Will Weak Bank Earnings Force Investors into Gold?

Early Monday, gold climbed to a three-week high as global noise continues to confuse investors.  Gold and silver both turned in strong performances last week as the US dollar came off its highs due to progress made in Europe.  Over the weekend though, Germany decided to clear the air on the bailout euphoria.

In a briefing, Steffen Seibert, chief spokesman for German Chancellor Angela Merkel, remarked that “dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled.” He added that ways to end the crisis “surely extends well into next year.”  As a result of the announcement, the dollar spiked and the Dow opened more than 100 points lower.  Surprisingly, the dollar spike did not send gold prices lower at the open.

Investors continue to turn to gold as the financial markets around the globe remain in shambles.  Last week, bank giant JP Morgan kicked off earnings with a sobering report.  Although JPM beat lowered expectations, a deeper analysis reveals that nearly 29 cents of earnings per share came from an accounting trick known as DVA, debit value adjustment.  Due to the bank’s widening credit spreads, accounting rules allow for the adjustment, because in theory a profit would be realized if the bank bought back its debt at a discount.  The DVA adjustment, which does not relate with the fundamental operations of the bank, added a whopping $1.2 billion in net income for the third quarter.  After taking the accounting-gain into consideration, JP Morgan only earned 73 cents per share, well below average estimates of 92 cents per share.

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This week, Citigroup confirmed that the JPM earnings release was the norm, rather than the exception.  Citi reported $20.8 billion in revenue and $1.23 earnings per share.  However, the third quarter revenues included nearly $2 billion of credit valuation adjustment, which added a whopping 39 cents to earnings per share.  Shares popped 6% at the open, but have given up gains as investors realize that earnings were inflated by more accounting shenanigans.  Other banks could follow suit later this week.  The WSJ reports, “Morgan Stanley is expected Wednesday to poast earnings of 30 cents a share.  While up from a 7 cent loss a year earlier, the result is likely to be bolstered by accounting gains resulting from falls in the value of the firm’s own debt.  Excluding those, Morgan’s core results could be as bad as last year’s.  Investors will also be keen for more information about Morgan’s exposure to major European countries.  Each firm is likely to argue that weak results are just part of a cyclical downturn.  But that line is wearing thin on investors who increasingly think a major shift is under way in the business of Wall Street.”  Will that shift include a move towards precious metals?

At the beginning of October, we speculated that although gold and silver have been positively correlated to equity markets, the decrease of speculative positions, as evident by the Commitment of Traders report, could return gold and silver to their safe-haven trading ways.  Monday is a perfect example of this.  The Dow heads lower while gold and silver remains relatively stable.  According to the latest COT report, speculators are still exiting gold and silver, even though prices have rebounded off recent lows.  Going forward, we expect gold and silver to regain their safe-haven status, especially as more banks report inflated earnings.

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