After months of dithering, the European Central Bank finally announced new monetary policy stimulus on Thursday designed to reverse the Eurozone’s slide toward economic stagnation and deflation. The deposit rate — which was offered to banks that park cash at the ECB — was cut into negative territory (to encourage them to lend it out instead), and the ECB announced other measures, including more long-term bank funding.
The ECB desperately needed to take action. GDP growth slowed to a meager 0.2% rate in the first quarter. Household spending grew just 0.1%. Producer prices are already in deflationary territory, dropping at a -1.2% annual rate. And the composite PMI economic activity index for May was revised down to 53.5 from 53.9.
There was, however, a tinge of disappointment as no open-ended bond purchase program — or quantitative easing — was announced. But the move was enough to light a fire beneath gold and silver, as well as related mining stocks, for the best one-day gain in these areas since early May.
Here’s how the ECB’s action is benefiting gold and silver:
For one, it removes a source of deflation risk as the Eurozone has been bogged down by the persistent strength of the euro over the last few years. This stems from ECB President Mario Draghi’s famous “whatever it takes” commitment to save the euro back in 2012. That strengthened the euro, attracting investment capital into Europe’s bond markets. While this has pushed down borrowing costs, it has slowly crushed export competitiveness and thus, economic growth. Credit creation has waned.
And now, inflation has dropped to such an extent that deflation or falling prices has become a real concern. With the ECB joining with the Federal Reserve and the Bank of Japan actively encouraging higher inflation, it’s no wonder gold and silver — classic inflation hedges — are seeing renewed buying interest.
Click to Enlarge There is also a risk that, by pushing the euro back down, Draghi could destabilize European bond markets. It’s certainly showing signs of froth, with Greece recently returning to the bond market despite chatter of requiring another $10 billion bailout package as its unemployment rate remains cripplingly high at 27%. And Ireland can borrow at interest rates lower than the U.S. government can.
And finally, there is a very real chance that the ECB will be forced to take even more aggressive action. Today’s lack of movement in the euro, despite a growing hedge fund bets against the currency (as shown in the blue line in the chart above from the folks at SentimenTrader) suggests a tinge of disappointment that outright QE wasn’t announced.
Click to Enlarge Draghi addressed this concern in his press conference, warning that “we aren’t finished here” and that more action would come if necessary.
In response to the action in gold and silver, I’m adding exposure to silver via the leveraged ProShares Ultra Silver (AGQ) to my Edge Sample Portfolio. I’ve already holding a position in the ProShares Ultra Gold (UGL).
As for individual gold and silver stocks in the sector that are on the move, stay tuned for a list of potential buys.