Italy: Déjà Vu All Over Again

Spinning Italy's distress into gold...

SERIOUS gold investors know that May has historically been a weak month for the price of the yellow metal, writes Frank Holmes at US Global Investors.

For the 10-year and 30-year periods, the month delivered negative returns. The general decline in enthusiasm comes before the late summer rally in anticipation of Diwali and the Indian wedding season, when gifts of gold are considered auspicious.

So in the past, the fifth month has provided an attractive buying opportunity.

This particular May, the price of gold also had to contend with a stronger US Dollar, which appreciated against the Euro as political strife in Italy spread throughout the entire continent. Priced in Euros, then, gold is performing well, having closed near a one-year high of €1125 on May 29.

Italian government bond yields surged dramatically following President Sergio Mattarella's decision to block the opposition parties' pick for economic minister, a Euroskeptic who supports Italy's exit from the Eurozone. The two-year bond in particular plunged the most since the creation of the bloc's common currency in 1999.

With no working government at the moment, it appears likely that Italy will hold another election soon, raising the odds that either the Five-Star Movement or the League – both populist, anti-establishment parties – could take control. Although at opposite ends of the political spectrum, the two parties have expressed interest in at least opening an earnest discussion on the idea of ditching the Euro.

Italy's appetite for change fits into what I see as a global trend right now. Based on what I've heard during my travels, middle class taxpayers, in the US and elsewhere, are increasingly fed up with special interests and entrenched bureaucrats. As a result, the UK elected to end its complicity with failed socialist rules and regulations from Brussels. Donald Trump, an outsider and disruptor, was recognized by American voters as the right candidate to take on the beltway party.

Similarly, it's possible that Italy could end up being next to say addio to further European Union (EU) control and take back its own economic and political destiny.

That said, the fear of another government debt crisis, similar to Greece's, has naturally rattled markets. Because Italy, the Eurozone's third-largest economy, already has the highest debt-to-GDP in the bloc after Greece, and because Five-Star and the League both support ending austerity and challenging Brussels' limits on government borrowing and spending, financials were the worst performing sector in the US market, falling close to 4.5% for the week ended May 29. The Euro Stoxx Banks Index was down 5% for the same period. Italian banks fared even worse, collapsing nearly 25% since their high in late April.

Gold is trading above $1300 an ounce again, but there could be bigger upside the more investors realize the full and global implications of Italy's political turmoil.

The country's public debt currently stands at 132% of GDP, and ratings agencies are reviewing a possible downgrade of its credit rating. Should it default on its billions of Dollars in loans, a chain reaction could quickly spread to financial markets all over the world.

This is a worst-case scenario, but it's for these reasons I think it's prudent to have a 10% weighting in gold, with 5% in physical gold and the other 5% in high-quality gold stocks, mutual funds and ETFs.