Gold Volatility Here to Stay in Battle Between QE and Austerity

(Reuters) – What kind of investor is rewarded, when they get what they ask for, with losses? A gold buyer, it seems.  The price of gold has fallen to $1600 per oz, a loss of about 15 percent from its August peak, as austerity has become almost the default setting for fiscal policy and as central banks, notably the European Central Bank, have declined to take forceful steps to stimulate.

While there are many variations, the essence of the argument for gold is that it provides insurance against the bad faith of others, principally in the form of deliberate debasement of a currency. Gold has been described as an anti-currency, because, unlike dollars or yen, it cannot simply be summoned into being, as currency is during quantitative easing. Gold is also, the theory goes, protection against profligacy by governments, which again ultimately may bring on inflation or otherwise devalue a currency.

Those fears, driven by extraordinary central bank action and growing government indebtedness, helped to more than double the price of gold since the onset of the financial crisis.

The irony is that, at least for now, the run of events is moving away from gold enthusiasts’ worst fears, undermining the price of the precious metal.

Take Europe, where there have been widespread calls for the ECB to support monetary union and head off a disastrous breakup by monetizing Italian and other weak governments’ debt through direct purchases.

It’s not going to happen, ECB officials maintain. “The treaty specifies very closely what our remit is, namely ensure price stability in the medium term.,” ECB President Mario Draghi told the European Parliament on Monday.

“The treaty also forbids monetary financing and we want to act within the treaty. I think that to take any other behavior that would somehow breach the treaty would also negatively affect the credibility of our institution.”

Draghi also said in a weekend interview that spreads between German and weak Italian and other bonds were driven, in essence, by their respective fiscal policies.

“This suggests that the ECB adheres to the view widely held in Germany that the interest rate differentials reflect fundamental market assessments rather than panic,” economist Christian Schulz at Berenberg Bank said in a note to clients.

“The central bank is not prepared to take decisive measures to defuse the crisis beyond its massive support for banks and continues to leave the resolution of the confidence crisis to governments.”

Depending on your view of the world that is good or bad news, but it is unequivocally bad for gold, as it lessens the chance of a major money printing operation in Europe, one that might drive the Federal Reserve to respond in kind.


Also significant is the extent to which austerity as a strategy has become embedded in much economic thought and action. The concept of not “overspending” to combat a downturn lies at the heart of the proposals to rescue the euro project, as member states will be far more limited in the deficits they may run.

Draghi emphasized this on Monday: “You need to have this austerity, you need to have control of your budgets.”

Britain too is making its own experiment in austerity, while the early results from Ireland’s efforts to starve itself into shape are disappointing, to judge by a 1.9 pct contraction in its economy last quarter.

And it’s not just Europe. In the U.S., which still faces a massive unemployment problem and a sluggish economy, disquiet among legislators sympathetic to the Tea Party threatens to derail a plan to extend long-term unemployment benefits and a cut in payroll taxes.

Again, for good or ill, austerity now seems to be the base position against which others must argue, the default option. This is a tremendous change from only a year ago, and one which is hugely negative for gold. After all, insurance that can be bought second by second is bound to be hugely volatile in price. We saw that on the way up for gold, and we are seeing it on the way down.

There are, to be sure, plenty of ways gold could rocket back up. The ECB talks tough, but the plans of the nations they hope will rescue the euro do not inspire much confidence. If it’s really a crisis of existence, will the ECB sit back and allow a fracture? And what will be the reaction of policy makers and central bankers globally to the waves of deflation that will flow from Europe’s chosen austerity?

Either way, gold should continue to be highly volatile, a good indicator of how uncertain we are, collectively, about the solution to our economic fix.

© Thomson Reuters 2011 All rights reserved


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