Improved Outlook for industrial metals

September has the reputation of being the worst month for stock markets. As equity markets are a leading indicator for economic activity, there was fear that only gold would shine and other metals would be falling. Already during the preceding month, the major burden for industrial metals was the fear that global economic growth would slow down and that the US economy would drift into a double dip recession. Even Fed chairman Bernanke admitted that the outlook for US GDP growth would be unusually uncertain. The Fed decided not to embark on its exit strategy but to keep a floor on its balance sheet, which increased the concern in the markets. The yield on the 10yr US Treasury T-Note plunged, which had been interpreted as another indication for the emergence of a double dip recession. However, September did not live up to its reputation so far. Quite the opposite, the first three trading days are promising for industrial metals.

The trigger for an improvement of sentiment had been the release of the manufacturing PMI indices. The official Chinese PMI remained above the 50 threshold in the previous month. However, the markets focus more on the Markit/HSBC PMI, which dipped below this level. This month, both indicators increased and the HSBC PMI rose from 49.4 to 51.9, which gave industrial metals a first push to the upside. In the eurozone, the PMI was revised up from its initial estimate to 55.1. In the US, the ISM manufacturing index was expected to decline by more than 2 points to 53.2 but it rose surprisingly to 56.3. We were never convinced by the arguments for a double dip recession. We argued that a reading of 60 or even above has not been sustainable in the past. The PMI indices then declined, but remained at levels, which point to further growth in the manufacturing sector.

Also the US non-farm payroll figures were a positive surprise. While I was working for Dresdner Kleinwort investment bank, one of my colleagues was the best US economist, Kevin Logan. One valuable lesson I learnt while working with him was that economists get more cautious if their forecasts were too optimistic for two consecutive times. Then their forecasts get a too pessimistic bias. This was also the case with the current US labor market report. The reports for June and July disappointed due to the lay-offs of temporary workers hired for the US census and by States due to budget constraints. However, as the Obama administration pushed through that the federal government provides funds to the states, it was likely that the forecasts for the non-farm payrolls got to pessimistic. Instead of the expected loss of 101,000 jobs, only 54,000 jobs were lost. In addition, the two preceding months had been revised up significantly.

The economic data released during the first 3 days of September demonstrate that the fears of a double dip US recession as well as a sharp slow down of Chinese GDP growth were overdone. Dr Doom got it wrong this time. We expect that figures will show that GDP growth in the US will moderate from the fast pace of the recovery, but will remain positive. In China, the authorities prevented an overheating of the economy, which might be now on a non-inflationary expansion path. Thus, the fears that demand for industrial metals would collapse are also not justified. Therefore, we expect that industrial metals are likely to rise on balance during the final four months of 2010.

The improved economic data had a negative impact on the yield of 10yr US Treasury Notes, which rose again. The recently close correlation between gold and the 10yr US T-Note future would argue that investors also take profits in gold as the risk of a new round of quantitative easing is getting less likely. However, some gold bugs might play now the inflation card despite an acceleration of inflation is far away given the low levels of capacity utilization rates. Nevertheless, we would not rule out, that gold decouples from the US T-Note futures and might advance further. But one should keep in mind, that gold is already overbought. The net long position of large speculators rose further in the week ending August 31 and is close to the peak in June. Therefore, we regard a correction still as the more likely scenario for gold.