HardAssetsInvestor

Written by Sumit Roy  |

September 07, 2011

Precious Metals Monitor: Double Top In Gold?

Details

Although the ECB struggles to contain the European sovereign debt crisis, gold runs out of steam for the second time above $1,900.

After falling off the radar for almost a month, European sovereign debt concerns reignited in a major way this week. In turn, we saw gold briefly surge to a record high on Tuesday, though prices have backed off those levels since then.

News that the European Central Bank settled 13.3 billion euros ($18.8 billion) worth of sovereign bonds last week spooked financial markets. That figure was above the 6.7 billion euros of the week before and well above expectations, suggesting that the ECB had to make increasingly large purchases to keep yields down. Already, the central bank has purchased 129 billion euros worth of primarily Italian and Spanish bonds since Aug. 8—a pace that is not sustainable.

In response, we saw a spike in Italian and Spanish interest rates. The 10-year bond yields for those countries spiked as high as 5.65 percent and 5.33 percent, respectively, on Tuesday. For much of the past month, those yields were stuck near 5 percent as the European Central Bank's purchases kept interest rates relatively low.

Though still below the euro-era records near 6 percent set in early August, the recent spike is concerning. But will it continue? That depends on how aggressive the ECB is with its purchases. Without the central bank in the market, yields would certainly be higher — probably much higher. In turn, the eurozone’s fourth- and fifth-biggest members would likely find themselves in a similar situation to Greece, Ireland and Portugal before them — in need of bailout funds.

But the funds necessary to bail out Italy and Spain would almost certainly overwhelm the remaining capacity of the 750-billion-euro Financial Stability Facility (European bailout fund). Thus, without the ECB in the market, there is a likelihood that the European sovereign debt crisis would head for a catastrophic outcome.

Until the troubled European governments get their finances in order through a combination of budget cuts and increases in revenue, the situation is unlikely to stabilize anytime soon. Weak economic growth is only complicating matters by depressing tax revenues and boosting welfare payments.

But in the meantime, the ECB is in the market and will do all it can to keep the situation under control. Markets will be watching the weekly figures on ECB bond settlements to see how much firepower the central bank is using to keep yields down.

As for gold, the yellow metal remains extremely volatile. We saw prices set a new record of $1921.15/oz. — slightly above the previous record of $1913.50 — before selling off sharply. From a technical perspective, it now looks like the metal may have put in a double top just above the $1900 level.

Does that mean gold is set to fall precipitously from here? Not necessarily, but a retest of the recent lows near $1700 is not out of the question. In any event, pullbacks may be considered good opportunities to accumulate positions. Gold’s long-term fundamentals remain extremely bullish.

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