How Europe Will Help Gold Shine Again

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The Good News: The euro crisis has failed to explode in the last three years, in spite of repeated predictions that it would. Many commentators now rejoice that the problem is solved.

The Bad News: Don't believe it. While a few of the countries have made steps toward recovery, there are still several that haven't, and, by and large, those that haven't are larger than those that have.

As always with European crises, the summer should be a quiet period as everyone puts aside these dire economic issues and goes on holiday. But there will be more fireworks after September's German election, when tough decisions will be made.

And that's why gold (and select emerging markets) remain strategic holdings in smart investors' portfolios.

Europe's Rogues Gallery

Greece is the worst basket case, and will almost certainly need bailing out again.

In spite of a drop in GDP of a full 25% since the start of the crisis, it is STILL expected to run a balance of payments deficit this year. That's worrying.

If you push an economy into a giant recession, you expect it to have trouble balancing its budget because government revenue declines and welfare spending increases. The Economist magazine's panel of forecasters expects Greece to run a budget deficit of 5.3% of GDP this year.

However, the balance of payments works the opposite way – a giant recession means domestic consumers can no longer afford foreign goods, while exporters can cut wages and the cost of supplies and make themselves more competitive.

In 2008-09, Latvia suffered a brutal recession while its currency was linked to the euro – but its current account swung from a deficit of 15% of GDP to a surplus of 10% of GDP. Latvians, unlike Greeks, are good at austerity, but the recession itself helped them solve their balance of payments problem.

Greece's failure to solve its own problem indicates that the economy is truly a basket case and that new debt is very unlikely to be repaid.

Cyprus, Greece's little brother, is still descending into the maelstrom following its banking crisis. Judging by the Greek example, there will be further crises here also.

On the positive side, Spain and Portugal both have sensible governments, which have done much of what they need to do. They have had bad recessions, and even 2014 is projected to show flat GDP in both cases, but both countries' balance of payments has swung positive, and the 2013 budget deficits are below their peaks in spite of the recessions.

Provided both countries' volatile electorates don't do anything stupid, and state spending cuts are extended into 2014, both countries should be growing again and stable by the second half of next year.

Italy's electorate, on the other hand, already did something stupid by electing the socialists in February, with a strong showing for a comedian who has refused to join any coalition.

The current account is about in balance, but unlike in Spain and Portugal, spending restraint was pretty conclusively defeated. (Mario Monti, the austerity candidate, got 8% of the vote.) What's more, Italy will almost certainly have another election within the next six months – where almost anything could happen.

Finally, France is locked into a government that is bitterly opposed to austerity and wants to tax its most productive citizens at rates which, taking income tax and wealth tax together, exceed 100%.

Already, the state absorbs more than 55% of GDP and that proportion is rising. Naturally, both trade and budget balances are negative and getting worse. Yet the bond market still does not recognize the problem; 10-year French Treasury bonds "OATs" still yield less than British or U.S. Treasuries.

There are two possible routes to the next Euro crisis.

One: An economic crisis in one of the staggering euro members, probably France or Italy after the German election (any crisis before then will have money thrown at it by the European Central Bank).

Two: A general tightening of credit, which appears to be beginning in the United States and could easily spread to the world as a whole, as confidence in central bank bailouts disappears.

In that case, problems in the Eurozone that are now simply chronic will become immediate, as finance for the weak sisters will no longer be available. That route to disaster is unlikely in 2013, more likely in late 2014.

One way or another, the Eurozone has not finished with crisis, and the most likely outcome remains a breakup of the euro.

For us, Asia, the better parts of Latin America and even Africa look better than ever, as does gold.

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  1. Clay Montgomery | June 27, 2013

    I have investments in both silver and gold funds and have watched them drop dramatically and am now starting to worry. After reading your column my confidence is up in regarding to holding on the these funds. I hope your advise holds true. It seems that the IMF and the Fed have been hell bent of destroying gold and silver investments.

    • Martin | June 27, 2013

      Don't believe it….when the great deflation finally hits the fan (or whatever they hit), ALL commodities will sink to near oblivion as everyone scrambles to cut their losses and pay down their debts. Short-term, yes, Gold etc. may rise a bit, but very unlikely to approach the highs of 2011 again for decades

  2. atiyya | June 27, 2013

    GOLD IS GOING NOWHERE BUT DOWN SO SELL NOW.

  3. DD | June 27, 2013

    I just wish America would STOP implying they're exempt from all of this. This country has 10s of trillions of true debt and has yet to face the FACTS about this.

    As Peter Schiff says "Europe is just the warm up, the US is the grand finale" and I agree with him.

    Please STOP making out Europe is in a worse place – they are NOT! What is happening there WILL come here only much worse! It will be a choice of paying off the debt for next several generations to come or the US Gvt WILL start WWIII (this is the plan), but it's still Main Street that will choose in the end on what they want to do and will end up paying for it either way – the Gvt, Elite's et al will sit back, watch on and enjoy the show!

  4. Dick | June 27, 2013

    If this scenario comes true and it may, gold will rise in the beginning because the FED will have to react. Now, is Merkel going to shut the spigot? I'm no so sure. Europe survived because of the huge stimulus launched by the FED (US relative strength kept Euro export alive) and have a lot of room to work. Furthermore, if Japan keeps easing, they'll have to follow, German or not. Finally, Merkel is tight because of the elections; German's public is not really in favor of bail outs. After the elections, she'll have freer hands.

  5. Anonymole | June 27, 2013

    $/Gold/silver are ruled by the U.S. Fed and right now they have a conflicting dictum: keep the dollar as the world's reserve, yet keep the dollar cheap enough (QE) so that it continues to fuel the U.S. economy (and makes it easier to pay debt with cheap dollars.)

    If gold rises and becomes a worthy replacement for the US$ (dollar falls) then that's a problem.
    If the dollar rises (gold falls), interest rates rise, which curtails econ growth, and that's a problem too.

    So what do they do? They play devil's (the rich) advocate and artificially suppress the price of gold by selling naked shorts in the market. This drives the small investor out of gold, keeps the dollar artificially elevated (when all of this QE should see the dollar plunge), and lets the rich quietly gather up physical gold at severely reduced prices.

    As soon as table is set, it will turn, sending the dollar through the floor and gold through the roof. But not before all the small time investors are caught on the wrong side of the trade.

  6. enthusceptic | June 27, 2013

    I can only see that fundamentals will finally catch up with the market, and gold and silver prices will rise. All the funny money will one day be cut down to its real value.
    Is the fall in gold and silver prices connecte to all the QE – blow the fog horn? That´s above my pay grade.

  7. JJ | June 28, 2013

    People seem to be forgetting that China has a massive stockpile of gold. It is unlikely that they will watch their investment fall much more. Not impossible, but unlikely. The current gold price is simply a result of gold market manipulation. Gold will rise again, fall again, rise again… those who are controlling the manipulation won't shoot the golden cow or allow it to be shot by others.

  8. Roberthorse | June 28, 2013

    The question is how long can this PM market manipulation by corrupt and non-transparent governments and banks go on for in a world where such practices appear to be increasingly accepted. The World Gold Council [ha ha], the PM mining industry, and the mainstream media [who treat recent take-downs as logical trends rather than crimes which regulators -ha ha- purposefully ignore] remain silent when 100's of investors, who made a commonsense decision based on their delusion of free markets, are being shafted in this process.

    Ultimately of course PM will reach their true market value but will any of us older guys live long enough to see it?

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