Gold price recoups losses as Italy’s woes grow

There was further pandemonium in the markets yesterday, as traders came to terms with Greece’s referendum decision, and the fact that Italy appears to be on the brink of a serious financial crisis. The spread between 10-year Italian government debt and equivalent German debt spiked to 459 basis points yesterday, before the European Central Bank intervened – buying Italian bonds with new money in order to stop Italian yields soaring higher still.

As Ambrose Evans-Pritchard reports in the London Telegraph, “the point of no return” for Italy could come when LCH.Clearnet introduces higher margin requirements for those trading Italian government bonds. The trigger for this would be if Italian yields moved to 450 basis points over a basket of AAA benchmark bonds. Yesterday, the spread reached 388 points. Andrew Roberts from RBS notes that Italy’s debt stress is “dangerously close to a level that could cause pandemonium in financial markets.”

The effluence appears to be well and truly hitting the fan as far as the eurozone is concerned, with Italy’s woes placing new European Central Bank president Mario Draghi in a tricky position. Draghi, an Italian, cannot be seen to be acting in a partial manner towards Italian debt – yet monetisation of that debt remains essentially the last desperate option open to the eurozone. As one trader wryly notes in Pritchard’s article, Draghi “better find himself a German grandmother fast.”

The gold price staged a $40 rebound from yesterday’s intraday lows around $1,680 per ounce, and has moved back above $1,730 in trading this morning. Silver has also recovered ground following a move back below $33 per ounce. Gold is holding up better than equities and commodities such as copper and crude oil, with safe-haven buying providing support for the yellow metal. That said, in the short-term, the dash for cash – specifically US dollars – in the face of eurozone problems and concerns about possible bank failures means that gold and silver prices are facing headwinds.

However, over a longer time frame, a slow-and-steady devaluation of the greenback relative to other currencies remains the US Federal Reserve’s chosen plan for dragging the US back to health. With this objective in mind, speculation has been increasing that the Fed may announce the start of another round of quantitative easing later today, following the conclusion of its latest two-day Federal Open Market Committee meeting.

This remains unlikely, however, given the rises in consumer and producer prices in the US in recent months, and the increasing political controversy surrounding “quantitative easing”. Expect instead that Bernanke will reiterate the Fed’s attentiveness to the “threat” of deflation, and that it stands ready to engage in further easing should this be warranted.