On Monday, Greece successfully attracted bids worth of EUR20bn for its syndicated loan issue, at spreads below the alarmist levels registered barely a week earlier. A collective sigh of relief resounded in European capitals, echoed by the market, equally encouraged by Ben Bernanke’s ‘guaranteed’ re-election vote tally.

Yet the Greek episode is worth considering from the perspective of a gold investor. Since the Greek deficit problems were first revealed to the market in late November, the trade-weighted dollar has strengthened 6%, Euro has lost 7% to the dollar and MSCI world equity index has lost almost 1%. Meanwhile, gold (in dollar terms) has lost 9%. The market’s disaffection with the Euro’s prospects has, by default, strengthened the dollar despite lingering doubts about the very sustainability of the US banking system and the rapid recovery of the economy’s growth engine – the home-owning, middle-class consumer.

Over the last year, bouts of dollar strengthening have been highly correlated with periodic returns of risk aversion. Indeed, since September 2008, the negative correlation between the performance of US equity market and the trade-weighted dollar has been maintained at over 50% – the longest such uninterrupted period this century. The bouts of stronger dollar were invariably negative for SPX index and for gold. Remarkably, the Greek episode and the subsequent wobble in Euro have changed this. The negative correlation between the dollar and the US equity market has now dropped to 30% – the lowest level since the Lehman Brothers’ collapse.

Fundamental analysts scratch their head over the dollar’s recurrent attractiveness and its gold-smashing power. After all, US deficit as a % of GDP is higher than most European countries’. US debt as a % of GDP is also heading fast towards the levels of more profligate European states. Even though EU may have been deeply troubled by the drama in Athens, the Greek economy represents less than 3% of Eurozone’s GDP, a small fraction of California’s 14% contribution to US economy, to mention only the most fiscally troubled of America’s States. Then, there is Washington’s political disarray – with popular backlash against an administration which inherited the worst recession in more than a generation, the unstable positions of both the US Treasury secretary and (until recently) the Chairman of the Federal Reserve, the stalled health reform, the dysfunctionality of campaign contribution system which further entrenches vested interests, the populist agenda targeting the Wall St banks, the widespread (and commonly resented) gridlock at the Congress and the public finances which will click at $1 trillion deficit per annum even before the Medicare problem and other entitlements kick in around 2019. But, much to chagrin of DeGaulle and his anti-American successors, the US continues to issue debt in what still is the deepest bond market in the world. For other central banks, the liquidity remains the chief attraction of the dollar. As the recent announcement of Russian Central Bank testifies, the diversification into other currencies (in this case Canadian dollars) has its limits – especially if you sit on half a trillion US dollars worth of reserves.

What is, therefore, the lesson from the Greek episode for gold investors? It remains the same. The bouts of dollar strength should be viewed as buying opportunities for gold. However, two words of caution are necessary.


For the first time since last August, gold in US dollar terms has now dropped to the 100 day moving average. If long liquidation continues, further support level would be reached at around $1036/oz. There are signs that it could. After briefly touching 17, last week the VIX index of market volatility jumped to 28. Although the index has since eased somewhat, in the process it broke through 200 day moving average, a technical event last observed in very different market circumstances in March 2009.

Secondly, further dollar volatility should be expected as the prospects of changing short term interest rate differential between dollar and euro change almost daily. But, outside China, where lending spree only intensified this month, the recovery remains brittle and the inflation expectations relatively benign. German economy unexpectedly stalled in the fourth quarter and the US data remain patchy. Even though the very poor US home sales in December (down 17%) could yet be reversed by new tax credits for the hobbled consumer, a bet in favor of higher short term interest rates in the US could be premature.

In dollar terms, gold is now over 10% off its December peak. In the drachma-fearing, weakening Euro, gold has barely lost 4.4%. If the dollar continues to strengthen in synch with further sell-off in the equities, the spread between the Comex gold price and the physical gold clearing price in Asia may close further, offering a healthy entry point for gold investors even before the seasonally stable second quarter. How quickly this happens will also depend on how robust gold sales will be ahead of the Chinese New Year, which this time falls unusually late in the calendar.

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Tags: Chinese New Year, euro, Greek deficit, US recovery, VIX