The markets rallied last week as European leaders made progress at a two-day summit in Brussels. European Union participants said they would speed up plans to create a single supervisor to regulate the region’s banking system, and also agreed that EU bailout funds should be used to directly increase capital of struggling banks. The news was a surprise to traders, but little has changed in the big picture.
Expectations of the EU Summit were quite low and the small amount of positive news was enough to give investors a reason to go long, or at least cover some short positions. The euro soared to above $1.265, its largest one-day percentage jump against the U.S. dollar since October. The S&P 500 and Nasdaq also logged their best trading days of the year, while commodities stole the show. Gold surged $53 to settle at $1,604 and silver increased $1.32 to finish the second-quarter at $27.61.
Precious metals performed extremely well on Friday, as the EU Summit showed that Angela Merkel may not be as stubborn as previously thought. After standing against using the European Stability Mechanism to capitalize banks directly, the German Chancellor redrew her line in the sand. The permanent bailout fund will be able to provide funds directly to banks, allowing a country to avoid raising debt levels on its books. The fund will also be able to purchase sovereign bonds of countries that continue to meet determined budget cuts.
These recent developments sound good in theory, but there is one major flaw, the European Stability Mechanism fund and its 700 billion euro purse does not even exist yet. Furthermore, the ESM would, in theory, be able to bail out troubled countries such as Spain and Italy. However, the ESM is relying on these countries to contribute money towards the bailout package. Thus, you have Spain and Italy paying money they don’t have into a bailout fund that doesn’t exist, for their own bailout. The EU Summit rally is mostly due to professional jawboning scaring short sellers, because while the plan does not solve anything, it brings governments and central banks one step closer to trying to fix an insolvency problem with more debt, which may provide short-term relief, but will prove to be disastrous in the longer-term for fiat currencies.
Legendary commodities investor Jim Rogers recently told CNBC, “Just because now you have a way to get them (the banks) to borrow even more money, this is not solving the problem, this is making the problem worse. People need to stop spending money they don’t have. The solution to too much debt is not more debt. All this little agreement does is give them (banks) a chance to have even more debt for a while longer.” He also asked, “What are you going to do in two, three, four years when the market suddenly says ‘no more money’ and the Germans don’t have more money and the American debt has gone through the roof?”
For many investors, including Rogers, precious metals is one way that investors can hedge their concerns about the growing debt crisis that is sweeping the globe. History has shown that when fiat currencies are abused, hard assets such as gold and silver benefit in the long-term. Precious metals have underwhelmed in the second-quarter, but as more desperate measures are attempted by central banks, they stand ready to rise again.