On Sunday, February 24, Italian elections will begin and will continue on through Monday (polls close Monday at 9 AM New York time) with these results having possible serious implications for both the financial markets and GLD – investors need to pay close attention.
It was less than a year ago when Italian (and Spanish) bond prices were spiking and the Italian 10-year bond was close to the 7% level – an unsustainable level for the government’s debt and economic output. Things have calmed down significantly, and bond prices have dropped to the 4-4.5% range which is still high compared to the “core” European countries but is reasonable for Italy. But the Italian elections could throw a monkey-wrench into both the Italian and European bond markets.
These elections were not supposed to be this close. Pier Luigi Bersani , the pro-Europe and pro-austerity candidate, had a large lead on the other candidates and the markets were pleased because he would be very similar to the prior prime minister, Mario Monti. In the last month, it has all changed as Silvio Berlusconi (nicknamed “Il Cavaliere“) has gained significantly in the polls by promising to eliminate the newly instituted Monti property tax (he actually wants to refund all previously paid property taxes) and institute an amnesty for all tax evaders.
Italy has a blackout on all political polls two weeks prior to the elections, but as of the last poll on February 8th, the standings were the following: Bersani (33%), Berlusconi (28%), Beppe Grillo and the Five-star movement (16%), and Monti (14%). With a 5% error in the polling and around 30% of Italians undecided on who they are going to vote for, the Prime Minister position is clearly up for grabs.
Implications for GLD
There are two not unlikely scenarios that could cause risk to rise significantly in markets, shoot up bond prices, and thus benefit gold and GLD.
If Berlusconi wins the election, he has promised to roll back much of the reforms that the previous Monti government made to bring down the Italian budget deficit. This has caused a lot of unease in Europe with some German politicians warning Italians not to vote for Berlusconi and one Italian bank going so far as declaring that Italy will need a bailout if Berlusconi wins.
But a Berlusconi win is not the only scenario that can throw off Europe. If Bersani wins, but Berlusconi and the Five-star movement (a populist anti-Euro and anti-austerity party) gain enough votes, Bersani may not be able to form a coalition government because that requires 42.5 percent of the vote. Without being able to form a coalition government, it will be hard for a government to institute new reforms to bring down the Italian deficit, let alone continue the unpopular taxes and spending cuts that have calmed down financial markets.
For holders of GLD, any increase in risk in European markets is very bullish for the gold price for a few reasons. First, if Italian bond yields start rising significantly, then the ECB will have to act to buy even more Italian bonds or risk an out of control rise in Italian yields. If they buy more bonds, then the ECB is effectively printing Euros and thus increasing the money supply – which benefits gold and GLD. If they do not buy more bonds, then the bond vigilantes may force up yields to unsustainable levels and that could spiral out of control and force the Italian government to seek a bailout from the ECB. This would be a significant problem for the EU who has been struggling to control the consequences of a Greek bailout. Italy is much bigger than Greece, and if there have been problems dealing with the Greek situation, then Italy may be the proverbial straw that broke the Euro’s back.
Secondly, if Italian bond yields start rising due to an unfavorable (at least for the EU) election result, it will not only affect Italy, but it may also cause investors to question other European sovereign yields like Spain, Portugal, and even France. That would force the ECB to not only buy Italian bonds to force down yields, but also all the other periphery bonds – thus increasing the money supply and benefiting GLD.
Holders of GLD should be watching the Italian elections carefully because the consequences of these elections may have some major implications for financial markets in Europe and abroad. If Berlusconi can pull off the victory, or Bersani and those willing to work with him for austerity are denied the 42.5% majority needed to govern in Italy, then risk could jump significantly. This also means that chances are the ECB will expand its balance sheet and increase money supply in Europe which should have very bullish implications for GLD. Finally, investors must remember gold is an asset held by investors all over the world, and if European investors start to get uneasy or question the Euro, then they will move their investments to the alternatives, the dollar and other currencies, as well as, gold (and thus GLD).
I do not feel that the market has really discounted the risk reflected in the Italian elections and those investors who have been holding GLD should hold tight and even increase their positions. Investors who are in a more risk-seeking mood should consider buying SLV because it has a high correlation with GLD and tends to offer a higher upside on increases in GLD.