- Published on Friday, 07 September 2012 15:30
- Written by Sara Nunnally, Editor, Inside Investing Daily
- Hits: 423
Boy, did the markets move yesterday! The S&P 500 started on a gap up and finished even higher.
But let's put this move in a bigger context.
The markets loved the news that ECB president Mario Draghi is starting another bond program in Europe. Everyone hailed him for successfully saving the euro.
From our friends at EverBank:
The program announced by Draghi, named Outright Monetary Transactions, was identical to the one leaked out to the markets yesterday morning. The ECB policymakers agreed to an unlimited bond purchase program that was designed to regain control of interest rates in the euro region and assure the future of the euro. According to Draghi, the program "will enable us to address severe distortions in government bond markets that originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro." So Draghi and the rest of the ECB proved to the "bond vigilantes" that they could and would mount a coordinated defense of the euro by bringing out the big gun of unlimited funding. "Under appropriate conditions, we will have a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area."
In essence, this is a "Spartan" defense. Success at all costs, leaving everything on the table -- against attacks on sovereign bond interest rates.
But instead of the ingenious bottleneck battle like Leonidas conceived in the pass of Thermopylae, the ECB is fighting this battle on a wide-open plain, with attacks coming from all sides.
And the markets are cheering!
How can Draghi promise to win such a battle?
The truth is, he can't... not without massive printing of new euros. Bond buying can't last forever. This is the "nuclear option" that would destroy the EU all the same as those bond speculators. This announcement is Draghi saying, "I'm ready and willing to push the button."
We suspect he hopes to never take the program that far.
Again, from EverBank:
And the best part of this announcement is that, as of right now, there isn't even a need for the bond purchases. Neither Spain nor Italy have requested aid from Europe's rescue fund, and with rates moving lower in both countries, just the announcement of the program may be all that is needed.
We'll see. So far, the ruse is working.
This is the euro -- rallying more than 2% in the last five days.
But how long can this rally last? Spain is in a deep recession with high unemployment and a severe housing crisis. It will soon have to ask for a bailout whether it wants to or not.
Draghi's bond program would force Spain to accept new economic and fiscal conditions, something Spain really doesn't want to do... and if Greece in any indicator, something Spain might not be able to do without harsh social and political repercussions.
Nonetheless, if Spain buckles and takes part in the bond program, Draghi has to play ball, and that will force the euro lower.
So for now, we're seeing some euro strength, and the dollar is getting weaker and weaker. Gold's responding with a jump well above $1,700 per ounce, with October futures at $1,734 -- a level we haven't seen since February of this year.
This is going to be a massive balancing act... One, I think, in which the euro is going to get a bit of a breather and the bottom will start to fall out of the dollar.
It could be slow going, but by New Year, we might see gold up another $100-150 per ounce.
Here's what that move looks like from a technical perspective.
This is a five-year chart for gold. The thin green line shows the major trend during this time. The black line shows the breakdown over the past year, and the thick green line shows where gold has found major support.
This support has pushed gold prices back above the level of breakdown, and prices are now headed back up to the thin green line -- gold's previous uptrend.
If we extend that line out to the end of the year, we see a potential climb to $1,900 per ounce -- roughly $150 from current prices.
This is definitely a playable move for you traders out there, but beware of the rocky ascent. Prepare for strong resistance at $1,800 per ounce.
And if any more euro issues arise, the whole game will change.