Gold torn between euro weakness and the Greek debt crisis

The ECB prepared the markets for a rate hike in July at its monthly press conference and the euro lost about six cents versus the US dollar to 1.41 within a few days. If the sell-off were triggered by profit taking according to the old market adage to buy the rumors and to sell the facts, the impact of the stronger US dollar on Gold should have been negative. One would have expected that gold would give back a bigger part of the gains made before. However, this was not the case. The weakness of the euro against the US dollar was not triggered by profit taking, but by renewed fears of a Greek default on its national debt.

Partly, the drop of the euro could be blamed on the continuing protests in Greece against the austerity policy. The Greek government is trying to push the sixth saving package through parliament. However, the Greek government is in an uphill struggle like Sisyphus. The more they try to save, the more the GDP contracts and the debt to GDP ratio increases, which leads to further downgrades by the rating agencies. The agencies are part of the problem as they pour gasoline in the fire and prevent the fire-brigades from EU, ECB and IMF to extinguish the fire.

However, also the German government is more part of the problem then the solution. German academics have demanded to let Greece default and restructure its debt. The finance minister resisted this siren calls and rightly pointed out that it could lead to collapse of the financial system like the bankruptcy of Lehman Brothers. But suddenly, he changed his course and demanded that the private sector would have to make voluntarily a considerable contribution to a second bail-out package for Greece as it is rather unlikely that Greece would be able to obtain funding in the capital markets next year given the high interest rates in secondary markets and poor ratings by the agencies, which keep the outlook still on negative.

The ECB fears that the demand from Germany could trigger the credit event clause as the rating agencies already threatened. In this case, all Greek debt outstanding could be demanded to be redeemed immediately. In addition, the ECB would no longer be able to accept Greek government debt as collateral in the repo operations. This could trigger the default of banks in Greece. Fortunately, Germany has softened its stance after a meeting between German chancellor Merkel and French president Sarkozy in Berlin last Friday. This gave the euro a push higher and gold also profited from this move.

Also the politicians in Greece play a crucial role. The troika of IMF, EU and ECB demanded that also the opposition would back the agreement between Greece and the troika. However, the opposition party, which was responsible for the ballooning budget deficit between 2004 and 2009, is not willing to cooperate. They demand tax cuts, a measure the troika will not accept. Furthermore, the conservative opposition creates the illusion among the population that the austerity policy would not be necessary to avoid a default on the national debt and a collapse of the financial system. Thus, the support for the policy of the PM is decreasing. After a government reshuffle, the PM faces a confidence vote after this blog is published.

In the case that the PM of Greece will survive the confidence vote, the flight to the save haven of gold might ease somewhat. But in this case, the euro should strengthen versus the US dollar, which would be a positive factor for gold, especially as the diverging monetary policy in the eurozone and the US point to further dollar weakness. In the case that the development concerning Greece get worse, the euro might come under renewed pressure, but the impact on gold might be compensated by safe haven buying. In the short run, it looks like gold remains torn between these two opposing forces.