The major fundamental factors in our fair value models for the weekly metal prices were mixed this week. The major role played the outlook for US interest rates and stock markets for the precious metals.
Base metals were mixed but digested well the Chinese trade data, which showed a slower than expected increased of Chinese exports of 7.2% yoy compared with a 10% rise predicted by the consensus. Thus, the export surplus came in lower than expected at $31.6bn. Analysts reported that the import of metal was already affected by the probe of Qindao warehouses as banks are now more cautious with providing letters of credit to metal importers.
As far as US interest rates are concerned, two reports had an impact on markets. The first was a forecast revision by the chief US economist at Goldman Sachs. It took Mr. Hatzius a long time to wake up and to understand the messages, which the FOMC sent out with the quarterly short-term projections and dot charts. The message of the Fed was for quite some time that the first rate hike will take place most likely in mid-2015. But Goldman Sachs predicted against all odds that the first hike would not occur before Q1 2016. Now, also Goldman Sachs forecasts the first increase of the Fed Funds target rate for 2015. As the Fed prepared the markets for quite some time, this forecast revision should not have had any impact on markets. However, traders and analysts argued that the US stock market traded lower after the longer weekend due to the Goldman Sachs forecast revision. Another hint that the Chicago school theory financial markets are not information efficient is not worth a cent, neither an economics noble laureate.
The second report had been the minutes of the recent FOMC meeting, which were released on Wednesday. The interesting news of the minutes is that the majority intends to terminate the bond purchasing program with the October FOMC meeting. This implies that the purchases of US Treasury paper will be reduced not at the current speed of $5bn in October but by $10bn. However, ending QE3 by the end of October 2014 has also implications for the timing of the first rate hike by the Fed. Chair Mrs. Yellen stated several times that the first hike might take place about 6 month after terminating the bond purchase program. Therefore, the FOMC might decide already at the April 28 -29, 2015 FOMC meeting instead at the on at the end of June next year to increase the Fed Funds rate.
If the FOMC decides in April 2015 to hike the Fed Funds rate, then there are five more meetings scheduled were the committee could lift the key interest rate to a more normal level. Thus, also the level for the Fed Funds indicated by the dot charts of 1.25% by the end of 2015 gets more likely. However, the Fed Funds futures only price in a rate of 0.75%. From our point of view, fixed income markets are currently too optimistic for the outlook of Fed Funds by the end of next year. But adjusting expectations for the short-end will usually also have an impact on the long end of the US Treasury curve. Thus, 10yr US Treasury notes appear to be expensive at the current yield of 2.52%.
It might still take some time until the fixed income markets realize that the implied rate for the Fed Funds by the futures traded at the CME are too low compared with the signals send out by the Fed. However, once the market starts to correct its expectations, the potential impact on metal prices will be negative. On the one hand, rising US interest rates and yields increase the opportunity costs of holding metals. On the other hand, this development could reduce the attractiveness of commodity financing trades in China and thus, reduce the Chinese demand for metals used in commodity financing, which is not only limited to aluminum and copper, but also includes precious metals.
But that precious metals rose further during the past week, is the result of the “shoot first and ask later” mentality among traders and investors. On Thursday, Espirito Santo Financial Group (ESFG), which holds a stake of 25% in Portugal’s largest bank Banco Espirito Santo (BES), decided to suspend trading in its shares and bonds due to “material difficulties” at its largest shareholder Espirito Santo International (ESI), which is controlled by the Espirito Santo family. After BES shares fell by 19%, Portugal’s stock market regulator halted also trading in BES shares. Rumors swirled through markets that BES were in financial difficulties. As a result, not only the shares of BES and ESFG plunged, but it dragged also the Portuguese stock market and also other markets in Europe and the US lower. Furthermore, contagion spread also to the market for government bonds of the Eurozone. Yields on peripheral bonds jumped and Greece was only able to sell have the amount intended at an auction. The plunge of stock markets and soaring yields on peripheral Eurozone government bonds triggered a flight into save havens, which included also precious metals beside US Treasuries and German Bunds. During Thursday night, BES declared that its exposure to ESI would not put the bank at risk of running short of capital to assure investors about its financial stability.
This declaration led to a stabilization. However, according to reports published on Thursday, it should have been clear, that the problems of ESI are institution specific and not a general problem of the Portuguese banking sector in total. The flight to safe havens might support these assets for some time as investors might prefer to get more evidence that the Portuguese banking sector is not in troubles. Thus, in the short-run, the precious metals might be well supported by the safe haven status and as a mean to diversify the risk of holding equities. But the outlook for the US bond market in the medium-term indicates that the all-time high is far out of sight for gold and silver.