Gold and the Euro

Euros and Gold Bars

Gold and the Euro

 

Fiat currencies, like the US dollar and the euro, are an image of the economic and political well being of a nation. Trust and marketability of a fiat currency is dependent on the success or failure of the country that emits it. Gold, silver, copper derive their trust and marketability from their physical properties.

Many in the cryptocurrency world, but also many gold bugs, believe gold is money because it is rare. But gold is not rare. Other metals are much rarer. If gold was rare it would not be money. Quantity of money should be sufficient for global population to use it in exchanges. Copper was money with gold and silver for as long as gold was and it is not rare, on the contrary it is abundant. Gold supply for thousand of years grew but at the same rate as global population. The historic rate of gold inflation (new gold mined) is about 1.6% (0.4% in 2016) which is about the same as the world population growth (1.13% in 2016). Gold production per population growth in 2016 was 1.25%.

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We had the Donald Trump election shock that ended being bullish for the US dollar and bearish both for gold and the euro. Now we have an Emmanuel Macron win in the French election in the European Union. What effect if any will they have both on the euro and gold and why?

Initially Trump’s election was bearish for gold and the euro and bullish for the US dollar. What convinced investors to become bullish on the US stock market and the US dollar was not only the election of Donald Trump but more the win of both senate and the house of representatives by the Republicans. Assumption was that a Republican president with a Republican senate and a Republican house of representatives will work together and pass without difficulty pro market laws. It was an incorrect assumption that ignored US politics. Already under normal circumstances in US you don’t have party discipline in support of the government as in most other countries. Often Republicans vote against a Republican president and vice versa with a Democrat president. It was also an ignorance of the antagonism that exists between Donald Trump and the Republican party. A false assumption also was made that Donald Trump will be a Ronald Reagan and we will have a repeat of 1980s. Never less, a Trump bubble started with a drop in the price of gold and a rise in the US dollar and the stock market.

At the same time an existential crisis in the European Union (EU) was going on in 2016 accentuated by the immigration crisis caused by the civil wars in the Middle East and North Africa. Several EU elections and UK’s Brexit referendum questioned the existence of the EU and the euro area. This uncertainty discredited the euro in favor mostly of the US dollar but also the Swiss franc, Japanese yen and gold. However, despite the positive outcome in favour of Brexit, the euro did not drop as much as it should have and that I expected. Looking at the quarterly official forex reserves data published by the International Monetary Fund (IMF) it was evident that the Russians and the Chinese, who hold large amounts of euros as official foreign exchange reserves, were not selling and therefore supported the euro.

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Before and after Brexit on several occasions both Russia’s president Putin and China’s president Xi expressed their preference and support for a “strong” EU and the euro. Despite its existential problems since its introduction in 2002, the euro is up 24% versus the US dollar. Gold did a lot better and was up 354% during the same period.

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Some of the money that run out of the euro went into gold, Swiss franc and Japanese yen and not into the US dollar indicating clearly a loss of safe haven status not only by the euro but also by the US dollar. IMF data shows gold allocation in official international (foreign exchange, gold, SDR) reserves increasing since the 2008 financial crisis.

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I didn’t expect too much impact from Brexit on the euro because the UK was not part of Schengen nor of the euro area. However, the French election was different. First, Marine le Pen had good chances to win and second and most important, she made the election specifically a quasi referendum both on the EU and the euro. France is not a marginal member of the EU but at the core and principal cofounder with Germany of the EU. One of them leaving the EU would have produced the collapse of the EU and the euro. Election of Donald Trump in the US gave a boost to the anti EU/euro movement in Europe at first but soon after the election he became a major liability to the anti EU/euro movement.

All those geopolitical events were bullish for the US dollar and bearish short term for the euro but also to lesser extend to gold. It was however evident to me that the Trump euphoria would not last and that Donald Trump was no Ronald Reagan nor was the US economic and political environment the same as in 1980. In December, I stated that I expected the Trump bubble to burst by April/May and it did.

Information also was clear to me that the EU will not collapse and that support in France for leaving the EU and the euro was very low. Polls constantly showed 70% support for the euro and 60% for the EU in France but also through out the EU. French presidential election confirmed. At the same time, chaos in US after the US election and Trump’s actions hurt far right anti EU/euro political parties. Social unrest in US was my prediction for 2016/17 when nobody was predicting it. Polarisation was deep in the US before the election and continues. Donald Trump did not unify the country after the election but on the contrary, he is polarising and dividing it even more. Popular vote in November was split 50-50 with a slight advantage to Hilary Clinton despite a clear electoral win by Donald Trump.

My January outlook for 2017 was bearish on the US and the US dollar and bullish EU and euro and also Russia and the ruble. However, I said that then that I did not expect the euro and gold to move up before April/May. This was the time when I expected the Trump bubble to burst and it looks like I will be proven right. Euro started to move up after the first round of the French election and continued after the second round and gold is now braking out of the 2013 down trend. A break of the gold price in US dollar above $1,350 will confirm the already break out to the upside in gold priced in euro and SDR.

I expect now that the EU/euro existential crisis is over with the massive win by the pro EU/euro Emmanuel Macron in France a change in attitude towards the euro by world central banks and foreign exchange markets. I also expect the percentage of the euro in official foreign exchange reserves to increase slightly. Still, I believe gold will be preferred over the euro.

But don’t ignore the problems of the international monetary system that affect all fiat currencies including the euro and the US dollar. This is very bullish for gold versus both the US dollar and the euro. Don’t be fooled by the apparent correlation between the euro and gold. It is only temporary as you can see in the long-term charts below.

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If we look at a chart of gold in Special Drawing Rights (SDR) which is an index of five major fiat currencies (US dollar, EU euro, British pound, Japanese yen, Chinese yuan) then we can clearly see that gold increased in all fiat currencies since 2000 but lagging in US dollars.

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Gold priced in an index of currencies of the 20 largest economies by GDP shows gold up 447% versus all currencies since 2002 while it was up 368% in US dollar.

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Gold price in SDR already broke to the upside negating the hypothesis that we were in a correction within a major bear market and rather confirms my long-held hypothesis that we are in a correction within a secular bull market in gold.

Since the SDR was redefined as a basket of currencies in 1973, rather than approximately one gram of gold (0.888671 grams), the SDR lost 97% of its value in gold.

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Social unrest and political chaos in US will intensify while it will diminish in the EU shifting pressure from the euro to the US dollar. This favours the euro, swiss franc and gold. However geopolitical problems and a reset of the international monetary system favor a continuation of the gold bull market in all currencies that started in 2000, including the best of them the Swiss franc.

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No need of advance math to see from all the charts that the correlation between the euro and gold is weak and temporary. Since US election however it was very strong as you can see in the chart bellow.

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When money run out of the euro in 2016 it went into US dollar, Swiss franc, Japanese yen and gold. When money will run out of the US dollar it will run into euro, Swiss franc, Japanese yen and gold. But in a major financial crisis and reset of the international monetary system it will all run into gold. Silver as poor man’s gold will also benefit and so too platinum but to a much lesser extend.

 

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