Possible Devaluation Of The Euro Casts A Shadow Over Gold's Future

As the European Union struggles with rising unemployment they now have to face a future of increased competition from the Japanese as they actively devalue the Yen. The new government in Japan, under the Premiership of Shinzo Abe, has managed to devalue the Yen by round 20% so far. In the short term this devaluation should boost Japanese exports as their goods are available at a substantial discount. This action mirrors that of the United States as they continue with their programme of Quantitative Easing. The United Kingdom has also joined in this ‘race to the bottom’ and has managed to reduce the value the British Pound.

The European Central Bank (ECB), under the guidance of Mario Draghi, cut interest rates to a new record low in May and said it would act again if necessary. However, in this tit for tat, cut for cut environment, the ball appears to be back in ECBs court. A money printing strategy may not appeal to Jens Weidmann, President of the German Bundesbank, however, the German car makers may think otherwise given the cheaper competition from Japan. Devaluation would also appeal to the other members of the union as they would see such a move as a boost for their beleaguered economies.

Devaluation of the Euro
Now let’s assume that the ECB decide to print enough Euros to match the fall in the value of the Yen, devaluation in the order of 20%. It then follows that this move would have a knock-on effect on the value of all of the other currencies including the US Dollar. As the Euro falls the value of the dollar would rise in terms of the US$ Index.

The dollar index weights each currency as follows:

Euro (EUR) 57.6%
Yen (JPY) 13.6%
Pound (GBP) 11.9%
Dollar (CAD) 9.1%
Krona (SEK) 4.2%
Franc (CHF) 3.6%

So we can see that any movement in the Euro will have a major effect on the dollar. If a devaluation of 20% was achieved, then, not putting too fine a point on it, we have a drop in the value of this basket of currencies of about 10%, or an increase in the value of the dollar of about 10%. The dollar current stands at 83.57 so it would rise to about 92 on the Dollar Index.

Effect on Gold Prices in Dollar terms
So what does this mean for gold bugs? Gold has an inverse relationship with the dollar, so in dollar terms gold prices could drop by 10%, which would take today’s price of $1400/oz down to $1260/oz. We are aware of the myriad of factors that we are not taking into account in this exercise, but we believe that the currency war deserves to be given a high priority in any investment considerations.

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Conclusion
Recognition of this possibility does not mean that the bull market in precious metals is over, but it may present us with an opportunity to generate a profit while we are waiting for the rally to resume.

If ECB do decide to print their way out of trouble then a trader could look to position themselves on the ‘short’ side of gold in order to take advantage of the fall in www.skoptionstrading.com makes no guarantee or warranty on the accuracy or completeness of the data provided. Nothing contained herein is intended or shall be deemed to be investment advice, implied or otherwise. This letter represents our views and replicates trades that we are making but nothing more than that. Always consult your registered adviser to assist you with your investments. We accept no liability for any loss arising from the use of the data contained on this letter. Options contain a high level of risk that may result in the loss of part or all invested capital and therefore are suitable for experienced and professional investors and traders only. Past performance is neither a guide nor guarantee of future success.