HH How The Eurozone Affects Gold, And Why You Should Care

Having said that, let’s take a look at the market from a more fundamental angle.

The Widening Economic Divergence

For weeks, I’ve been highlighting the economic malaise confronting the Eurozone. And like a fork in the road, the U.S. and Europe continue to head in opposite directions. More importantly, though, the fundamental fate of the two regions, and the subsequent performance of the EUR/USD, will go a long way in determining the precious metals’ destiny.

Figure 5

If you analyze the chart above, you can see that gold and silver tend to track the performance of the EUR/USD. And while gold bucked the trend on Tuesday (Jan. 26), silver still remains a loyal follower. Thus, as the European economy sinks further into quicksand, its relative underperformance is likely to pressure the EUR/USD and usher the PMs lower.

On Friday (Jan. 22), the IHS Markit Eurozone Composite PMI fell to 47.5 in January (down from 49.1 in December), with services falling to 45.0 (from 46.4) and manufacturing falling to 54.7 (from 55.2).

Please see below:

Figure 6

To explain, PMI (Purchasing Managers’ Index) data is compiled through a monthly survey of executives at more than 400 companies. A PMI above 50 indicates business conditions are expanding, while a PMI below 50 indicates that business conditions are contracting (the scale on the left side of the chart).

In contrast to the Eurozone, the U.S. Composite PMI rose to 58 in January (up from 55.3 in December), with services rising to 57.5 (up from 54.8) and manufacturing rising to 59.1 (up from 57.1).

Figure 7

In addition, after European Central Bank (ECB) President Christine Lagarde revealed (on Jan. 21) that the Eurozone economy likely shrank in the fourth-quarter (all but sealing a double-dip recession), Germany (the Eurozone’s largest economy) cut its 2021 GDP growth forecast from 4.4% to 3.0%.

And not looking any better, the International Monetary Fund’s (IMF) World Economic Outlook Report – which covers IMF economists' analysis over the short and medium-term – has the U.S. economy expanding by 5.1% in 2021 versus only 4.2% for the Eurozone. More importantly though, the Eurozone economy is expected to contract by 7.2% in 2020 versus 3.4% for the U.S. As a result, Europe has to dig itself out of a much larger hole.

Please see below:

Figure 8

Also noteworthy, the IMF downgraded its GDP growth forecast for Canada. And because the USD/CAD accounts for more than 9% of the movement in the USD Index (though still well below the nearly 58% derived from the EUR/USD) it’s an important variable to monitor.

Continuing the theme of Eurozone underperformance, U.S. consumer confidence (released on Jan. 26) rose from 87.1 in December (revised) to 89.3 in January (the red box below).

Figure 9 - Source: Bloomberg/ Daniel Lacalle

In contrast, Eurozone consumer confidence (released on Jan. 21) retreated in January. And while both regions’ readings are still well below pre-pandemic levels, currencies trade on a relative basis. As a result, the relative underperformance of the Eurozone is bearish for the EUR/USD.

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Disclaimer: All essays, research, and information found on the Website represent the analyses and opinions of Mr. Radomski and Sunshine Profits' associates only. As such, it may prove wrong ...

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Monica Kingsley 2 months ago Contributor's comment

I am not really sharing such a bearish $GOLD and GDX view, and in my today's stocks and gold analysis, I lay out why