Market Report: Option expiry and Deutsche Bank

Gold and silver drifted lower over the week, in falls which are commonly accepted to reflect prices being massaged ahead of option expiry on Comex.

Gold lost $16 to $1325, and silver, 58 cents to $19.11 in early European trade this morning (Friday). If this sort of thing happened on a regulated market in London, the regulators would be crawling all over the suspected riggers. But hey, it’s America.

Putting this behind us, we should focus on the rapidly developing banking crisis in Germany and on its impact on the US dollar. These are separate issues, but they are much intertwined.

This week, a collapse of Deutsche Bank was openly discussed in the general media, and there are signs that institutional depositors in wholesale money markets have begun to minimise their exposure. The result is that DB’s shares on Wall Street last night dropped 7% into new low ground and continued this weakness overnight (Thursday/Friday) into the Frankfurt opening in heavy volume.

A run on the bank in the wholesale markets can generally be met from DB’s own liquidity. What cannot so easily be handled is a run on the bank from retail depositors, and this will almost certainly be triggered if the share price continues to fall. Furthermore, Commerzbank, the second largest German bank, announced massive job cuts yesterday and is suspending dividend payments. Altogether, a feeling of crisis pervades the German banking system, rich in deposits from all round the Eurozone as a result of banking woes elsewhere. And this is the point: these deposits are potentially flightier than most commentators think.

The German Government will almost certainly be forced to come to the rescue, which will open the way for the Italians to take similar action, abating the banking crisis in the short-term. The likelihood that a government rescue of the banking system will be bungled is a serious possibility, adding to general uncertainty.

Meanwhile, in the money markets the swap basis between euros and dollars shows an acute relative shortage of 3-month dollar money, which so far is not being reflected in spot currency rates. The consequences for the euro, however, are certain to be negative, and it is likely to drop below chart support at EUR110 (currently 112).

This being the case, the dollar could strengthen as Europe’s banking crisis deepens, because the euro is by far the largest component of the dollar’s trade weighted index. And if that strength spills over into other dollar rates, we could see JPY rally from its current level of 100.9, and GBP fall through the 1.30 level. Combine this with the growing concerns over loss of consumer confidence in the Eurozone and elsewhere, and dollar strength could feed temporarily into lower base metal and energy prices.

These developments are neither outright bullish nor bearish for gold in the short term. A strong dollar is a mixed blessing for precious metal prices, maybe postponing the Fed’s intended increase in interest rates in December, while exerting some downward pressure on the gold price.

In a banking crisis, the first reaction is usually to secure safety for deposits, rather than a rush to buy physical gold – that might come later. However, assuming the dollar strengthens in the coming weeks by up to five per cent on its trade weighted index, the $1300 level could easily be broken on the downside, yet prices in euros, sterling and even Japanese yen could rise by two or three per cent.

I leave you with a chart of gold in these currencies so far this year to provide some context.

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