How Will a Greek Default Affect The Price of Gold?

One of the major news events that may affect the financial markets, besides the results from Super Tuesday, is the ramifications in case Greece will default on its debt. Let’s examine, how, if at all, such a scenario will affect the price of gold.

Despite the many reports coming from Europe, the events in the U.S. still affect the bullion market more than the events in Europe: case in point, the testimony of Bernanke from last week dragged gold and silver prices and resulted in the worst performing week for bullion prices this year so far. Nevertheless, yesterday’s sharp decline of gold and silver prices was probably stemmed primarily from the speculation around the Greek default and the EU GDP contraction in the Q4 2011.

The speculation of Greece defaulting on its debt may reach another climax on Thursday, March 8th in this ongoing saga as private creditors will need to respond to an offer that will effectively have them write off nearly 70% of the face value of their Greek bonds in return for new issued debt. Currently, Greek government bonds are traded at less than 20 cents in the Euro. Will a scenario in which Greece defaults on its debt affect the price of gold? I have already referred to the effect of the European debt crisis on gold price, but let’s reexamine this issue.

To answer this question, let’s first examine will the markets stir up if such an event will occur. Obviously, this event will probably bring down, at least in the short term the Euro. But consider that ECB offered many EU banks nearly one billion euro three year loans at low cost and almost no substantial collaterals as part of the LTOR operation.  This fund alone will help many of Greece’s creditors to offset the losses from such an event. Thus, the markets will probably react to this event, but it might not be as bad as many think at least in the short run.

In any case, if there will be such a drastic event how will it affect the price of gold?

I think this scenario could affect gold price from two directions: Euro/USD and gold holdings.

The chart below presents the development of gold price and Euro/USD during 2012. It shows how both of them are linked and move in a similar way.

Gold price and EURO USD 2012 MARCH 7 From the Euro/USD standpoint, the relation to gold is straight forward: if the Euro will decline as it has in recent weeks, the price of gold will come down.

The correlation between gold price and Euro/USD is strong and robust in the past few months, i.e. as Euro strengthens against the U.S. dollar; gold price tends to rise as well.

correlation Gold price and euro to us dollar 2011-2012 March 2012Therefore in an event of default the Euro will probably trade down and will drag along with it the price of gold.

Gold Holding: if creditors and banks won’t agree to Greece’s terms, they may sell their gold holding to offset their losses. This theory however is harder to prove and thus should be taken with a grain of salt. Furthermore, as stated above since many banks will have the LTRO to fall back on, it makes the scenario of selling of gold less likely.

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