rate of 1.8%. However, even worse was the downward revision of GDP growth in Q1 from 1.9% to a mere 0.4% annualized. The US Treasury market rallied and the yield on 10yr US T-Notes fell to 2.80%. The bond market speculates that the Fed might embark on QE3. However, the GDP deflator rose stronger than expected at 2.3% and the rise for the previous quarter was revised up from 1.9 to 2.5%. Also the PCE deflator increased. Data for the core PCE, the Fed’s favored inflation gauge, had not been released last Friday. However, it looks that QE2 was successful in pushing the core inflation rate towards the target. Thus, another round of buying US Treasury paper by the Fed might not be at the agenda of the FOMC. Therefore, another push for gold by QE3 appears less likely at present