Why Italy's Gold Hoard Tells You the Precious Metal is...

Why Italy's Gold Hoard Tells You the Precious Metal is Ridiculously Cheap
Tuesday, 26 February 2013
Melbourne, Australia
By Greg Canavan
• Why Italy wants the good old bunga bunga times back
• The bogus idea of the risk free rate
• Plus, is history set to repeat in the silver market?
From Greg Canavan in St Kilda:

--Gold up, markets down. We haven't been able to say that in a long time. Overnight, markets tumbled on concerns over indecisive elections in Italy. The thought of Silvio Berlusconi getting back behind the wheel of the Italian government is a truly frightening one for speculators (we've given up using the word investor, it's an anachronism). It should be a frightening one for Italians too. But sometimes if you ask, you shall receive.

--Italians have had a taste of austerity, or living within their means, and they don't like it. They want Berlusconi and his bunga bunga parties back. They want good times. You can't blame them really. The battle between any society, at its core, is a battle between the forces of deflation, austerity and probity versus the forces of inflation, easy money, and profligacy. Usually, inflation and easy money emerge victorious.

--But in Europe they're trying something different. The euro, a sort of gold standard, is exerting discipline on its constituent countries. And it's working to some extent...if by working we mean getting countries' finances in order. Last year, Greece's current account narrowed by 73% to 5.6 billion euros, the lowest since it joined the Eurozone. Greek society has taken an almighty hit to achieve this result, though.

--In Italy, things are looking better...sort of. Its current account recently went into surplus. Basically, that means it has more incomings than outgoings. Judging by the current account's long term trend (see graph below), Italy is in pretty good shape. But it's the government that is the problem, not the private sector.


--Italy's government debt-to-GDP ratio is 126%. Total government debt is €2 trillion. It cost €80 billion to service that debt last year. The way debt dynamics work, if Italy can't grow faster than the interest on the debt (around 4.5% currently) the debt-to-GDP ratio gets worse.

--Austerity, then, is the only way of chipping away at the debt problem. If the government can run a budget surplus, it helps with the debt dynamics. But people don't like it when a government stops redistributing wealth in a way they've grown accustomed to, even if it really can't afford to keep doing so.

--So they yearn for old times...the times that got them into the hole in the first place...and demand the return of old, leathery, charismatic rogues like Berlusconi. Talk about a rock and a hard place!

--What the Italians are really asking for is their currency, the lira, back. Austerity is a policy requirement to stay in the 'hard' currency area of the euro. Under a lira, Italy would have monetary independence and could set for a course of inflation and 'good times', rather than deflation and austerity.

--Of course it's not as easy as that. If Italy left the euro it would need to do something about the €2 trillion government debt pile, like renege on it or convert it to lira. In which case interest rates would skyrocket and the country would lose the ability to borrow in the capital markets. Then the current account surplus would come in handy, as Italy would have to support itself.

--What about gold? According to official figures, Italy has the third largest official stash of gold in the world, a handy 2,450 tonnes. Couldn't they sell some of that to get rid of their debt? It went up last night, so it would be worth more than it was yesterday...

--Rounding up to US$1,600 an ounce, Italy's gold 'hoard' is worth a whopping US$138 billion, or €105 billion euros. Gee, they could sell all their gold and reduce their debt by...5%. No wonder Italy isn't selling an ounce. Gold is far too cheap to sell at these levels.

--At US$10,000 an ounce, Italy's official reserves would only be worth US$863.6 billion, or around €660 billion euros, which is only 33% of its government debt.

--The point is that gold is cheap at these levels. Ridiculously cheap. It may get cheaper in the short term, who knows, but the long term upside potential is enormous.