Yet another day where the bears were in charge, despite the fact that some European markets were shuttered for Ascension Day. European equities continued to slide, with losses generally ranging from 1% to 2%. Russia fared worse than most, falling by more than 4%. In the forex world, the dollar was again in the ascendancy; the euro fell under 1.27, cable dropped to near 1.58, and the Aussie traded through 0.99. Commodities were also under pressure, with Brent under USD 110 and aluminium prices down 1.5%. The overriding concern is that once Greece leaves the eurozone, to what degree will the contagion spread throughout the rest of Europe? Spain and Italy remain the elephants in the room – will depositors continue to flee to the north once Greece has fully defaulted? Meanwhile, European leaders seem exhausted and clueless, all recognising the apparent futility of attempting to have yet another summit which ends up in the same old cul-de-sac.
Greek deposit contagion. As is so often the case, it is usually an accelerated flow of money in a particular direction that forces the hand of policy-makers and elected officials. In the case of Greece, it is very likely that the flight of depositors from the local banking system will soon be the trigger for its departure from the eurozone. According to an article in today’s Financial Times, senior bankers in Athens claim that around EUR 1.2bn of deposits were withdrawn from bank accounts in Greece on the first two days of this week. It is worth noting that the deposit base in Greece has been contracting for some time – since the end of 2010, domestic deposits in Greece have fallen from close to EUR 240bn to around EUR 160bn currently, a decline of nearly one third. Greek depositors are likely to be further unsettled by the news yesterday that the ECB is not prepared to provide access to funding to undercapitalised Greek banks. Under the terms of the recent bailout, funds for recapitalisation are available and have been disbursed by the EFSF to the Greek bank recapitalisation agency, but as yet the funds have not been distributed. For those Greek banks without access to ECB funding, there is assistance from the Greek central bank; however, this also requires ECB approval and it is unable to authorise funding for banks that are insolvent. Given the accelerated pace of deposit-outflow, it is entirely plausible that one or more Greek banks might soon run out of the money required to discharge its liabilities. Without additional assistance from Europe the government in Greece may be forced to intervene and start printing drachmas. This process may not be too far away. If Athens is forced to go down this route, then Greek banks will default on their loans from the ECB and the latter will require huge sums from other European governments (many of which do not have much money) in order to become properly recapitalised. The dominos are starting to fall more quickly now.
Slowing pace of gold demand. The data on Q1 gold demand from the World Gold Council - although a little dated - makes for interesting reading nevertheless, especially in light of the latest price developments. It’s the official sector purchases that are of most interest, given that these tend to be more volatile than the more stable investment and jewellery demand, which is driven primarily by India and China. Although central banks and other official institutions were still adding to gold in Q1, the pace of purchases (81 tonnes) was the slowest for five quarters and came predominantly in the end of the quarter (mainly Russia and Mexico). It was back in Q4-10 when official purchases last fell globally and, although gold prices were still on the rise during this period, the pace of gains did slow. The question is whether official purchases could turn negative once again in the current quarter. Furthermore, judging by the latest Fed minutes from the US, there remains a reluctance to push for further QE in the US or extend ‘Operation Twist’, both of which, to varying degrees, have worked to push the dollar lower. Both reduced the likelihood of QE and the trend of waning official sector-demand is likely to add to the downward pressure on the gold price in the coming months. As we’ve pointed out previously, gold’s long-term uptrend has been broken and, in dollar terms, it’s nearly 20% off the highs seen in September of last year. By all accounts, gold has certainly lost its shine.
Fed on heightened alert. Notwithstanding the more reassuring recovery signs evident thus far in 2012, asset markets are far too complacent regarding the need for additional monetary accommodation from the Fed in the second half of this year. This discussion around additional Fed stimulus may seem slightly premature given the performance of the economy over recent quarters. There is little doubt that some parts of the economy are doing much better than they have done for years. Just yesterday, it was reported that housing starts jumped 30% in the year ended April, although activity remains well below the peak of 2006. Boosted by rising auto output, industrial production jumped 1.1% last month, the largest MoM gain since late 2010. In the labour market, the unemployment rate fell to 8.1% in April, the lowest for more than three years. Operation Twist completes at the end of next month so Fed officials certainly have time on their side before planning any further policy initiatives. Recall that the Fed purchased some USD 2.3trln of bonds and other securities (referred to commonly as QE1 and QE2), and it has committed to maintain the overnight bank lending rate at near zero until late 2014. At this stage it is premature to rule out further QE from the Fed over coming months.