Italexit And Gold

Thursday, March 10, 2016

Forget Grexit or Brexit. Italexit is next. What are the economic problems of Italy…and how could they affect the gold market?

Bad Loans, Bad Loans Everywhere

Dropping out from the Eurozone or the European Union is now fashionable. Financial media reported on a Grexit (Greece), Brexit (Great Britain), Frexit (France), Spexit (Spain), Finxit (Finland), Irexit (Ireland), and Portugexit (Portugal). Now, Italian banks attracted the attention. If anyone wonders why here is the answer: in January gross bad loans at Italian banks rose further to €202.05 billion (up 9 percent from a year ago), according to new data released yesterday.

The IMF’s analysis shows that since the onset of the global financial crisis, total non-performing loans (NPLs) have more than tripled to 17 percent of total loans (as of June 2014, now it is probably higher), from just above 5 percent in 2007. It is more than four times the European average. In June 2014, Italian NPLs amounted to €333 billion, or 24 percent of Italy’s GDP (with bad debts, i.e., the worst category of NPLs, accounting for more than half of that). Moreover, in some cases, bad loans make up an alarming 30 percent of individual banks’ balance sheets. These piles of bad debts could not be ignored any longer. Last week, the ECB demanded that Banca Carige, one of the troubled lenders, present new funding and strategic plans to meet supervisory requirements. In consequence, its shares plunged 10 percent, dragging down other banks as well (Italian banking shares lost more than 25 percent of their value in the first two months of the year), which revived concerns about Italian banks.

Italexit and Gold

Generally speaking, Italian economic problems are not confined to the banking sector. It has recorded practically no productivity growth for 15 years (i.e. since it adopted the euro) while the economic growth has been sluggish. The public debt is 133 percent of the GDP, the second highest ratio in the Eurozone, just after Greece. But let’s focus on the Italian banks’ problems. What do they imply for the gold market? Well, a high NPL ratio depresses a bank’s profitability and constrains new lending. Data showed bank lending to non-financial companies fell 0.9 percent in January after a 0.7 percent drop in December. Italy is the third economy in the Eurozone, therefore, it could drag on the Eurozone’s GDP growth. A weaker Eurozone means a stronger greenback, which would not help gold, however, the yellow metal has been recently rising despite the appreciation of the U.S. dollar. On the other hand, the risk of contagion from Italy’s troubled banks could spur safe-haven demand for gold. Any financial crisis in Italy could entail far greater consequences for the Eurozone (think about fragile Spain or Portugal) that those spurred by Greece. The latter is only the 44th largest economy in the world while Italy represents the 8th largest economy in the world. The financial crisis could also have political implications, like the rise of anti-EU parties in Italy or even Italy’s exit from the Eurozone (now, it’s unlikely).

Conclusions

The modern banking was born in the 14th century in rich Italian cities, contributing to the development of the Renaissance. It is believed that the world “bank” is derived from the Italian word banco, a bench used for transactions by bankers. Now, it seems that the heirs of the powerful House of Medici forgot how to run a bank. Several years after the end of the global financial crisis, Italian banks are still full of non-performing loans. It seems that the piles of bad debts are so high that they cannot be ignored any longer. Will the Eurozone’s financial problems ever end? The risk of contagion from Italian banks poses another threat to the already fragile Eurozone, or even the world’s financial system. In such a scenario, gold should gain, however, it would have to compete with the U.S. dollar to attract safe-haven bids.

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.