HardAssetsInvestor

Written by Sumit Roy  |

October 25, 2011

Precious Metals Monitor: Gold Breaks Out After Hitting $1700, Watch Italian Yields After EU Summit

Details

Gold rally above $1700 may continue as long as financial markets remain stable.

Precious metals prices surged today ahead of a key summit of EU leaders on Wednesday. Policymakers have promised to reach a comprehensive solution to solve the eurozone debt crisis at this meeting. Whether the divisions between member countries can be bridged to reach a consensus solution remains to be seen, but for now, markets remain hopeful as evidenced by the S&P 500 stock index, which is near its highest levels in over two months ahead of this key event.

As for precious metals, they are in the process of breaking out to the upside after successfully testing key support levels last week. As we wrote in the last edition of Precious Metals Monitor, gold and silver dips to near $1600/oz and $30/oz, respectively, may act as compelling buying opportunities. And indeed, we saw the metals bounce right off those levels.

With the EU summit less than a day away, it is easy to assume that the outcome will determine where precious metals go from here. But barring a complete debacle, we believe that the summit will not provide much in the way of surprises for investors.

That is because the framework of the “comprehensive solution” has already been known for some time now. That is, Greece’s debt will be reduced to more manageable levels; a bank recapitalization plan will be unveiled; and the European Financial Stability Facility (bailout fund) will be enhanced.

More telling will be the reaction in sovereign-debt markets once the official details of the plan are released. In particular, Italian and Spanish bonds should be closely watched for signs of relief or distress.

Yields on Italian and Spanish 10-year bonds stand uncomfortably high at 5.95 percent and 5.54 percent, respectively. Italian yields look particularly concerning as they stand at the highest levels since early August, when they hit a euro-era record near 6.4 percent. That’s even after the European Central Bank purchased €4.5 worth of sovereign bonds last week, up from €2.2 the week before.






A major spike in Italian and Spanish yields will be negative for all risk assets, including precious metals. That will bring significant systemic risk back on the table. Instead, a scenario where Italian yields stay elevated but contained may be the best outcome for precious metals, as it represents a “kick the can down the road” scenario. At the same time, financial markets will remain stable, giving investors confidence to deploy capital into risk assets such as gold and silver.

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