Brexit highlights the vulnerability of the Eurozone banking system. What does it mean for the gold market?
We have already reported on the plunge in European banking stocks after the Brexit vote, but the topic requires more attention. The reason is that the threat of a continental banking crisis is much bigger than the economic and political problems of the UK. The UK is not in the Eurozone, therefore its withdrawal would not be as significant as in the case of members of the Euro club. It seems that investors are aware of this peculiar fact: the stock markets in the south of the Eurozone plunged much more than in the UK. For example, UniCredit, the largest bank in Italy, is down more about 90 percent since the 2008 high and about 70 percent since its 2015 high.
The disastrous condition of Italian banks shows Europe’s failure to deal with its banking problems after the Great Recession. In contrast to America, Europeans did not restructure their banks quickly (distressed assets were not written down and balance sheets were not recapitalized). They just bailed out Greece (a few times!). This difference in response to the crisis explains the slower pace of economic growth in the Eurozone, and now there are risks that Brexit will cause a financial catastrophe in the continental Europe.
Indeed, the banking crisis in Italy could be much worse than Greece’s debt crisis, as Italy is a much more important economy. Italy is actually the third largest national economy in the Eurozone, and the eight largest in the world (by nominal GDP). It creates the core of the Eurozone, not the periphery. Beyond financial risks, the banking crisis could also bring the populist Five Star Movement to power.
And to be clear, the risks are not limited to the south of the Eurozone. German banks also face important challenges due to their heavy exposure to London. Some analysts point out that Deutsche Bank has a massive and risky exposure in the derivatives market, and that its bankruptcy could even lead to the next ‘Lehman moment’.
The take-home message is that the Brexit vote exposed the vulnerability of the Eurozone banking system. The increased risk of the next European banking crisis is positive for the gold market, as the shiny metal attracts safe-haven bids during financial turmoil. The flirt with the insolvency of Italian or German banks may be more important for the gold market than Greece’s debt crisis or the internal UK’s problem, as the Eurozone would be in real threat of collapse. However, investors should remember that no one knows when the problems of European banks would fully reveal (and if there is a full-blown crisis), as Europeans are experts in sweeping things under the carpet.
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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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