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Political Economy, the Euro and Precious Metals

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Political Economy, the Euro and Precious Metals

While it is conventional knowledge that political events stand at the forefront of economic change, this link has recently been highlighted by global events and continues to be intensified by reaction to these occurrences. Specifically, the unfolding of the Eurozone bailout plan continues to influence investor decision to buy Euro-backed securities while other events, including those in Greece, Italy, and Spain continue to do the same. Attitude of the Chinese central bank toward Euro investments is also playing a major role. The effects of these influences on the Euro are spilling over into precious metals markets is a tangible way.

Outlook on the future of the Euro has changed nearly every day since ECB Chairman, Jean-Claude Trichet announced that he would buy Greek debt as collateral for the $860 billion bailout plan. First, there were concerns over the effects of austerity measures taken by the Greek government on its ability to service bailout debt. After that, all eyes turned to German parliament as they debated whether to fund this plan to the tune of $150 billion or not. Most recently however, it has been the downgrade of Spain’s IDR from AAA to AA+, and Italy’s sale of over €9 billion in 3, 7, and 10-year paper which have caused investors worldwide to take a second look at the Euro.

There is, some think, a light at the end of the tunnel. China’s Premier, Wen Jiabao recently stated that China has not lost confidence in the Euro. For this reason, they do not plan to withdraw their support. This abutment, in conjunction with the recent German decision to back the bailout could have the ability to at least maintain present Euro value.

Still, there are those who have their doubts. A sentiment of distrust toward The People’s Bank of China is common worldwide. Since having stated officially that they would allow the Yuan to float against the U.S. Dollar, all the while observably maintaining a bracket peg in order to promote export-led growth, the Chinese central bank has experienced several credibility issues in the eyes of analysts worldwide. The fear as it relates to the Euro bailout is that while China has stated that they have not lost faith in the Euro, and will not be divesting from it, their sovereign wealth fund, China Investment Corporation has been doing just that. If this is the case of course, China would be able to encourage investor confidence in the Euro while secretly benefiting from the sale of the $2.4 trillion (USD) in Euro assets while the currency still trades high.

Just as the Euro has been experiencing marked fluctuation in the past two weeks, so have precious metals. Historically speaking, precious metals - especially gold - exhibit a negative correlation with competing assets, such as Euro-backed paper. That is, if investors lose confidence in the stocks (for example), they will move their capital to another, more trustworthy market. Conversely, if stocks are on the rise, investors will take their money out of precious metals so as to free up more capital for investment in stocks. This relationship has been clearly observed over the past two weeks as gold, silver, palladium, and platinum have had their ups and downs with opposite shifts in the Euro. What remains to be seen is what the ultimate outcome of the Euro will be. Until then, we can only observe political indicators and speculate as to how they might affect the Euro and precious metals.

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