The Goldenbar Report

Editorial: Euro Blues
01 June 2005

A Goldenbar Editorial
by Ed Bugos

Print Copy

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.

Edmond J. Bugos

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