In recent weeks the European banking sector’s refinancing problems have grown significantly, as major credit rating agencies have downgraded a number of important banks. Thus, Italian and French bonds have come under increasing pressure. Some market observers believe that the most indebted eurozone countries will ultimately resort to selling their gold reserves.
Italy’s central bank owns 2,452 metric tonnes of gold – the world’s fourth largest holding. According to data from the World Gold Council, only the US, Germany and the International Monetary Fund (IMF) own more gold than Italy. In the face of an escalating sovereign crisis in Europe, an increasing number of investors are wondering whether some countries might start selling part of their gold reserves. In recent months the yield on 10-year Italian government debt hit a high of 7.48%, and a few days ago the yield on five-year bonds hit a new record high. Soon Italy might not be able to refinance its maturing sovereign debt. Although the European Central Bank is buying Italian debt, the country faces the risk of following the same fate as Portugal, Ireland or Greece. These countries had to seek bailout by the European Union and the IMF after the yield on their bonds soared out of control.
Now the financial markets are focusing on Italy, the third-largest eurozone economy. This has contributed to the latest devaluation of the euro, which has dropped from US$1.45 to US$1.30. However, due to this rally in the US dollar, commodities, precious metals and emerging market stocks have come under strong sales pressure.
Italy’s gold reserves are currently worth $120 billion. This would be more than enough to cover Italy’s budget deficit, which currently stands at $80 billion. French gold reserves are slightly smaller than Italy’s and would not be enough to settle the french government’s current budget deficit of $150 billion. Nevertheless, according to market observers, by selling its gold reserves France would significantly reduce its deficit and could soothe the financial markets. The yield on European bonds could drop, thus easing the pressure on the euro.
In recent weeks the commodity markets have been under strong sales pressure due to the negative outlook for the global economy. More and more investors are dreading similar developments as in 2008, after the US investment bank Lehman Brothers crashed. The Lehman collapse was followed by massive drops in stock markets. Arguably, today’s economic problems are much more serious than three year ago. Countries on the verge of bankruptcy have to find solutions – and find them fast – to what seems to be a no-win situation.
Should European central banks decide to openly sell their gold, the yellow metal’s price would likely fall. But, in the longer run, the gold price will still benefit from this situation. Once the European governments have nothing else to turn to other than the European Central Bank’s printing press, gold and other tangible assets will surely increase further in value – relative to rapidly-depreciating fiat currencies.