Even though the break-up of the eurozone in its current form has entered mainstream debate this week, gold is only marginally higher vs. Friday’s closing levels, which to some may look curious. On one level , this should be set against the 3.5% rise in the dollar seen since the lows of the end of October, which ordinarily would have dragged the gold price lower due to valuation effects. In the wider view however, the implications for gold from a partial break-up of the eurozone are far from clear-cut.
For the ‘outs’, there would certainly be inflationary effects from a euro exit. There would be substantial exchange rate-devaluations, which would not only be inflationary but would also allow the economies to recover faster than would otherwise be the case. There is of course the risk that inflation is so rampant that it counteracts the competitive kick from the exchange rate-devaluations, but that’s another issue.
Set against this are the implications for the remaining rump of the eurozone. Leaving aside which nations this may comprise, one of the major dangers is that we see the euro appreciate on the back of the exit of the smaller countries. Given that the ‘outs’ are, on balance, likely to be smaller in GDP terms than the ‘ins’, the deflationary impact may well dominate. But again, looking at the wider view, it’s what happens to real interest rates that will likely dominate the gold reaction. Our measure of global real rates is nearly at zero, reflecting the rally in bonds (pushing down yields) and relatively low inflation which would have to move into negative territory for gold to continue to push higher and for past correlations to be maintained (lower real interest rates pushing gold higher). All in all, it’s not a done deal that gold will gain from a fracture of the single currency and from a loss of faith in paper currencies.
