by Colin Cieszynski, CFA, CMT, CFTe, Chief Market Strategist, CMC Markets Q2 appears to be shaping up as a potential watershed quarter for the Eurozone. The decisions made in the next few months have the potential to make this the end of the beginning or the beginning of the end of the currency union. The election of Syriza in Greece and the dismissal of the previous establishment has shed new light on the fact that the financial crisis induced austerity measures in Greece, Spain and elsewhere have created a humanitarian crisis of persistently high unemployment and poverty not really seen in the West since the Great Depression of the 1930s. It has also become clear that the austerity programs have created a viscous circle driving some economies into the ground and leaving some countries in the Eurozone unlikely to ever be able to pay their debts unless serious changes and reforms are made on all sides. This quarter, the debt crisis that has been dragging on for years may finally come to a head with Greece running out of money and the latest extension set to run out at the end of this quarter. There are a lot off themes playing out in addition to what to do about Greece, including a battle for power between elected officials on one side and unelected bankers and bureaucrats on the other. Depending on how things go, people across Europe may start to ask the questions of just who is calling the shots in the Eurozone anyway? If the impoverished in Greece are going to be stonewalled, what about the people in other struggling parts of Europe? Is there hope for a better future for all in the Eurozone, or is it going to be all about some countries gaining at the expense of others? Greece has been the canary in the coal mine exposing cracks in the Eurozone for years. Even though it’s a small country, if it has to go out the door and leave the Euro, other, much larger countries like Spain and Italy could follow it in future. Whatever is done about or to Greece may then become the template for other countries just as the bailouts/austerity policies did a few years back. What happens this quarter could set a new ball rolling, the question is will it head toward a stronger partnership or disintegration? While negotiations over Greece may capture the main headlines, these themes may also play out in key votes over this quarter which may set the stage for bigger battles down the road. At the end of March, regional and local elections were held in France and Spain with more to come in the second quarter. Although they didn’t win, parties looking to fight the establishment, National Front and Podemos scored a substantial part of the vote making them forces to be reckoned with, not ignored. These gains do, however, suggest that Syriza could have difficulty getting much support from establishment parties in other countries worried about giving traction to populist alternatives. The UK election set for early May also could be a big turning point. Can the UK Independence Party make the same kind of headway similar parties have made in other countries? Could it become the kingmaker in a coalition government? The Conservatives have promised to hold a referendum on leaving the EU by 2017 if they win, so this vote may give an indication of how much support there is for staying in the EU and how many people want change. Another election in Greece or a referendum on Eurozone membership can’t be ruled out if negotiations go badly. With debt repayments due throughout the quarter, until things are settled one way or another Greece could be in the headlines on a regular basis. As far as trading goes, the street hates uncertainty. Any political trends or developments that suggest more uncertainty or countries taking steps toward leaving the Eurozone or the EU could depress stocks and currencies, while steps toward solidifying support for either body could boost markets. The ECB stimulus program gets rolling While the political and fiscal trend in the Eurozone remains hawkish with the prime focus still on fiscal austerity and structural reform, the monetary trend has gone increasingly dovish over the last year. After months of talking stimulus, the ECB finally launched its long awaited stimulus in March, settling €35 billion of purchases in the first two weeks and putting itself on track to purchase €60B per month. ECB President Draghi has indicated that he does not see any signs of running out of bonds to buy. This quarter, traders will be keeping an eye on the size of the ECB balance sheet to make sure that it is actually starting to grow again. The central bank had indicated plans to restore the €1 trillion it had removed from its balance sheet but for nine months it had been mainly talk with limited action. The ECB and Gold What the ECB does with its balance sheet may also have a big impact on gold in the coming quarter. The chart below shows that over the last few years, gold has followed the rise and fall of the ECB’s balance sheet and EUR more closely than the US, its traditional opponent. Source: CMC Markets In particular, note how gold completely ignored the US massive US QE3 stimulus program. Instead, gold steadily fell over the last three years while the ECB ran a stealth taper program by using weekly LTRO repayments to shrink its balance sheet. In recent months, both the ECB and the Fed balance sheets have levelled off, the US with the end of the QE3 program and the ECB showing the end of the stealth taper and baby steps toward its new QE program. Despite all the stimulus talk, to date, the ECB has not really started to grow again but gold in EUR terms has picked up indicating growing speculation that monetary help may finally be on the way. Focus Chart: EUR versus Gold The crucible where all of the political and financial forces tugging at the EU and the Eurozone comes together is in the action of the Euro versus gold. A growing ECB balance sheet may help gold to recover, while continued failure to do so could knock gold back. On the political side, any increase in uncertainty about Greece or other countries staying in the Eurozone could boost gold, while successful discussions could knock it back. By early March, EUR had become quite depressed and responded strongly and swiftly to a USD correction as speculation of an early rate liftoff in the US was unwound. Over the next three months EUR may continue to trade actively against both USD and gold. Source: CMC Markets The chart above shows that for most of the last year, both EUR and gold have been generally trending lower against USD. Since the start of 2015, however, they have increasingly been heading in different directions. The ECB’s announcement back in January that it planned to launch QE sent EUR lower and gold sharply higher. This news opened a huge performance gap between EUR and gold that has remained wide and could widen further as QE ramps up. How to trade gold against the Euro While gold is most commonly traded against the US Dollar, traders can capture the performance of the yellow metal relative to the Euro by placing two trades. Think of gold as a currency pair, XAUUSD, or the number of USD it costs to buy one ounce of gold. A long position in the gold contract can be seen as being long gold and short USD in forex terms. If one is bullish on gold relative to EUR they can: Go long the gold contract Long Gold, short USD Go short EURUSD Short EUR, long USD The short and long USD positions cancel each other out, so the end result of these two trades is that the reflect being long gold and short EUR. If one is bearish on gold relative to EUR they can: Go short the gold contract Short Gold, long USD Go long EURUSD Long EUR, short USD The short and long USD positions cancel each other out, so the end result of these two trades is that the reflect being short gold and long EUR. CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.