Deutsche Bank’s Plunge And Gold

Monday, October 3, 2016

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Last week, the shares of Deutsche Bank plunged to a record low. What does it mean for the gold market?

Deutsche Bank In The Spotlight Again

It was not a good week for Deutsche Bank (DB), as concerns about the bank’s stability took the center stage. Its shares fell below €10 in Frankfurt for the first time ever. Well, Germany’s largest bank has been facing a tough year (or even a decade, actually), as its shares declined almost 46 percent year-to-date. The chart below presents the German Chain Saw Massacre.

Chart 1: The price of the US-listed shares of the Deutsche Bank from October 2015 to September 2016.

DB’s implosion is not very surprising. We reported on the bank’s problem as early as February, pointing out that “investors are increasingly worried about the condition of Deutsche Bank”. We wrote about DB again in July, when the Brexit vote exposed the fatal conditions of the bank and the whole European banking system. We noted then that, according to the IMF, “Deutsche Bank is the largest contributor to systemic risks among the largest lenders globally” and that “Deutsche Bank is heavily exposed to the Brexit risk, as about 20 percent of its revenue reportedly comes from the UK”.

Now, the situation deteriorated in September because of a $14 billion fine proposed by the U.S. Department of Justice earlier this month for mortgage securities fraud leading up to the 2007-2009 global financial crisis. Next, press reports emerged that the German Chancellor Angela Merkel ruled out any state aid for the lender. We doubt such suggestions as DB is simply too big to fail. Deutsche Bank is the fourth largest bank in Europe and the eleventh in the world. Investors should not understate the significance of DB’s connections to the rest of the financial system. Last but not least, several hedge funds reduced exposure to the bank. As Bloomberg reported, a number of funds that clear derivatives trades with Deutsche Bank have withdrawn some excess cash and positions held at the lender. It is a clear sign of the counterparties’ rising concerns about doing business with DB.

Deutsche Bank And Gold

Initially, gold prices rose modestly as equities fell on worries over the stability of DB, but a stronger greenback capped gains. However, the stocks of the German lender rebounded later on Friday on speculation it would reach a lower settlement with the U.S. Department of Justice. According to media reports, the settlement deal would amount to $5.4 billion, well below the DOJ’s initial demand of $14 billion. In consequence, the relief in equity markets and reduced safe-haven bids pushed the price of gold down.

Conclusions

The recent market worries about DB’s condition have calmed down. If rumors of a much-lower-than-expected fine turn out to be true, this will be positive for the German lender and negative for safe-haven assets, such as gold. However, investors should not forget about the long-term prospects (and that rumors about cutting a deal with the U.S. Justice Department may be unsubstantiated). Although DB may not go bankrupt now, its default risk rose. And it should be clear that something major is wrong with DB. Its shares have been collapsing for years, hence there is something more than fears whether the bank could pay the fine. Oh, no, the real risks are more significant – it could be the exposure to Italian banks, Brexit or Chinese economy, or it could be DB’s rotten derivatives book and high leverage (at a ratio of 25 to 1). Whatever it is, it will show up one day. It goes without saying that any financial turmoil should be positive for the gold market. However, European problems would strengthen the U.S. dollar, which would cap any potential gains.

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.

Arkadiusz Sieroń is the author of Sunshine Profits’ monthly Gold Market Overview report, in which he keeps subscribers up-to-date regarding key fundamental developments affecting the gold market and helps them prepare for the major changes. Arkadiusz is a certified Investment Adviser, a long-time precious metals market enthusiast, and a Ph.D. candidate. He is also a Laureate of the 6th International Vernon Smith Prize.  You can reach Arkadiusz at Sunshine Profits’ contact page.