“Another ECB-Induced Printing Program” Ahead?

Gold futures closed out the month of May on a down note, albeit by only $1.50, or 0.1%, on Thursday at $1,564.20 per ounce.  However, in doing so the yellow metal extended its monthly loss to 6.0% and turned its year-to-date return into negative territory, by 0.2%.

One of the key drivers of gold weakness was the significant rally in the U.S. dollar, driven by safe haven buying amid the escalating European sovereign debt crisis.  Eric Sprott – founder of Sprott Asset Management and one of the most prominent gold bulls over the past decade – recently presented his outlook for the yellow metal in light of the financial turmoil in Europe.

In an article entitled The Real Banking Crisis, Part II, Sprott began by discussing the dire set of circumstances facing the euro zone, particularly in Greece and Spain.  ”The recent escalation in withdrawals has forced the Greek banks to draw on an €18 billion emergency fund (released on May 28th), which if depleted, will leave the country with a cushion of a mere €3 billion,” he noted. “It’s now down to the wire. Greece is essentially €21 billion away from a complete banking collapse, or alternatively, another large-scale bailout from the European Central Bank (ECB).”

“The recent bank runs in Greece and Spain are part of a broader trend that has been building for months now,” Sprott continued. “Foreign depositors in the peripheral EU countries are understandably nervous and have been steadily lowering their exposure to Eurozone sovereign debt.”

He went on to say that “We’re now at the point where a bank run in one Eurozone country could quickly seize up the entire system – not just in Greece or Spain, but throughout the entire Eurozone and beyond. Greek and Spanish banks are just like all the others; they operate with leverage ratios averaging 25x their equity capital. They are all so overleveraged that it takes very little in deposit withdrawals to cause instantaneous liquidity issues. This is why we’ll likely see another ECB-induced printing program announced (with a new abbreviation, hopefully) before a broader bank run can take root. The Eurozone authorities simply cannot risk the consequences of bank runs in countries like Spain, Portugal or Italy, which are far too big to bailout for the over-stretched ECB. It’s not about Greece staying or leaving the European Union anymore, it’s about the bailout ability of European banking system to survive the impact of massive money transfers.”

As for gold, Sprott asserted that “The most counterintuitive aspect of the Greece/Eurozone debacle has been its impact on the price of gold. Gold is now back below $1600 for the third time since August 2011; each time has coincided with severe banking stress within Greece and the broader Eurozone.”  However, he noted that “The futures market sell-off also appears to be waning now, since the European banking crisis has provided central banks with a politically-palatable excuse to take action if it deteriorates any further.”

Sprott later concluded by writing that “The question now is how long this can go on for, and how long gold can remain under pressure in a banking crisis that has the potential to spread beyond Greece and Spain? So much now rests on the policy responses fashioned by the US Fed and ECB, and just as much also rests on what’s left of European citizens’ confidence in their local banking institutions. Neither of these things can be precisely measured or predicted, but we continue to firmly believe that depositors in Greece and Spain will choose gold over drachmas or pesetas if they have the foresight and are given the freedom to act accordingly. The number one reason we have always believed gold should be owned, and why we believe it will go higher, is people’s growing distrust of the banking system – and we are now there. We will wait and see how the summer develops, and keep our attention firmly focused of the second phase of the bank run now spreading across southern Europe.”