By David and Eric Coffin
We are extremely comfortable that our prognosticating for 2012 may or may not work out. Which puts us in the same camp as most others. That said, a contrarian turn ahead of possible normalizing of the debt issues still with us that we suggested in December does seem to be gaining ground in the market. With that should come a greater focus on basic technical indicators like metal stockpile changes. Don’t get hung up on day to day changes. Both bull and bear issues in this market are really year to year, which means looking for value and for sustainability.
This month we review a gold juniors merger in the making. It involves two Canadian focused explorers we have mentioned in the past, and which we put in the same room for reasons outlined in the review. We are in an environment of high metal pricing,by historic standards, but weak risk appetite. Combinations like this that pool talent in a busy sector plus complimentary assets may become more common. They can lower risk in even early phase stories.
Generally speaking, we are a little less cautious and a little more optimistic. At a minimum, we expect gains to be more notable gains later in the year.
2012 has started out stronger than many were predicting. Granted, the year is only two weeks old but some bullets have already been dodged. Some credit for this should go to new ECB head Mario Draghi. He's been a calm hand on the tiller so far.
The European Central Bank operates under many policy constraints. Germany's Bundesbank had heavy influence over the ECB's core mandate and it’s a Teutonic one indeed with inflation control and price stability as its sole remit.
Former ECB head Jean Claude Trichet followed the mandate closely until last year when he became more proactive. Trichet still stuck to the script but became more creative in interpreting it. His frustration with the Euro political class also became more evident as he neared the end of his tenure.
Trichet was ahead of the curve in raising interest rates twice and too slow to reverse the increases but he recognized the danger of a liquidity crunch in the banking sector. Opening the lending window when he did in 2009 gave the Eurozone banking sector some breathing room. Unfortunately, that respite wasn’t taken advantage of to clean up balance sheets in any meaningful way.
Draghi took over the ECB on November 1 and started to make changes quickly. The first ECB governing meeting after he started the job marked the first cut in ECB rates in two years. The real impact of the rate cut was psychological. The message was sent that the new head of Europe’s central bank would do as much as he could while still staying within ECB mandate.
Draghi has generally agreed with the party line when discussing things like Eurobonds which Germany still flatly refuses to consider. He has gotten considerably more creative when it comes to dealing with bank liquidity issues however.
In December, Draghi introduced the first three year refinancing operation for Euro area banks. The facility allowed qualified institutions (basically any Euro area bank) to borrow from the ECB at a zero interest rate for a three year term. Banks are required to put up collateral, normally holdings of sufficiently high grade sovereign bonds.
The facility was expected to total about 150-200 billion Euros. The market was shocked when the loan total came in at close to 500 billion.
Banks needed the funding. Euro area banks hold large amounts of medium term debt that has to be rolled over before the end of 2013 and many of the larger ones are being pressured to increase reserve ratios and tier one capital.
So is this the Euro version of Quantitative Easing? Not exactly, though it looks like it if you squint. Quantitative Easing is the creation of money out of thin air by a central bank for asset purchases. The ECB didn’t (and probably won’t) take that step which would directly contravene its price stability mandate. Draghi gets around that by setting up loan facilities. When banks pay the loans back in three years (assuming they do) the ECB balance sheet would shrink again.
There would and should be some monetary expansion if the banks are taking thesefunds and re-Traders treating the lending facilities as money printing are one reason for the Euro’s recent weakness.
