October was a banner month for US stock markets, which rallied over 9% after suffering a significant pullback in September. With the S&P posting its best single month since 1991, there was ample reason to watch stock prices closely, which is exactly what most traders were doing through most of October. This attention to the securities markets combined with a stronger dollar to take much of the investment demand out of the gold market. Don’t forget however, that demand for gold doesn’t just show up when gold is rising: It also shows up when everything else is falling.
The DOW lost over 200 points yesterday on the final trading day of the month. It’s off another 240 points this morning. That’s is a slide of over 4% in less than two trading sessions, indicating that the overall sentiment surrounding US stocks is turning negative very quickly. If this trend continues, we can expect gold demand to pick up and fill the cash vacuum created by the exodus from securities.
After a much applauded solution was agreed upon in Europe last week with the aim of addressing the Greek debt crisis, it appears now that the Greeks themselves may be throwing a wrench in the whole operation. Just this morning it was announced that Greece has decided to hold a referendum, allowing citizens to vote on austerity measures which have already been promised to the EU. In short, this is a signal that Greece is likely unwilling to make the deep cuts which they have promised to make. Without these cuts, all the progress the EU has made over the last month will be essentially lost.
Less we think that what happens in Greece stays in Greece, we have yesterday’s bankruptcy of MF Global to remind us just how close to home this crisis really is. The 40 year old commodities trading firm, which helped numerous US companies hedge and trade futures contracts, filed for chapter 11 protection yesterday as exposure to European sovereign debt brought the firm to its knees. Though MF Global itself is “small enough to fail”, many of its creditors are not. JP Morgan, Deutsche Bank, and numerous other major financial institutions were listed in the bankruptcy filing as having loaned money to MF Global.
The concern here is not that MF Global itself is systemically crucial, but rather that we have no idea how many more “MF Globals” are out there. Less than a week ago, the firm seemed to be on solid footing. Like Bear Sterns and Lehman before it however, once MF’s leveraged bets began to go south, there was no stopping the fast and complete failure of the entire firm. Even after the lessons learned in 2008, even after the bailouts and bankruptcies, there is still no way to ascertain the overall level of dangerous debt exposure held by US financial institutions. Had you told me three years ago we would still not have a handle on this by the end of 2011, I would have been horrified. Yet here we are.
Gold, for its part, traded lower this morning, following the commodities and stock markets as they all endured risk-off selling. The key question for gold will be whether or not US firms are affected by more instability in the Euro zone. If this happens, it will take strength out of the dollar very quickly. In that scenario, gold has the potential for exponential gains as we have seen numerous times in the past. Remember that the stronger dollar is the only thing holding gold in check at the moment. With no resolution to the debt problems here in the US, and with no idea how much exposure US firms really have to European debt, the high flying dollar is ripe for a correction. When this happens, you better already have your gold in hand.
Mike Getlin is Executive Vice President of Merit Financial, home to America's fastest growing physical gold IRA company. Please send comments or questions to firstname.lastname@example.org.