Euro Blues
Ed Bugos
France
rejected the EU constitution this weekend in a referendum garnering 55
percent for the “no” camp, pretty much as expected. The latest
polls also show that when the Netherlands vote on Wednesday, 60 percent
will vote “no.” The constitution is supposed to create a European
president and foreign minister, to give more power to the European parliament,
and other reforms aimed at improving economic growth in the EU.
All 25 members are to vote by November
2006.
From what I understand, the French oppose
the constitution because they feel it would further hurt the labor market
and industry in their own ailing economy.
Their attitude may reflect a growing protectionist
sentiment or at least opposition to full-fledged integration on nationalist
grounds of some kind. The nationalists would feel that full integration
would dilute their cultural backbone while the EU economy benefits at
their expense. Either way it is basically opposition to free trade, which
is why the EU was allegedly developed in the first place. Ironically,
France is one of the first places where the free trade idea was spawned
during the 18th century.
So the United States might as well be looking
at its own future when it looks at France and Germany, or Canada. Don’t
even bother to argue – look at the complaints today about the jobs
being lost to China, let alone the President’s trade tariffs. There
is a strong protectionist wind blowing through Washington today.
Free trade is increasingly a dying idea,
not for any sound reason, and not far behind is the whole idea of free
exchange. Anyhow, it is a blow to the EU initiative, and by extension
to the Euro. I’m not so sure it should be a blow to the Euro’s
foreign exchange value since the concepts of protectionism and nationalism
are not limited to Europe these days. However, there is fear that these
“no” votes will lead to a disintegration of the EU down the
road. That’s not really news to our readers since we’ve already
pointed out the inherent fundamental weakness of the stability and growth
pact, and its long run effects on the Euro’s ability to dislodge
the US dollar from its role as reserve currency. So the Euro could very
well be topping now in terms of the US dollar, at least for the medium
term. Nevertheless, this does not change my gold call.
I expected it and have already shown that
it is more than possible for gold prices to rise even as the USd stops
falling on foreign exchange markets. The main significance for this news
is that the Euro price of gold should now start to rise – in other
words, the real value of the Euro should begin to reflect the ECB’s
inflation rate.
Whatever
effect it might have on the foreign exchange value of the US dollar there
is no fundamental reason to expect that its REAL value would be bolstered
just because its FX value is… except maybe in the short term. My
feeling, as I wrote beforehand, is that this event is bullish for gold
prices overall (the graph to the right shows Euro gold prices).
Equity/Commodity Correlations:
In light of the divergence between gold stocks and gold prices over the
past year or so I thought that it might be a good idea to review the like
correlations in the energy sector since 1998. Note in the accompanying
graph that prior to 2004 oil prices and oil shares did not always move
together – in fact they spent most of their time moving in opposite
directions (shaded regions). Moreover, the peaks and troughs were usually
led by the commodity, and not the shares. Of course, had equity investors
expected the big surge in oil prices that was to follow in 2004 and beyond,
it might have been different.
However,
every time the price of oil would approach US$30/bbl, the oil stocks dove,
which seemed counterintuitive to those of us expecting oil to break out
above that level. It took time for confidence to build on the equity side,
in part because earnings weren’t doing that great on a relative
basis despite the strength in oil prices, yet.
Sound familiar? It should, since that’s
precisely what’s happening in the gold sector today.
Gold stock earnings have not yet increased
at an attractive enough pace to entice equity investors who may be skeptical
that gold might make it to US$500… never mind break out past it.
As oil prices began to look firm at the US$30 handle, and then as they
left it behind, blowing away the skeptics altogether (remember how
many times it was reported that oil would fall back down to below US$20),
the market jumped all over the oil shares… its confidence rewarded
by the enormous boost to cashflows following on the subsequent record
move in oil prices. Looking at the oil share index in 2002: it broke down
even as oil prices drove up past US$30. Part of the reason for this particular
break was the general market collapse in the summer of 2002 that was accompanied
by all the sectors. Nevertheless,
it shows that blind faith in the equity sector as an accurate forecaster
of the underlying commodity price trend can be a misguided and costly
strategy... this may be especially true if everyone expects it, and especially
at the early stages of a bull market.
Ed Bugos
Editor - The GoldenBar Report
www.goldenbar.com
June 1, 2005
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