Gold Reacting to Rising Elements of European Risks

The U.S. Comex gold futures climbed 1.17 percent this week after rising 1.29 percent in the previous two weeks on the back of heightened concerns of the European debt crisis. The S&P 500 index dropped almost 1 percent from its recent high on 14 March while the Euro Stoxx 50 Index plunged almost 2 percent this week. The Euro/Dollar bore the brunt and dropped to a four-month low at 1.2859 during Asian open on Wednesday. The U.S. 10-year Treasury bond yield dropped about 16bp since the recent high of 2.05 percent on 11 March.

Renewed Turmoil in Europe

In the recent EU Summit, the European finance ministers agreed to extend the bailout for Portugal and Ireland. They also agreed on the Euros 10 billion rescue plan for Cyprus, a reduction from the original Euros 17 billion. However, the banks in Cyprus will have to impose a levy on bank deposits in a progressive manner compared to the previously announced 6.75 percent levy on bank deposits up to Euros 100,000 and a 9.9 percent levy on deposits above that amount. On 19 March, the Cyprus lawmakers voted the levy down as depositors and the Russia government both cried unjust, urging the EU-17 finance ministers to negotiate a new package. This unprecedented levy could have triggered scare of similar levies being imposed on other peripheral European banks, raising renewed concerns on the European debt crisis and capital flight to safer havens. The risk-off scenario has increased demand for alternatives such as gold and safer assets such as U.S. Treasuries.

Better-than-expected Economic Data in the U.S. and Germany and Chinese Inflation

Stronger economic numbers from the U.S. and Germany have tempered the market’s enthusiasm in gold. The February housing starts in the U.S. rose to 917,000 compared to an expected 915,000. The March ZEW consumer confidence index in Germany has risen to a three-year high in March, giving hopes that Germany will return to a positive GDP growth in Q1. In China, the PBOC governor warned on the high inflation rate in February of 3.2 percent and released a survey saying that 68 percent of the Chinese households believes that housing prices are too high. The government is likely to tighten the property market again, thus curbing any expectations of further monetary easing in the short-term.

Watching the Fed

With the ongoing Cyprus and Euro situations and the better economic data from the U.S., the Fed will likely in his FOMC announcement on 20 March incorporate some optimism in the U.S. outlook and mention the downside risks of global financial markets while largely maintain the low interest rate and the existing QE program.