DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking: In-between the lines - Bernhard Eschweiler
(firmenpresse) - DGAP-News: Silvia Quandt&Cie. AG, Merchant&Investment Banking /
Key word(s): Miscellaneous
Silvia Quandt&Cie. AG, Merchant&Investment Banking: In-between the
lines - Bernhard Eschweiler
15.07.2011 / 09:13
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- Market focus on Italy likely to expedite policy action - look for:
- Push for 2nd Greek rescue package as well as EFSF interventions and
upsizing
- Gold benefits less from latest turmoil
When we wrote about Greece two weeks ago, we thought to get relief for a
few weeks to focus on other issues. Well, think again! Worse, contagion
is not only spreading from Greece to Portugal and Ireland, but is also
threatening Spain and most importantly Italy. The risk is that the Euro
debt crisis will take a new dimension that could threaten the entire
financial system, but the chance is also that this will force policymakers
to take more decisive action. The renewed tensions have squashed equity
markets and boosted German Bunds. Gold is also up, but less than one would
expect, given the turmoil. Supply-demand imbalances still favor gold, but
the fear of inflation seems to be fading.
Who's in control?
The drop in market sentiment on Monday, which was reflected in the sharp
widening of government bond spreads, a plunge in equity markets, especially
some bank stocks, and a weaker Euro, was not triggered by a specific event
on that day. Instead, market participants were getting worried that
policymakers are losing control. The key issue is the failure to resolve
the Greek debt problem. The downgrade of Portugal, the rating agencies'
rejection of the French proposal to roll over bank exposure to Greece and
Mr. Tremonti's political troubles at home were not helpful.
Markets calmed down on Tuesday despite the failure of EU finance ministers
to reach an agreement on Greece. Even the downgrade of Ireland to
sub-investment grade failed to rattle markets on Wednesday. However, such
calm means little in the current market environment. The market dynamic on
Monday has been a reminder that contagion is a reality, no matter how
overused the term may be. Italy, unlike Greece, Ireland and Portugal, is
not facing an acute fiscal crisis. In fact, the government has
been able to cut the deficit to 4.6% of GDP last year and is set to make
further progress thanks to Mr. Tremonti's consolidation efforts. Yet, the
market views Italy as vulnerable, especially due to its high level of debt
(120% of GDP) and lackluster economic performance. And Italy matters a lot
more than Greece. A debt crisis in Italy would have a devastating impact
on the Italian banking system and the financial system in Europe as a
whole.
Whether Monday was enough of a scare to get policy-makers moving remains to
be seen. If not, the market will be back and push even harder. Although
vague, the announcement that the EFSF could buy government debt directly in
the market and lower the interest rate on its loans are first signs that
something is moving. It is difficult to predict how the dynamics will work
out over the next few days or weeks, but three outcomes seem increasingly
likely.
- First, a push to seal the second support package for Greece. The
stumbling block is Germany's demand for private-sector participation.
Attempts to structure a voluntary participation have been rejected by
the rating agencies. A solution that involves a partial default or a
haircut cannot be ruled out, but resistance is very large, especially
from the ECB. In our judgment, Germany will probably find a
politically acceptable way to soften its demand.
- Second, direct interventions by the EFSF in the bond market. The
question is not whether the EFSF will enter the secondary market at
all, but with what aim and size. One option is to replace the ECB and
focus just on smoothing volatility. The second option is to reduce the
overall level of government debt in the market. This can be done with
the issuer country or directly. In either case, the size would be much
larger and, thus, the political resistance bigger.
- Third, an increase of the size of the EFSF. This is probably the least
likely outcome in the short-run, especially if implementation of the
first two steps leads to success. However, upsizing the EFSF to, say,
an effective purchasing power of EUR 1 trillion would be a powerful
sign of commitment if markets get further out of control.
To be sure, these three measures do not constitute the final solution, but
they are key steps to restore stability. The final solution will only
come, once the EU plus IMF and ECB hold most or all of the trouble debt.
At that stage, debt restructuring outside the market is feasible and
probably necessary.
Is gold losing some of its luster?
As would be expected, gold moved higher in response to the market turmoil.
In fact, it reached a new high of USD 1585 per ounce. In Euros, the move
was compounded thanks to the drop of the Euro. Nevertheless, the up-move
feels a bit lame, given the extent of uncertainty. A break through USD
1600 per ounce would have been more convincing.
A year ago, we published a very optimistic report on gold, setting a target
of USD 2000 per ounce for the following two years. Since then, gold has
rallied 36% and has finished half the distance to the 2000 target. In our
judgment, the rally in gold so far was driven by supply-demand dynamics.
On the supply side, mining capacities are limited and central banks are
holding on to their stocks. In fact, some are increasing their holdings,
such as China and India. On the demand side, jewelry demand from emerging
markets, notably China and India, is soaring, while investors want to hold
more gold in their portfolios as insurance against inflation, debt default,
currency devaluation, and general economic uncertainty. Investor demand
has been a particularly powerful factor. Gold investments are about 1% of
the global bond and equity market capitalization. Even the total
value of
aboveground gold equals just 5% of the global bond and equity markets.
Thus, just small asset allocation changes toward gold imply huge increases
in gold demand.
Economic and financial tail risks are likely to persist for some time and
will push the gold price higher. Whether gold will reach USD 2000 per
ounce within the next 12 months, however, is less assured. One push
factor seems to be easing and that is the fear of inflation, which earlier
in the year was a key driver of gold demand. No matter how messy the
politics, it is getting clear that fiscal consolidation and labor market
restructuring are already well underway and that is not inflationary.
Powerful proof was the last US labor market report, which showed a drop in
hourly wages as well as a sharp decline in government jobs.
Disclaimer
This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor,
and was first published 15 July 2011, Silvia Quandt Research GmbH,
Grüneburgweg 18, 60322 Frankfurt is responsible for its preparation. German
Regulatory Authority: Bundesanstalt für Finanzdienstleistungsaufsicht
(BaFin), Graurheindorfer Str. 108, 53117 Bonn and Lurgiallee 12, 60439
Frankfurt.
Publication according to article 5 (4) no. 3 of the German Regulation
concerning the analysis of financial instruments (Finanzanalyseverordnung):
Number of recommendations Thereof recommendations for issuers to which
from Silvia Quandt Research investment banking services were provided
during
GmbH in 2011 the preceding twelve months
Buys: 95 37
Neutral: 42 1
Avoid: 4 0
Company disclosures
Article 34b of the German Securities Trading Act (Wertpapierhandelsgesetz)
in combination with the German regulation concerning the analysis of
financial instruments (Finanzanalyseverordnung) requires an enterprise
preparing a securities analysis to point out possible conflicts of interest
with respect to the company or companies that are the subject of the
analysis. A conflict of interest is presumed to exist, in particular, if an
enterprise preparing a security analysis:
(a) holds more than 5 % of the share capital of the company or companies
analysed;
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securities of the company or companies in the previous 12 months;
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analysed during the last 12 months for which a compensation has been or
will be paid;
(d) is serving as a liquidity provider for the company's securities by
issuing buy and sell orders;
(e) is party to an agreement with the company or companies that is the
subject of the analysis relating to the production of the recommendation;
(f) or the analyst covering the issue has other significant financial
interests with respect to the company or companies that are the subject of
this analysis, for example holding a seat on the company's boards.
In this respective analysis the following of the above-mentioned conflicts
of interests exist: none
Silvia Quandt Research GmbH, Silvia Quandt&Cie. AG, and its affiliated
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personal views of the analyst about the subject securities or issuers. No
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