Good News from the Eurozone = Good or Bad News for Gold?

Recently, gold and the Euro have been behaving more like two peas in a pod reacting to winds from the West...

So the Eurozone Summit has started and boy have the markets been watching out for this the whole week. In summary, these were the most poignant actions taken in the Eurozone so far:

1 - Six Central Banks around the world announced that they would be working with each other to hand out loans in dollars to Eurozone banks last week;

2 - The ECB (European Central Bank) cut interest rates by a quarter percent;

3 - The ECB announced the offering of 3-year loans to the banks; and

4 - The ECB is going to come through with lowered reserve ratios.

The above four items can be translated into more STABILITY (as opposed to more liquidity). Everything seemed rather joyous at this point and the Euro even rallied. But then some awful news just HAD to happen. I suppose it's kind of like a trick everyone learns by the time they hit junior high or high school. Tell your parents how hard you've been studying, how good your grades are and, heck, how young they look - then drop the bomb on them that you wrapped their luxury car around a telephone pole. The ECB President then announced that the ECB would NOT be buying bonds; and ALL of the gains made by the Euro were wiped clean. The HSBC even commented, "The gold price declines were so rapid and extensive that some investors theorized that central banks - including the Federal Reserve - were actively selling gold." Most of the other currencies then took a cue and started sinking too. Naturally, doom-and-gloom talk started festering and now there's talk that France might be getting two downgrades...

Fear not, though, because there was somewhat of a happy ending to news of the 'car accident.' Yesterday morning, Eurozone leaders announced the addition of 200 billion Euros to their EFSF (i.e., European Financial Stability Fund) and the tightening of anti-deficit rules. According to Draghi, this was a, "...very good outcome for euro-area members and it's going to be the basis for a good fiscal compact and more disciplined economic policy in euro-are countries."

So you might be wondering what this means for gold...

A few days ago, Mitch on this site blogged about how gold usually goes up when the Eurozone has good news leaning towards stability, but that this formula then reversed itself earlier last week. And he's right, but here are some more specifics. Traditionally, whenever the Euro dropped, the dollar would follow suit leaving gold in center stage to shine on up. In other words, a more inverse correlation between the Euro and gold, which seemed more applicable early last week. But more recently, gold has become an 'offset' to the dollar. If the dollar starts to look bullish, then that puts BOTH the Euro and gold at risk. In other words, the way I like to see it, is that gold will tend to have a direct correlation with the Euro and a negative/inverse correlation to the dollar. Early last week, on Sunday, when gold seemed to drop after slightly good news came out of the Eurozone, if you took a look at the dollar's close on the Friday before that, you'll notice that it rose $0.25. Interesting eh?

Even further I think that BOTH gold and the euro rely MORE heavily on what the DOLLAR is doing - and so that is where I'll be keeping an even closer eye.

Up next, we need to watch for whether the S&P will downgrade the AAA Eurozone members and if so, we could see some more volatile action in the Euro...

Keep up the good fight,

- Patton