As More Cracks in the Eurozone Emerge, Investors Buy More Sovereign Debt Instead of Gold

It seems that investors have shrugged off the latest developments around the world, in particular the Eurozone and are looking for direction from the US Federal Reserve. In the meantime, gold prices struggle for a firm direction as investors remain on the side-lines awaiting the next event that will propel prices upward. However, the events are unfolding right before their eyes, even though prices continue to trend slightly lower.

After an April 20 meeting during the IMF-World Bank Spring Meetings in Washington, a joint statement  issued by the G-20 and the IMF’s policy-setting International Monetary and Financial Committee (IMFC) said there are firm commitments to increase resources available to the IMF by more than $430 billion. The statement added that these resources will be available for the whole membership of the IMF and not earmarked for any particular region.

Over the weekend, the Group of Twenty (G-20) advanced and emerging market economies, along with the broader IMF membership, agreed on pledges to boost the institution’s lending capacity by more than $430 billion. IMF Managing Director Christine Lagarde told a news conference April 20 that the new commitments would almost double the IMF’s lending power. Lagarde said. “These resources are being made available for crisis prevention and resolution and to meet the potential financing needs of all IMF members.” She also stated. “They will be drawn only if they are needed, and if drawn, will be refunded with interest.”

Evidently, the total amount of $430 billion of extra contributions to the fund includes $200 billion from the Eurozone, $60 billion from Japan, $15 billion from South Korea, $15 billion from UK, $15 billion from Saudi Arabia, $10 billion from Sweden, $10 billion from Switzerland, $9.3 billion from Norway, $8 billion from Poland, $7 billion from Australia, $5.3 billion from Denmark, $4 billion from Singapore and $1.5 billion from Czech Republic. In addition, $68 billion has been secured from the BRICS countries and some middle-sized economies. However, the exact amounts have not yet been revealed. The final amount from BRICS will be announced at a G20 meeting in Mexico in June. Russia has already said it will commit $10 billion. Although the initial goal of Lagarde was to raise $600 billion, she has managed to double the IMF’s current resources of $485 billion to above $1 trillion as a result of this fund raising campaign.

Even though Spain has an economy shrinking at an annualized rate of at around –1.75%, high unemployment (24% unemployment), and an insolvent banking sector, on Tuesday last week the Spanish government managed to sell 3.18 billion euros in 12-month and 18-month Treasury bills, higher than the planned 3 billion euros. However, the cost of borrowing increased slightly when compared with previous auctions. The yield for the 12-month T-bill was 2.62% compared with 1.42%, while the yield for the 18-month paper was 3.11%, up from 1.715% in a previous auction.

In a second bond auction, held last Thursday, Spain managed to sell EUR 2.54 billion of 2- and 10-year bonds yesterday reaching the maximum target of EUR 2.5 billion. The yield on the 10 year bond rose to 5.743%, which was up from the previous 5.403%. And, the yield on the two year was 3.463%. Demand was solid with bid to cover ratio for the ten year bond at 2.42 times, bid-to-cover ratio for the two year bond was at 3.28.

Today, Spain’s short-term borrowing costs nearly doubled at an auction of 3- and 6-month Treasury bills as investors demand ever higher premiums while the government struggles to convince markets it can control its finances. The Treasury sold 725 million euros ($951.53 million) of the 3-month bill and 1.2 billion euros of the 6-month bill. The average yield on the 3-month bill was 0.634, up from 0.381% while the 6-month bill cost 1.580% compared with 0.836% a month ago.

Spain’s debt costs have surged in the last month and yields on the 10-year bonds have climbed to over 6% in the last couple of weeks as investors fear for the sustainability of the country’s economy.

In the meantime, Italy paid a full percentage point more than a month ago to sell 3.44 billion ($4.5 billion) euros of zero-coupon bonds at an auction on Tuesday. It paid 3.36% on its two-year fixed-rate bond, up from 2.35% a month ago – reflecting investors growing concerns about Italy and Spain’s finances.

Even though Spain has been able to raise money through its debt auctions, its financial woes have not gone away.  Investors are now focusing on the latest data from the Bank of Spain that shows Spanish banks are burdened with about 176 billion euros of “troubled” real estate assets and that 21% of the 298 billion euros of loans linked to property developers are non-performing. . Spanish banks will also need to set aside EUR 53.8 billion to meet the new real estate rules. Banks will take provisions of EUR 29.1 billion and create a capital buffer of EUR 15.6 billion. Despite the increase in the country’s bad loans, the yield on Spain’s 10-year bond fell to a 1-1/2 week low of 5.72% on optimism over the bond auctions.

To make matter a little worse in the Eurozone, political tensions are increasing in France and Holland. The Dutch Prime Minister Mark Rutte tendered his government’s resignation on Monday following the collapse of talks to implement austerity measures in the Netherlands. This spooked the markets, resulting in a sharp sell-off in global equities and commodities.  Moody’s, the credit rating agency, warned that the government’s collapse was credit negative.

Another negative factor included the French presidential election. In the first round of France’s presidential vote, incumbent president Sarkozy came in second to Socialist Hollande. Hollande won 28.5% of vote while Sarkozy won 27.1%. A surprise in the market was that Le Pen won 18.1% vote, a record for the party. The second round takes place on May 6.

As political and financial problems in the Eurozone continue to worsen, the amount of debt is spiralling out of control. In the end, the ECB will be forced to provide additional bailouts. In a weird irony, this policy of our current central bankers and financial leaders could end up destroying these economies instead of saving them. No matter the price, it is simply prudent to diversify into the highest quality currency available, namely gold and silver bullion.

Gold prices continue to trade sideways as they struggle to find any clear direction. At the moment they remain neutral as they trade between $1625/oz and $$1675/oz.

About the author

 David Levenstein is a leading expert on investing in precious metals . Although he began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients.