A solution à la Cosa Nostra

One part of the business model of organizations belonging to the Cosa Nostra is to sell and to provide protection. However, what differentiates the mobsters from legal companies is that the mafia extorts protection money from unwilling customers by inflicting the damage, against which they are promised to get protected. Last Wednesday, Charles Dellara, the chief negotiator of the International Institute of Finance (IIF), a Washington DC based organization representing financial institutions, must have felt like a small shop owner in little Italy getting a visit from racketeers. Before the summit of EU head of states started on Wednesday, October 26, negotiations between the IIF and the EU on a higher voluntarily hair-cut for Greece debt reached a deadlock. At midnight, Mr. Dellara was asked to join the meeting of the eurozone head of states, where they faced him with the alternative either to accept a 50% hair-cut or Greece would default. Mr. Dellara accepted the lesser evil.

After the IIF agreed on a higher hair-cut, it took the eurozone head of states another four hours to reach a compromise on a package of measures. Banks will have to be recapitalized by a total amount of about 100bn euro. Also the EFSF, the European Financial Stability Facility, will be leveraged. Despite many details are still open, the financial markets welcomed the compromise.

However, it appears that the German finance minister Schaeuble is resistant against learning from past mistakes. Already after the EU summit in July, negative comments from Mr. Schaeuble increased the uncertainty among financial market participants and contributed to the rise of yields on peripheral government bonds and also a spill-over to the core countries. Now only two days after the summit ended, it is again Mr. Schaeuble warning against expecting too much from the summit. It would be a long way and many more summits would be required until the debt crisis in the eurozone is solved. Also outgoing ECB president Trichet sounded the same warnings in a newspaper interview.

Those warnings are counterproductive. Instead of giving the markets some hope that the crisis will be solved, those comments suggest that the worst might not yet be reached. Like Bill Clinton told former US president Bush senior in the presidential election campaign “It’s the economy, stupid” the German finance minister has to be told “It’s the market psychology, stupid”.

But the risk is not only that the financial markets might pare gains following the remarks from the German finance minister and the outgoing ECB president. The turmoil in financial markets during August and September had also an impact on business survey data. While real economic activity data remained resilient, the US GDP even grew stronger in Q3 than in Q2, expectations for future economic activity worsened, in particular in the eurozone. In the case that financial markets pare gains following the comments from the German finance minister, the already depressed business expectations could drop further. Then it would be only a question of time that falling business expectations also drag business activities down.

Gold posted the strongest daily gain last week on Tuesday after the press release that the summit of EU-27 finance ministers, originally scheduled to talk place a few hours before the summit of the EU head of states, was cancelled. Many market participants and commentators were confused by this headline. They did not realize that the decisive summit is the one of the head of states. Thus, even at Bloomberg TV, the commentator gave the initial impression that there would be another postponement of the EU summit and a failure to find a compromise for a solution. However, as it got clear that the summit would take place, gold defended the gains. Also stock markets pared losses. We interpret the recovery of stock markets on Wednesday and the rally on Thursday as the decisive factor that gold held the gains and even advanced further to close the week with a gain of more than 100$/oz compared to the preceding weekly close.

The outlook for gold and other precious metals will thus depend on the market reaction on the warnings from the German finance minister. If Mr. Schaeuble’s remarks lead again to turbulences in stock markets, precious metals are likely to be dragged lower. However, if the market will ignore him this time, then stock markets might recover further as economic data recently come in better than expected. This would also be supportive for the precious metals.