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Italian Crisis Means Uncertainty For Gold Despite Safe-Haven Demand

Kitco News

(Kitco News) - Italian political turmoil has created a conundrum for gold investors.

If the crisis continues and leads to an election that threatens whether Italy keeps the euro as its currency – and this sentiment spreads to other European nations -- gold is likely to draw significant safe-haven buying, particularly if equities go into a freefall, analyst said.

Such a contagion scenario unfolded several years ago when a debt crisis hit Greece and soon engulfed countries like Spain, Italy and Portugal as well.

Yet, the upside in gold – in U.S. dollar terms anyway -- may end up being limited if the turmoil should also result in dollar strength, since the precious metal tends to move inversely to the U.S. currency.

As a result, gold has been somewhat range-bound ever since the Italian crisis intensified in recent days, analysts said.

“There are so many components to it,” said veteran gold trader Kevin Grady, president of Phoenix Futures and Options LLC. “That’s why gold is [nearly] unchanged right now – because people are trying to figure it out. Is the currency going to be the thing that moves gold? Will interest rates be the thing that moves gold? Right now, people aren’t sure.”

In fact, as of late Wednesday morning, the session’s high and low in Comex August gold was within Tuesday’s trading band. Technical-chart analysts refer to this as an “inside day” and see it as a sign of market indecision about the next short-term price move.

Traders will be watching to see if there is safe-haven buying of U.S. bonds, a sell-off in the euro or further declines in equities, all of which can affect precious metals.

One way or the other, “outside markets are going to be driving gold,” Grady said.

“Any time you see uncertainty – and especially uncertainty with a currency – you see an initial pull for people to go in and buy gold,” Grady said. “But the problem is – what is that going to do to the U.S. dollar? That is going to be gold’s problem. If you see the U.S. dollar rally strongly against the euro, I think it’s going to be hard for gold to rally.”

Safe-Haven Buying Likely If Equities Tank

Italy has faced political uncertainty since March elections, with no coalition government formed despite protracted talks. There is a power struggle among lawmakers who oppose and favor participation in the European Union. There is a perceived risk that President Sergio Mattarella could dissolve Parliament, meaning yet another election, with European news organizations saying this could happen as early as July. If so, this could improve prospects for so-called Euroskeptics, meaning any election could end up being a referendum on the euro. This has left investors on edge, particularly if Italy rejects the euro and denizens of other nations get the same idea. Further, Italy’s economy is the third largest in the euro zone but has been anemic, with the country already heavily in debt.

“Ultimately, if we are under some sort of contagion, gold will be an asset that will outperform,” said Bart Melek, head of commodity strategy with TD Securities.

This especially would be the case if equities sell off, he said.

Conversely, gold prices could ease if the Italian political situation is resolved without any danger of a euro-zone breakup and appetite in risk markets improves, Melek said.

Phil Flynn, senior market analyst with at Price Futures Group, figures gold could be slip if the turmoil lasts only a short time but underpins the dollar and hurts the euro.

“But if we do start to see the worst-case scenario, where Italy looks to get out of the euro, that could create a risk-off scenario that brings gold back,” Flynn said. “But that is a story for down the road.”

Should there be heavy safe-haven flows into the U.S. Treasury market, this could also end up helping gold, observers pointed out. As the price of bonds rise, the yield falls, which tends to help gold, and vice-versa. In fact, rising Treasury yields had been one of the main factors undercutting the precious metal earlier this month, when gold hit its weakest level of 2018.

“Will people be running to U.S. Treasuries, or will they not?” Grady asked rhetorically. “That’s why gold is sitting here right now and waiting for a reaction.”

Dollar Strength Could Curb Gold Gains

Gold did in fact initially draw safe-haven buying during the most recent leg of political uncertainty, Grady said. He pointed out that preliminary data show the number of open positions in Comex gold futures rose Tuesday, which was likely fresh bullish positions.

“But once the dollar started rallying, you saw the euro sell off, and gold followed the euro,” Grady said.

Comex August gold rallied as high as $1,311.30 an ounce on Tuesday before falling back and finishing the day at $1,304.10. The metal is not far above that so far Wednesday, trading at $1,305.90 as of 10:48 a.m. EDT.

Still, even if gold does not benefit in U.S. dollar terms, the precious metal may well rise against the euro. This happened at times back during the Greek debt crisis.

There was increased risk aversion on Tuesday, when the Dow Jones Industrial Average sold off sharply, which led to buying of so-called safe havens.

“These [safe havens] included gold, though only gold priced in euros,” Commerzbank said. “At its peak, it gained by 1.6% or €18 to reach over €1,130 per troy ounce for a time, its highest level in nearly a year.”

However, Commerzbank added, there was “no one-way street” for gold prices, as the metal also reacted to fluctuations in yields on Italian government bonds – in particular the yield spread between 10-year Italian and German government bonds.

“Gold marked its high at around midday yesterday when the yield spread climbed to over 300 basis points,” Commerzbank said. “Subsequently its gains dwindled away almost entirely because the yield spread narrowed significantly again. It then widened once more in late trading, driving gold back up again. While the political uncertainties in the euro zone continue or even increase, gold should remain in good demand as a safe haven.”

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