Gold-EUR Correlation on the Rise

Montreal, Canada

Gold prices continue to maintain a negative correlation to the U.S. dollar ever since former U.S. President, Richard Nixon, closed the gold window in August 1971. That relationship will always remain negative because gold represents real wealth and a true inflation-hedge while the dollar is backed by absolutely nothing, except U.S. printing presses and more than $14 trillion of national debt. Gold is real wealth, the dollar is not.

But over the last 12 months and since the advent of the Greek credit crisis, gold prices have witnessed a greater correlation to the EUR and less to the dollar. This is perhaps explained by the ongoing uncertainty pervading across European debt markets and whether or not the Germans will eventually raise the bailout ceiling for peripheral eurozone deadbeats.

European Debt Crisis

German banks have more than $510 billion dollars in outstanding loans to Ireland, Greece, Portugal and Spain; the political will to finance additional bailouts is obviously enormous and the future of the Franco-German éntente depends on its outcome. So does the future of EMU, or European Monetary Union.

Measured in EUR terms, gold prices peaked in early December and have since declined 9% as the EUR has mustered yet another rally. Credit spreads across Europe have declined markedly this month, especially in Spain, as the Zapatero government vows to tackle the massive bad loans plaguing its Cajas. Portuguese spreads have also declined while those in Ireland and Greece remain high compared to benchmark German bunds.

After the dollar, the EUR is the world’s second de facto reserve currency among central banks. That trend has been in place since the mid-2000s as more central banks sell dollars for the EUR. I think that’s the equivalent of drinking vodka compared to whiskey; if consumed enough, both alcoholic beverages will intoxicate. The reference point here is that neither the dollar nor the EUR should be viewed as safe havens. They’re littered with deficits.

A real safe haven should harbor no debt, no foreign claims against its sovereign assets and remain outside the confines of the credit system. No currencies represent this framework, with the exceptions of China, Norway and Switzerland.

Global debt has exploded over the last three years to the tune of $41 trillion dollars compared to $10 trillion dollars in 2008, according to The Economist. The debt super-cycle, as coined by Montreal-based Bank Credit Analyst, is definitely approaching the point of bust, unless governments get a grip on spending. And that’s unlikely to happens until world markets force the issue down their throats.

This year, the Europeans will need to raise $3 trillion dollars to finance or rollover existing debt, according to the Institute of International Finance. That’s not small change.

Unless the European Central Bank (ECB) can remain active behind auctions and finance a good portion of this debt, some sort of dislocation seems imminent. I have my doubts the crisis is over and highly recommend buying gold and Swiss francs if you’re EUR-based at these lower levels ahead of the next explosion.

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